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Financial Stability Index for the Financial Sector of Pakistan

Sadia Babar (), Rashid Latief (), Sumaira Ashraf () and Sania Nawaz ()
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Sadia Babar: Faculty of Management and Social Science, Capital University of Science and Technology, Islamabad 44000, Pakistan
Rashid Latief: College of Finance, Nanjing Agricultural University, Nanjing 210095, China
Sumaira Ashraf: CEFAGE Research Center, University of Évora, Évora 7000-812, Portugal
Sania Nawaz: Faculty of Management and Social Science, Capital University of Science and Technology, Islamabad 44000, Pakistan

Economies, 2019, vol. 7, issue 3, 1-24

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.

Keywords: financial stability index; financial sector; financial stress; financial crises; financial stability (search for similar items in EconPapers)
JEL-codes: E F I J O Q (search for similar items in EconPapers)
Date: 2019
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Handle: RePEc:gam:jecomi:v:7:y:2019:i:3:p:81-:d:257136