Exploring the role of risk and corruption on bank stability: evidence from Pakistan

DOIhttps://doi.org/10.1108/JMLC-03-2018-0019
Date07 May 2019
Pages270-288
Published date07 May 2019
AuthorMuhammad Ali,Amna Sohail,Lubna Khan,Chin-Hong Puah
Exploring the role of risk and
corruption on bank stability:
evidence from Pakistan
Muhammad Ali,Amna Sohail and Lubna Khan
Department ofBusiness Administration,Iqra University, Karachi, Pakistan, and
Chin-Hong Puah
Department of Economics, Faculty of Economics and Business,
Universiti Malaysia Sarawak, Kota Samarahan, Malaysia
Abstract
Purpose This paper aimsto explore the impact of liquidity risk, credit risk, fundingrisk and corruption on
bank stabilityof the banking system in Pakistan.
Design/methodology/approach The empirical analysisis conned to 24 retail banks, which include 5
Islamic and19 conventional banks during the period of 2007-2015.
Findings The ndings of this study suggest thatbank size, liquidity risk, funding risk and corruption
exert a positive impacton bank stability. Additionally, the authors nd a negativerelationship between credit
risk and bank stability.
Originality/value As per the knowledge of the authors, the present research is the rst attempt that
discussesthe issues of bank stability related to risk and corruption faced by the banking system.
Keywords Liquidity risk, Corruption, Credit risk, Bank stability, Funding risk
Paper type Research paper
1. Introduction
Bank stability relates as a situation where the nancial intermediation offered by the
banking sector worksefciently and continues without any disturbance despite any internal
or external shock. According to the State Bank of Pakistan (SBP), nancial stability is a
gradual process, and it depends on the ability of the bankingsector to understand the needs
of the economy. A stable banking systemhas several implications such as, enhancement of
economic growth, efcient nancial intermediation, public well-being, investment patterns,
competition and others. Banking sector stability also stems the condence of economic
agents in the nancial system. In general, the state bankof a country primarily administers
the soundness of nancial sector that ultimately playsa signicant role in determining the
growth and developmentof the bankingsector.
Moreover, commercial banks are closely associated with business models, consumer
operations and other economic activities. It includes monthly salaries, deposit mobilization,
consumer nance and borrowing money for consumption or investment purpose. In this
context, past studies have highlighted the role of the banking sector to predict efcient
businessenvironment (Beck and Levine, 2004;Wilhelm, 2002). Similarly, an efcient banking
system is also necessary for the businessesdue to their involvement in banking transactions.
On the same vein, Da Rin and Hellmann (2002) state that the banking sector has key role to
strengthen industrialization in the developing economies. However, the instability in the
bankingsector can cause large disruptionin the society and economicgrowth.
JMLC
22,2
270
Journalof Money Laundering
Control
Vol.22 No. 2, 2019
pp. 270-288
© Emerald Publishing Limited
1368-5201
DOI 10.1108/JMLC-03-2018-0019
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/1368-5201.htm
In Pakistan, the regulatory structure of the nancial intermediaries can broadly be
classied into commercial banks and non-banking nancial institutions (NBFIs). The
commercial banks in Pakistan are furthercategorized into conventional banks (that provide
conventional nancial instruments) and Islamic Banks (that provide Shariah-compliant
nancial products). Additionally, Islamic banking has shown substantial growth in the
presence of the stable conventional banking system. With deeply grounded roots of the
conventional banking system, the Islamic banking system has also shown substantial
growth. This rapid growth in the Islamicbanking industry is facilitated by certain reasons.
First, this industry has attained a considerable amount of attention in the country,
particularly by the Muslim community. Second, Islamic banks proved themselves to be
more resilient during and after the nancial crisis.According to Hasan and Dridi (2010), the
higher performance of Islamic banks during an economic recession is due to its nature of
Islamicity of the products. Additionally, Islamic banks follow Islamic laws and offer asset-
based nancing. A robust growth has been experienced in the IslamicBanking industry in
Pakistan. Recent facts indicatethat the total assets of Islamic banks have increased by 14.4
per cent, while conventional banksassetgrew by 5.9 per cent. Similarly, total nancing for
Islamic banks has experienced a growth of 6.2 per cent, but conventional banksnancing
growth has declined by 4.7 per cent. In sum, it is necessary to understand the issues related
to nancial stabilitythat help policymakers to promote competitivebusiness environment.
On the other side, a widespread of corruption has made some difculties to accomplish
this task. Corruption is one of the greatest challenges faced by the developing countries. In
recent times, the poor governance and increase level of corruption opens a forum to discuss
the relationship between corruption and banking performance. Mauro (1995) and Park
(2012) conclude that bad governance and misuse of public ofce reduce bank asset quality
and level of investment. The term corruptionisbroadly dened as the misuse of the public
ofce for private gain, bribery, money laundering, double dealing, under the table
transactions and the illegal nancial activities. Corruption substantially undermines the
broader efforts of efcient allocation of resources. It also effect the poverty reduction and
economic growth process (Treisman,2000). In Pakistan, the government has established an
anti-corruption unit, namely,the National Accountability Bureau (NAB) to combat all levels
of corruption. The prime role NAB is to eradicate corruption from the society by spreading
awareness to the general masses, law enforcement and taking preventive measuresagainst
corruption. This unit has taken some serious actions against the corruption, but the
situation still needs time to decrease the level of corruption. Additionally, an international
agency Transparency Internationaldenes an index for all countries that shows corruption
perception prevail in the country. According to the Corruption Perception Index (CPI)
statistics issued by TransparencyInternational in 2015, Pakistan was ranked 116 outof 176
countries with a score of 30. This show that the level of corruption has increased in the
country. Although, the Governmentof Pakistan has shown serious concerns to eliminate the
corruption from society. But, thereis still a need to understand the reasons of corruption in
Pakistan. Figure 1 represents the corruptionperception scores for Pakistan during the year
2001-2015.
Past literature report that the corruption has an adverse impact on the business
environment. According to Swaleheen (2008), corruption reduces the incentives to save,
thereby reducing the overall saving rate in the economy and exerts a negativeeffect on the
banking performance. According to Weill (2011), bank lending is extremely inuenced by
corruption in Russia, whileits harmful effects decline private borrowing as compared to the
government borrowings. By the same token, Park (2012) also argued that corruption not
only undermines economic growthbut also impedes the performance of the banking sector.
Role of risk
and corruption
271

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