Impact of Macroeconomic and Bank specific variables on Credit Risk in Pakistan: A Comparative Analysis of Islamic and Conventional Banks

Abstract

This study intends to investigate the impact of macroeconomic variables and bank specific variables on the credit risk in the banking sector of Pakistan. The effect has been evaluated for 4 Islamic banks and 13 for the conventional banks for 2008-2018. The study assessed the dynamic panel model using the GMM to classify the factors that control the extent of the credit risk. Outcomes of the study suggest that in the conventional banking system, GDP growth, unemployment, loan loss provision, inflation, real exchange rate, interest rate, capital adequacy ratio, return on assets, inefficiency ratio, and the bank size significantly affect the behavior of the credit risk. By contrast, in Islamic banks, all above mentioned variables are significant except financing loss provision and the interest rate. Therefore, to achieve a much more reliable banking system, the Government should establish prudent macroeconomics policies. In addition to that, taking into account the current economic condition, the high-level financial institutions should also consider the internal composition of the institutions to reduce the possibility of credit risk.