Explainable AI in Financial Forecasting: Balancing Predictive Accuracy and Economic Interpretability

Abstract

This study examines the impact of Basel III banking reforms on the financial performance and stability of the banking sector in Pakistan. The study focuses on key Basel III regulatory indicators, including the Capital Adequacy Ratio and Leverage Ratio, and evaluates their association with financial performance and stability indicators such as Return on Equity, Return on Assets, Earnings per Share, Non-Performing Loans and Z-Score. A quantitative research approach is adopted using secondary panel data from selected commercial banks operating in Pakistan. The data are analysed using descriptive statistics, correlation analysis, fixed- and random-effect models, and the Hausman specification test. The fixed effect model indicates that bank-specific characteristics significantly influence the relationship between Basel III reforms and banking outcomes. The findings suggest that Basel III reforms have a meaningful role in strengthening capital adequacy, improving risk management and supporting banking sector stability, although their effect on profitability is mixed. The study provides useful implications for regulators, policymakers and banking institutions in Pakistan.

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