Exploring the interplay of credit and liquidity risks: Impacts on banks’ profitability

Abstract

This research delves into the intricate relationship between credit and liquidity risks and their far-reaching consequences on the overall profitability of banks. Leveraging a comprehensive dataset comprising 132 observations across twelve distinct financial institutions, spanning the period from 2009 to 2019, the analysis employs a sophisticated empirical framework grounded in simultaneous equations. By incorporating three meticulously chosen control variables, this approach adeptly disentangles the distinct effects of credit and liquidity risks on banks’ financial performance. The methodological trajectory unfolds in a sequential manner, commencing with isolated scrutiny of the individual impacts of credit and liquidity risks on banks’ profitability. This evaluation is gauged through robust metrics such as Returns on Assets and Economics. Subsequently, a nuanced exploration ensues, probing the intricate interplay between these two risks and their combined effect on banks’ profitability. Eminent findings emerge from this investigation, underscoring the adverse consequences of escalated credit risk on bank liquidity, accompanied by a simultaneous elevation in overall risk exposure. This disturbing trend notably casts a substantial shadow over banks’ profitability. Conclusively, this study consistently establishes the detrimental impact of the confluence of credit and liquidity risks on the financial well-being of banks. Evidently, this interaction exerts a negative influence on banks’ profitability, a perspective persistently reinforced by the authors’ analyses. The insights garnered from this study hold notable implications for the banking community and financial practitioners. By enhancing comprehension of the distinct attributes of credit and liquidity risks, this research contributes to a refined understanding of risk management dynamics. Moreover, it accentuates the urgency of fortifying the holistic management of liquidity-credit risks, a call to action that resonates deeply with both bankers and financiers seeking to navigate the intricate terrain of contemporary financial landscapes.