Modelling liquidity management in Islamic banks from a microeconomic perspective

The main objective of this paper is to examine the determinants of banking liquidity by explicitly integrating Islamic financial intermediation into a standard microeconomic model. Our model includes the banks’ liquidity reserves in line with profit-maximization motives and provides an analytical framework for interpreting the excess liquidity behavior commonly seen in the Islamic banking sector. Excess reserves result from an increase in a bank's deposits base combined with Islamic banks’ limited opportunities for financing and placement. The monetary policy rate appears to be a key instrument that central banks can use to resolve the problem of excess reserves.