Examining the effect of liquidity creation on banking profitability and stability: moderating role of political instability

Abstract

PurposeThe paper aims to test the effect of liquidity creation on profitability and stability with the moderating role of political instability and its level of implication on the overall banking sector of Pakistan.Design/methodology/approachThis study uses the panel data estimation technique, including fixed- and random-effect model, by taking sample data of 28 banks of Pakistan that are providing their services from 2006 to 2019. Moreover, this study uses the Genreralized Method of Moments (GMM) estimation technique to check the robustness of the results.FindingsThe empirical outcomes of this study found a negative relationship of liquidity creation with profitability meanwhile positive relation with banking stability. However, this study shows a negative relation of political instability with liquidity creation, profitability and stability of overall banks of Pakistan.Practical implicationsThe findings of this paper recommended the vital role of liquidity creation in the profitability and stability of banks, especially in the decision-making process of the investors and bank managers, and how it is affected strongly in the presence of an unstable political situation. These findings may be helpful for policymakers to devise appropriate policies to maintain a fair field between state authority and financial institutions and also assist in formulating strategies to strengthen the banking sector of Pakistan to avoid financial turmoil in the future.Originality/valueAs per the knowledge of the authors, this study is the first contribution to examine the moderating effect of political instability on liquidity creation, profitability and stability of the overall banking sector of Pakistan.