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This study aims to analyze the imbalances in the public finance structure of Pakistan’s economy and highlight the need for comprehensive reforms. Specifically, it aims to contribute to the empirical literature by analyzing the relationship between fiscal vulnerability, financial stress and macroeconomic policies in Pakistan’s economy between 1971 and 2020.

The study develops an index of fiscal vulnerability, an index of financial stress and an index of macroeconomic policies. The fiscal vulnerability index is based on the patterns of fiscal indicators resulting from past trends of the selected variables in Pakistan’s economy. The financial stress in Pakistan is caused from the financial disorders that are acknowledged in the composite index, which is based on variables with the potential to indicate periods of stress stemming from the foreign exchange market, the securities market and the monetary policy components. The macroeconomic policies index is developed to analyze the mechanism through which fiscal vulnerability and financial stress have influenced macroeconomic policies in Pakistan. The causal association between fiscal vulnerability, financial stress and macroeconomic policies is analyzed using the auto-regressive distributive lags approach.

There exists a long-run relationship between the three indices, and a bi-directional causality between fiscal vulnerability and macroeconomic policies.

This study contributes to the development of a fiscal monitoring mechanism, which has the basic purpose of analyzing the refinancing risk of public liabilities. Moreover, it focuses on fiscal vulnerability from a macroeconomic perspective. The study tries to develop a framework to assess fiscal vulnerability in light of “The Risk Octagon” theory, which focuses on three risk components: fiscal variables, macroeconomic-disruption-associated shocks and non-fiscal country-specific variables. The initial contribution of this work to the literature is to develop a framework (a fiscal vulnerability index, financial stress index and macroeconomic policies index) for effective and result-oriented macro-fiscal surveillance. Moreover, empirical literature emphasized and advised developing countries to develop their own capacity mechanisms to assess their fiscal vulnerability in light of the IMF guidelines regarding vulnerability assessments. This study thus attempts to fulfill the said gap identified in literature.

This study aims to investigate the impact of liquidity creation (LC) on the profitability and stability of banks while considering the moderating role of corruption.

Panel data from 23 conventional banks and five Islamic banks in Pakistan spanning from 2008 to 2021 were used for analysis. The study used fixed effect and random effect models, along with the generalized method of moments estimation to ensure robustness of the results.

The study reveals a negative relationship between LC and banking profitability, but a positive association with banking stability. Additionally, corruption is found to play a moderating role in the relationship between LC, profitability and stability in the banking sector of Pakistan.

The findings have practical implications for bank managers and investors, emphasizing the negative relationship between LC and profitability in Pakistan. Moreover, the study highlights the significant impact of corruption on bank performance, which can guide policymakers in formulating strategies to strengthen the banking sector and prevent financial turmoil in the future.

This study makes a significant contribution to the existing literature by examining the moderating role of corruption in the relationship between LC, profitability and stability in both conventional and Islamic banks.

The paper aims to test the effect of liquidity creation on profitability and stability with the moderating role of political instability and its level of implication on the overall banking sector of Pakistan.

This study uses the panel data estimation technique, including fixed- and random-effect model, by taking sample data of 28 banks of Pakistan that are providing their services from 2006 to 2019. Moreover, this study uses the Genreralized Method of Moments (GMM) estimation technique to check the robustness of the results.

The empirical outcomes of this study found a negative relationship of liquidity creation with profitability meanwhile positive relation with banking stability. However, this study shows a negative relation of political instability with liquidity creation, profitability and stability of overall banks of Pakistan.

The findings of this paper recommended the vital role of liquidity creation in the profitability and stability of banks, especially in the decision-making process of the investors and bank managers, and how it is affected strongly in the presence of an unstable political situation. These findings may be helpful for policymakers to devise appropriate policies to maintain a fair field between state authority and financial institutions and also assist in formulating strategies to strengthen the banking sector of Pakistan to avoid financial turmoil in the future.

As per the knowledge of the authors, this study is the first contribution to examine the moderating effect of political instability on liquidity creation, profitability and stability of the overall banking sector of Pakistan.