Financial stability and macroeconomic risk: an outlook from emerging economies

Financial stability or stability in the banking industry constitutes one of the core enabling conditions critical for economic growth and development among economies globally. This paper examines the impact of macroeconomic risk (instability in key macroeconomic variables) on stability in the banking industry using data from 32 countries in Sub-Saharan Africa (SSA) from 2001 to 2018. The study uses principal component analysis (PCA) constructed macroeconomic risk index and proxies financial stability by two indicators - bank liquid reserves to bank assets ratio and bank Z score respectively. Empirical estimates examining the relationships in the study uses the two-step system generalised method of moments (GMM) model. The results suggest that macroeconomic risk (instability in the macroeconomic environment) contributes significantly to instability in the banking industry among economies in Sub-Sahara Africa; this conclusion is similar for the two measures of financial stability employed in the study. The results further suggest that trade liberalisation has significant moderating impact on the financial stability (bank liquid reserves to asset ratio) - macroeconomic risk nexus. The empirical estimates additionally show that macroeconomic risk may negate any positive impact financial sector improvement may have on financial stability among economies in the sub-region.