Can fiscal rules improve banking system stability in developing countries?

This paper investigates the impact of fiscal rule adoption on banking system stability in developing countries. Using a panel of 62 developing economies over the period 1990–2020, we assess whether adopting a fiscal rule contributes to reducing the level of bank nonperforming loans, a key indicator of banking vulnerability. The analysis relies on entropy balancing to ensure covariates balance between treated and control groups. Results indicate that the adoption of fiscal rules significantly reduces the ratio of nonperforming loans, with an average treatment effect of approximately 0.85 percentage points. The study identifies multiple transmission channels—sovereign credit ratings, income inequality reduction, and macroeconomic stabilization—through which fiscal rules strengthen banking stability. Heterogeneity analysis reveals that the effect varies by the type and duration of the rule and by structural financial characteristics. This research contributes to the literature by extending the role of fiscal rules beyond debt and deficit control, framing them as institutional anchors for financial stability in fiscally and economically vulnerable contexts.