Financial Stability and Macroeconomic Environment: Evidence from Panel Data Analysis of South Asian Countries

Abstract

The main objective of current study is to develop an aggregate financial stability index (AFSI) for the financial system of South Asian economies. The index is constructed using indicators relating to financial sector development, vulnerability and soundness. The AFSI would support the monetary authorities to access the state of financial stability and to discover financial sector vulnerabilities at an early stage. Another objective of the study is to analyze the relationship between financial stability and key macroeconomic indicators using panel data analysis techniques. Long-run results estimated by applying fully modified ordinary least squares (FMOLS) and pooled mean group (PMG) estimators technique suggest that strong macroeconomic environment is necessary for systematic financial stability, particularly, high economic growth rate, trade balance and low inflation rate. Foreign direct investment is found to be beneficial in increasing financial stability in South Asian economies.