Financial Stability Index for the Financial Sector of Pakistan

Abstract

This study aims to develop a financial stability index for the Pakistani financial sector by using the financial reports for the period of 2001–2011. Specifically, we constructed three different classes of indices in this study based on a variance-equal weighted approach, a linear probability approach, and a logistic approach. We also assessed the prediction accuracy of the financial stability index. All indices indicated that profitability, liquid liability to the liquid asset, non-performing loan, uncovered liabilities, interest spread and inter-fund to liquid liabilities variables contribute significantly to the determination of financial stress of commercial banks. We also compared the results of indices computed with different methodologies—among them was the index constructed by employing coefficients of the logistic model and which performed outstandingly in predicting distressed and non-distressed banks. Moreover, the findings of this study suggest that in regard to return on assets and return on equity, when employed in a stepwise manner for developing the financial stability index, the results are similar in the sense that both profitability indicators have the same behavior. Finally, we conclude that the financial stability indices developed in this study could help decision makers to detect and avoid instability in the future.

How Banks Can Leverage Credit Risk Evaluation to Improve Financial Performance

“…Ethical findings reveal that there is a beneficial effect on the financial performance of non-performing loans/gross loans ratio, as well as a negative impact of the provision for facilities loss/net facilities ratio on financial performance, and no impact of capital adequacy ratio, as well as the credit interest/credit facilities ratio on the banks' financial performance when analyzed by ROA. This is in agreement with Babar et al (2019) who discovered that non-performing loans/gross loans have beneficial effects on the financial performance of companies as assessed by ROE and ROA, along with Hajiheydari et al (2021), who concluded that the capital adequacy ratio has no impact on credit risk evaluation. This is in contrast with results from Al-Dmour et al (2021), who discovered that the ratio of capital to total risk assets has a positive impact on financial performance.…”

Bank Specific Risks and Financial Stability Nexus: Evidence From Pakistan

“…Financial stability refers to the capability of a financial organization to accelerate its economic procedures, absorb shocks, and control risk (Schinasi, 2004). After the global financial catastrophe of 2007/2008, many studies examined the factors explaining the financial stability of banks Babar et al, 2019;Kim et al, 2020). These researchers examine many internal factors, such as "liquidity risk, " "credit risk, " and "operational risk" (Ghenimi et al, 2017;Amara and Mabrouki, 2019;Khemais, 2019;Djebali and Zaghdoudi, 2020).…”

Analysis of the Literature of Financial Stress Index and Proposed Model for Pakistan.

“…According to the research done by Babar et al, (2019) the banks have complete control over the financial market of Pakistan. Moreover, the analysis of the financial market shows that out of the banking system total assets, almost 44% of assets are now concentrated in the securities of government until 2015 December.…”

“…According to these records, efforts have been made for the foreign stress index of Pakistan. The twin deficit issues in the year 2012 had depicted little amount of stress on the financial market (Babar et al, 2019).…”