Examining the Impact of Credit Risk, Liquidity Risk and Operational Efficiency on Bank Profitability: The Moderating Role of Capital Structure in Pakistan

Abstract

This study investigates the determinants of bank profitability in Pakistan, focusing on the direct effects of credit risk (non-performing loans ratio, NPL), liquidity risk (loan-to-deposit ratio, LDR), and operational efficiency (operating expenses to operating income ratio, BOPO), while examining the moderating role of capital structure (debt-to-total assets ratio, DTA). It addresses gaps in the Pakistani banking literature, where evidence on risk-profitability relationships remains mixed and few studies jointly analyze these factors with capital structure moderation. A deductive, quantitative approach was employed, utilizing secondary panel data from 16 commercial banks listed on the Pakistan Stock Exchange over a 15-year period (2010–2024). Data was analyzed using Stata 17. The Hausman specification test was conducted, which supported the use of a random effects panel regression model for estimation. The results reveal significant negative impacts of credit risk, liquidity risk, and operational inefficiency on profitability (ROA). Capital structure significantly moderates these relationships: it amplifies the adverse effect of operational inefficiency but weakens the negative impact of credit risk on profitability. The model is statistically significant (p < 0.01) with an overall explanatory power of 62.7% (R-squared = 0.627). The findings highlight the critical importance of integrated risk management and cost efficiency for sustaining bank profitability in Pakistan. For bank managers, the study underscores that leverage decisions must be carefully balanced with operational controls. For regulators, including the State Bank of Pakistan, the results suggest that supervisory frameworks should consider the conditional role of capital structure, advocating for policies that promote both prudent leverage and enhanced operational efficiency.