ABSTRACT
Background: There is a raging debate on how the COVID-19 pandemic disrupted the financial market environments, affected the banks’ strength as the credit channel, and the nexus between market liquidity and credit risk. During the COVID-19 crisis in the banking sector, credit risk and liquidity risk cannot be ignored as they have a considerable bearing on the performance and survival of banks.Purpose: Within the context of COVID-19, bank-specific and external factors were examined to determine the relationship between liquidity and the credit risk of South African domiciled banks.Research methodology: Quarterly panel data from 13 South African domiciled banks from 2018 to 2021 were examined using panel data methodologies: fixed effects and the system GMM.Results: In an analysis of the period between 2019Q1 to 2021Q1 the results suggest a positive relationship between liquidity and credit risk, the COVID-19 pandemic was found to have an implication on the nexus as the COVID-19 dummy variable was significant. Also, the results show that liquidity deteriorated with an increase in COVID-19 cases during the pandemic period. During the Pre-COVID-19 liquidity improved with a decrease in credit risk. Nevertheless, during COVID-19 liquidity was not influenced by credit risk. The results are contrary to the pre-COVID-19 period as the government interventions to support households and non-financial firms could have changed the dynamics of liquidity and loan losses.Novelty: The pandemic has ushered in a novel set of responses whose lasting impacts are not yet certain. The originality of the article lies in the nature of the investigation, where the nexus between liquidity and credit risk under the COVID-19 shocks/pandemic set-up. This is a unique study as the study revealed that policymakers and researchers alike should pay particular attention to the vulnerabilities to shocks from within and outside of the financial system as COVID-19 was found to significantly affect liquidity and credit risk. Since the pandemic is still active, further research is necessary to examine the cointegrating and causal relationship in the long run.