The nexus between credit risk and liquidity risk and their impact on banks financial performance: Evidence from Pakistan

Abstract

Risk management became an important dilemma in the banking literature and has gained consideration since the financial crisis of 2007-08 which brought numerous challenges for most organizations. More than 325 banks’ failure were reported in the United States during the worldwide financial crisis. The high number of banks failures needs to evaluate the risk management efficiency of banking institutions of Pakistan. In this study, we used the PVAR model and Simultaneous equation approach to examine the link between Liquidity Risk and Credit Risk and its influence on banks’ performance working in Pakistan. The panel data was collected from 33 banking institutions between the period 2008 - 2018. The results revealed that Credit Risk and Liquidity Risk are not interrelated with each other. However, the two risks independently influence the banks’ performance and their relative interaction plays a major role in the instability of the banking sector. The finding forms the foundation for recent regulatory exertions to better understand the two types of risks and to strengthen the joint management of both Liquidity Risk and Credit Risk.