Impact of Internal and Macroeconomic Risks on Financial Performance, Growth, and Stability of Domestic and Foreign Banks in Pakistan

Abstract

The current study aims to scrutinize and compare the effects of internal and macroeconomic risks taken by foreign and domestic banks in Pakistan on their financial performance, growth, and stability. It also compares the substantial impact of both types of risks between foreign and domestic (both Islamic and conventional) banks. Internal risks include liquidity risk, operational risk, credit risk, and capital risk, whereas macroeconomic risks include exchange rate risk, interest rate risk, and inflation rate risk. Using a two-step system GMM with the collapse command, a sample of commercial banks including both Islamic and conventional banks was analyzed over the period 2008-2020. Based on the results, it was determined that both types of banks experience negative exposure to both macroeconomic and internal risks, affecting their financial performance, growth, and stability. However, the impact of both categories of risks was found to be more substantial in the case of domestic banks. Moreover, the results also hold true for both Islamic and conventional banks. The findings recommend that both domestic and foreign Islamic banks are more competent in the practices of risk management, as compared to domestic and foreign conventional banks. The current study has implications for investors, bank management, policymakers, and regulators. In particular, domestic conventional banks should prioritize to enhance their cost management, granting and monitoring of credit, and risk diversification, as well as upgrading their human and technological capital.