The Effect of Credit, and Liquidity Risk, along with Capital Adequacy and Audit Quality on Bank's Financial Stability : a Comparative Study between Islamic and Conventional Banks of Pakistan

This paper aims to investigate how credit risk, liquidity risk, capital adequacy ratio, and audit quality affect a bank's stability both separately and in combination, and then compare the resulting banking stability between Islamic and commercial banks in Pakistan, while also taking into account the phenomenal growth of Islamic banking and its potential future effects. The results show that there are no economically significant reciprocal momentary or time-lag associations between the capital adequacy ratio and audit quality, not with credit risk or liquidity risk, nor between these two risk categories. Additionally, each risk category along with CAR and audit quality has an impact individually on banking stability. Furthermore, the results suggested that CAR, loan asset, and ROA seems to have a significant and positive effect on banks' stability. Whereas, liquidity GAP seems to have a negative impact. In addition, Islamic banks' stability also seems to be positively affected by Liquidity risk, audit quality, and inflation, whereas bank size seems to positively impact conventional banks' stability. In Addition, conventional banks seem to be negatively impacted by ROE, and credit risk. For Islamic banks, Liquidity risk, audit quality, and inflation seem to have a significant and positive effect on banks' stability. Moreover, there seems to be positive complementarity between credit, liquidity risk, audit quality, and CAR in explaining stability for conventional banks, On the contrary, complementarities are negative in the case of Islamic banks. We discovered that the four factors — two risks, CAR, and audit quality — when taken collectively had a significant impact on banking stability. We also conclude that, in comparison to Pakistan's conventional banks, Islamic banks are more stable and less likely to go bankrupt due to these risk factors