Venturing into Risk Management: Examining Credit Risk and Performance in Pakistani Commercial Banks through Panel VAR Analysis from a Business Perspective

Abstract

In Pakistan's dynamic financial sector, effective credit risk management by commercial banks is critical to maintaining financial stability. In this study, we embarked on a unique and comprehensive journey, adopting the Panel Vector Autoregressive (PVAR) analysis, a novel methodology in this context. This approach allowed us to delve into the intricate relationship between credit risk management strategies and the aggregate business performance of commercial banks. The data used in this study spans from 2010Q1 to 2022Q4, investigating the comprehensive nexus of credit risk and macroeconomic indicators using a large dataset encompassing 18 strategically critical commercial banks of Pakistan. Our study uncovers several profound insights, documenting a remarkable increase in credit risk upon increases in the interest rate. The repercussions of the non-performing loans are observed nearly two years after the successive phases of a stern posture of monetary policy have been implemented. Our research findings carry significant weight for the banking industry. We discovered that the levels of credit risk could be reined in due to the protective shield offered by phases of sudden economic booms. This underscores the reinforcing effect of the improving economic conditions on defaults of loans, providing practical and actionable insights for credit risk management strategies.