Investigating the Nonlinear Relationship Between Liquidity Risk and Bank Profitability in Iran

Articles in Press

Document Type : Original Article

Authors

Esmaeil Bayza ¹

Sakineh Sojoodi ²

hosein asgharpur ghorchi ¹

¹ Department of Economics, Faculty of Economics and Management, University of Tabriz, Tabriz, Iran

² University of Tabriz

https://doi.org/10.22067/mfe.2026.96770.1646

Abstract

Bank profitability is one of the key indicators of the soundness and resilience of the banking system, playing an important role in capital strengthening, shock absorption, and the continuity of financing for the economy. This study examines the non-linear effect of liquidity risk on the profitability of Iranian commercial banks. To this end, panel data for 12 banks listed on the Tehran Stock Exchange over the period 1382–1401 (2003–2022) are compiled, and return on assets (ROA) is used as the profitability measure. Liquidity risk is proxied by the ratio of total loans to total assets. In addition, credit risk, first differences of income diversification, the ratio of administrative expenses to assets, and bank size are included as control variables. After confirming cross-sectional dependence and applying the second-generation CIPS unit root test, the Panel Smooth Transition Regression (PSTR) model is employed to test for non-linearity. Linearity tests indicate that a simple linear specification cannot capture the behavior of liquidity risk, while a PSTR model with two thresholds and three regimes based on bank size provides a better fit. The results show that the effect of liquidity risk on profitability is negative and statistically significant for small and large banks, but positive for medium-sized banks; in other words, there exists an intermediate level of liquidity risk at which a more active use of liquidity capacity translates into higher profitability. Credit risk reduces ROA across all regimes, whereas changes in income diversification play a limited, mainly control role. Overall, the findings imply that prudential policies and liquidity risk management should be tailored to bank size, alongside simultaneous control of credit risk, to sustain bank profitability in Iran.

Keywords

Liquidity risk

Bank profitability

Panel Smooth Transition Regression (PSTR)

Bank size

Subjects

• Money Banking

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