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Defining Financial Stability

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Financial stability is a state in which the financial system, i.e. the key financial markets and the financial institutional system is resistant to economic shocks and is fit to smoothly fulfil its basic functions: the intermediation of financial funds, management of risks and the arrangement of payments.

Financial stability is one of the most widely discussed issues in today’s economic literature. The relevance of analyses on financial stability was first recognised during the international financial crises at the end of the 90s, also strengthened by the financial and economic crisis emerging in 2007. These developments prompted the need for continuously providing the professional public opinion with an up-to-date and reliable picture of the condition of a given country’s financial sector. Owing to the mutual relations of dependence – affording interpretation on both a vertical and horizontal level – the analyses need to cover the whole financial intermediary system; in other words, in addition to the banking system, it is also necessary to analyse non-bank institutions that in some form take part in financial intermediation. These include numerous types of institutions, including brokerage firms, investment funds, insurers and other (various) funds. When analysing the stability of an institutional system, we examine the degree in which the whole of the system is capable of resisting external and internal shocks. Of course, shocks do not always result in crises, but an unstable financial environment can in itself impede the healthy development of the economy.

Different theories define the causes of financial instability; their relevance may vary according to the period and countries drawn into the scope of analysis. Among the problem factors affecting the whole of the financial system, literature commonly defines the following ones: rapid liberalisation of the financial sector, inadequate economic policy, noncredible exchange rate mechanism, inefficient resource allocation, weak supervision, insufficient accounting and audit regulation, poor market discipline.

The aforementioned causes of financial crises emerge not only collectively, but also individually, or in a random combination, therefore the analysis of financial stability is an extremely complex task. The focus on individual branches distorts the overall picture, thus the issues need to be examined in their complexity in the course of analysing financial stability.