The Role of Islamic Banks in the Transmission of Liquidity Shocks Across Countries

We study the international transmission of bank liquidity shocks from multinational, Islamic, bank-holding companies to their subsidiaries. Based on a total sample of 120 Islamic and conventional bank subsidiaries, we test whether foreign bank lending for Islamic and conventional banks is determined by different factors. We estimate a model that includes subsidiary and parent bank characteristics as well as host and home country variables. Our empirical findings show that lending is negatively affected by the fragility of conventional parent banks' subsidiaries. Nevertheless, we show that parent Islamic banks do not significantly affect lending by subsidiaries. Finally, we examine the market discipline regarding the transmission of liquidity shocks. We also find that reduction in foreign Islamic bank lending is stronger for those that are dependent on the interbank market. We establish that the depositors react to a deterioration of bank performance and punish their institutions by withdrawing their money. We show that market discipline has a more important role for Islamic banks, whereas liquidity needs determine the change in conventional banks.