Key Drivers of Financial Stability in the Banking Sector of Emerging and Developing Economies

Key Drivers of Financial Stability in the Banking Sector of Emerging and Developing Economies

Abstract

This study analyzes the key drivers of financial stability in the banking sector of emerging and developing economies, aiming to identify the role of macroeconomic factors, institutions, and intrinsic bank characteristics in their resilience to financial shocks. The research focuses on answering the question: what factors determine the stability of the banking system in the context of developing economies frequently facing economic volatility and external risks? The study uses a balanced panel dataset of 120 commercial banks in 15 emerging and developing countries from 2015–2025. Financial stability is measured by the Z-score, while explanatory variables include capital adequacy ratio, asset quality, liquidity ratio, credit growth, GDP growth, inflation, and institutional quality. Panel data regression, combining fixed effects modeling and System GMM estimation, was applied to address endogeneity issues and test the robustness of the results. Empirical results show that a 1 percentage point increase in capital adequacy ratio leads to a Z-score increase of approximately 0.35–0.42 units, while the non-performing loan ratio has a statistically significant negative impact on banking stability. At the macro level, GDP growth promotes financial stability, while excessive credit growth increases systemic risk. Furthermore, countries with high institutional quality and governance efficiency record significantly higher levels of banking stability. This study contributes comprehensive quantitative evidence, integrating micro and macro factors within a unified analytical framework, and provides important policy implications for strengthening banking supervision and consolidating sustainable financial stability.

Keywords: Financial stability; Banking sector; Emerging and developing economies; Institutional quality.