FINANCIAL LIBERALIZATION AND BANK RISK IN PAKISTAN: COMPARATIVE INSIGHTS FOR EMERGING FINANCIAL MARKETS

Abstract

This study examines how financial liberalization affects bank risk-taking in Pakistan’s dual banking system. Using data from 26 banks (2011–2020), it explores the relationship between liberalization and risk behavior, identifying market discipline and regulatory quality as key mechanisms influencing risk-taking across commercial and Islamic banks. The study uses panel data from 26 commercial and Islamic banks in Pakistan (2011–2020). Robust statistical methods are employed to analyze the relationship between liberalization and risk-taking, controlling for bank-specific factors and macroeconomic variables. A comparative assessment of commercial and Islamic banks provides deeper sector-specific insights. The study finds a negative relationship between financial liberalization and bank risk-taking, with varying effects across commercial and Islamic banks. Enhanced market discipline and improved regulatory quality are identified as mechanisms that reduce risk-taking. The results remain consistent across various risk measures, bank-specific factors, and macroeconomic controls. The study is limited by its focus on data from 26 banks in Pakistan, and the findings may not apply to other countries or banking systems. It also does not fully address all macroeconomic factors influencing risk-taking. Future studies could expand to different regions and use broader datasets for generalization. This research provides original bank-level evidence on the impact of financial liberalization on risk-taking in Pakistan’s dual banking system. Unlike earlier studies relying on aggregate data, it uses a decade-long panel framework and compares commercial and Islamic banks, offering new insights into governance and regulatory factors influencing risk-taking.