The Role of Regulation in Banking: Liquidity Risk Perspective

Abstract

The liquidity crisis in 2008 sparked interest in the role of regulation that could promote resilience and stability in the banking system. While the Public Interest theory suggests that legal policies could discipline banking activities, the Private Interest theory predicts otherwise, which impairs banking performance. The conflicting theories warrant comprehensive research, especially for Islamic banks, as they emerge to gain their systemic importance. Given this, this study examines the role of banking regulation on liquidity risk management of banks in OIC countries from 2000 to 2014. The findings suggest that restrictions on banking activities and capital requirement pose a significant impact on liquidity risk. However, the marginal effect of regulatory capital is more pronounced in conventional banks compared to Islamic banks.