Excess Liquidity Management in Islamic Banks: Shariah and Operational Challenges in Pakistan

Abstract

Purpose: Excess liquidity represents one of the most structurally entrenched challenges in Islamic banking. In Pakistan, the financing to deposit ratio of Islamic banks stands at approximately 39 percent meaning that 61 percent of available deposits are not being deployed productively. This study investigates the reasons why this gap persists, examining the structural, operational, Shariah related, and sectoral dimensions of excess liquidity management in Islamic banks of Pakistan.

Design/Methodology/Approach: This study employs a qualitative interpretivist research design and conducted twenty-five semi-structured interviews with Shariah scholars, Shariah compliance practitioners, and senior non-Shariah banking professionals, including treasury heads and product developers from major Islamic banking institutions in Pakistan. The study analyses the data using Braun and Clarke's (2006) six-phase thematic analysis framework.

Findings: This study finds that Islamic banks in Pakistan are structurally dependent on a narrow set of instruments, primarily Ijarah Sukuk and interbank placements that are insufficient in volume, tenor diversity, and market depth to efficiently absorb surplus liquidity. Second, a critical short-term liquidity gap persists due to the absence of a functioning Islamic money market and short-tenor Sukuk. Third, the systematic exclusion of Pakistan's growing service sector represents both a major driver of excess liquidity and a missed growth opportunity. Fourth, Shariah compliance functions simultaneously as a safeguard and a constraint, with a persistent gap between theoretical structuring and practical execution.

Research Limitations/Implications: This study is limited to Pakistan and uses qualitative data from 25 expert participants. Future research should focus on developing Shariah compliant short tenor instruments and service sector financing models and should examine the regulatory conditions required for establishing a functioning Islamic money market in Pakistan.

Practical Implications: The findings of this study suggested that the State Bank of Pakistan needs to expand Ijarah Sukuk issuance across shorter tenors and facilitate the development of an Islamic money market. Besides this, Islamic banks need to develop more asset-less financing structures for service sector enterprises that represent more than 50 per cent of Pakistan's GDP but are largely unserved by Islamic banks.

Originality/Value: This study provides the first practitioner-grounded qualitative investigation of excess liquidity management challenges in Islamic banks of Pakistan, drawing simultaneously on Shariah scholars, compliance professionals, and treasury practitioners. It identifies service sector exclusion as a previously under-examined structural driver of excess liquidity, and links instrument scarcity, short-term deployment gaps, and Shariah governance constraints within a single integrated analytical framework.