The rapid growth of the Islamic banking industry worldwide presents new challenges and risks that require thorough analysis and effective management. It is therefore important to consider how these banks perform core banking functions, such as liquidity creation, and the subsequent credit risk management, keeping in mind the loan portfolio concentration in various industrial sectors. This study carries out a comparative analysis of the relationship between liquidity creation and credit risk in Islamic banks and conventional banks in Pakistan and Malaysia from 2004 to 2021. Our findings indicate that liquidity creation is positively and significantly linked with credit risk. However, loan concentration moderates this relationship, reversing it to a significant negative association. The study validates these results through fixed effect, random effect, generalized least squares regressions and propensity score matching techniques. Similarly, a comparison of Islamic banks and conventional banks reveals that while creating liquidity, Islamic banks in Pakistan experience greater credit risk in both on- and off-balance-sheet transactions compared with Malaysian Islamic banks and conventional Pakistani and Malaysian banks. This outcome highlights the need for a strategic credit risk management framework to support the robust growth of domestic Islamic banks and to enhance their competitiveness in comparison with conventional banks in Pakistan and Malaysia.