This study aims to examine the role of unreal bank profits in the dynamics of key variables such as liquidity and profitability, and to explain their implications for the mechanism of money creation in the Iranian banking system. The research sample includes 21 active banks, covering the period from 2011 to 2023. Using a panel vector autoregression model, the study investigates the dynamic relationships among phantom profit, return on assets, and liquidity across two analytical scenarios: (1) based on official reported data, and (2) adjusted data informed by expert opinion. In the first scenario, results revealed, first and second lags of phantom profit having a significant positive effect on its current level (0.472 and 0.201, respectively). Furthermore, liquidity had a significant negative coefficient (−0.145) in the PP equation, indicating that increased real liquidity can suppress phantom profits. In the second scenario the hidden share of non-performing loans misclassified as performing was estimated at an average of 13.6%. After adjusting for this distortion, the coefficients of PP lags decreased and the negative effect of LIQ intensified (−0.192), indicating reduced momentum of phantom profits and a stronger restraining role for liquidity. This study clearly demonstrates that unreal profits not only undermine banking system liquidity but also erode long-term profitability. In the absence of financial reporting distortions and accounting manipulations, a considerable portion of unhealthy liquidity would not be generated. Therefore, financial transparency, structural reform in reporting practices, and intelligent supervisory mechanisms are essential prerequisites for achieving monetary stability in Iran’s economy.