Impact of Financial Development, Financial Liberalization and Economic Growth on Financial Instability: Evidence from Panel Data

Abstract

Financial instability refers to the situation when financial system faces some disturbances and volatility. There are some important factors that can have a significant influence on the stability or instability of the financial sector. The main objective of this study is to examine the impact of financial sector development, financial liberalization, and GDP growth rate on financial instability. Using data from 53 countries from 2000 to 2016 and employing a battery of estimation techniques consisting of fixed effect, random effect, dynamic panel, and system GMM, the study finds that financial development and financial liberalization accentuate financial instability. The study also finds that economic growth dampens it. Furthermore, the relationship is robust to a variety of controls like monetary independence index, exchange rate stability, law and order, and government expenditure. The policy implication is straightforward that financial development and financial liberalization demand a caution.