Does Liquidity Risk Impact Asset Quality and Financial Stability? Evidence from Uzbekistan Commercial Banks

Abstract

This study investigates the impact of liquidity risk on asset quality and financial stability in Uzbekistan’s commercial banking sector. Using quarterly time-series data from 2016 to 2024, the study employs Ordinary Least Squares (OLS) regression with quadratic specifications to capture potential non-linear effects of liquidity. Two models are estimated to examine (i) the relationship between liquidity risk and asset quality, and (ii) the impact of liquidity risk on financial stability, proxied by net profit. The results indicate that liquidity risk does not have a statistically significant effect on asset quality, suggesting that credit performance is primarily driven by structural and macroeconomic factors rather than liquidity conditions. In contrast, the financial stability model demonstrates high explanatory power (R2 = 0.883), although individual coefficients are statistically insignificant due to severe multicollinearity among banking sector variables. The findings do not support the conventional liquidity–profitability trade-off hypothesis, as no evidence of a linear or non-linear relationship between liquidity and profitability is observed. Regulatory capital emerges as the most influential variable, indicating the importance of capital strength in supporting banking stability. This study contributes to the literature by providing novel empirical evidence from a transition economy, highlighting the limitations of isolating liquidity effects in rapidly expanding banking systems. The results suggest that in reform-oriented financial environments, banking stability is shaped more by structural growth and capital adequacy than by liquidity trade-offs, offering important implications for macroprudential policy design.