Governance perspective and the effect of economic policy uncertainty on financial stability: evidence from developed and developing economies

• Published in: Economic change and restructuring Vol. 56; no. 3; pp. 1971 - 2002
• Main Authors: Ali, Kishwar, Hongbing, Hu, Liew, Chee Yoong, Jianguo, Du
• Format: Journal Article
• Language: English
• Published: New York Springer US 01-06-2023; Springer Nature B.V
• Subjects: Banking; Data quality; Development Economics; Economic crisis; Economic Growth; Economic Policy; Economic stabilization; Economics; Economics and Finance; Financial management; Generalized method of moments; Governance; International Economics; International finance; Loans; Macroeconomics/Monetary Economics//Financial Economics; Market structure; Panel data; Policy making; Political Economy/Economic Systems; Robustness; Stability; Uncertainty; Economic policy uncertainty; Financial stability; Governance
• ISSN: 1573-9414; 1574-0277
• DOI: 10.1007/s10644-023-09497-6

Economic Policy Uncertainty (EPU) research has grown in importance in today's highly volatile and interconnected economy. This work investigates the relationship between EPU and Financial Stability (FS) (i.e., Z-scores and non-performing loans (NPL)) with the mediating variable of governance quality through a 23-country panel data from 2005 to 2019. The System Generalized Method of Moment (SYS-GMM) is adopted to address the issue of endogeneity, which is common in panel data regression. The two-stage Sequential of the Linear Panel Data Model (SELPDM) was also used to test the robustness of the results. According to the findings, EPU has a significant negative effect on financial stability (measured by the Z-score) and a significant positive effect on financial stability in the banking industry of most developed economies (proxied by NPL). We also discovered that good governance can be used to mitigate the negative effects of EPU on financial stability; however, this influence varies depending on region, bank, and market structure, and it was significantly greater during the global financial crisis. Finally, this study can help financial managers and policymakers develop appropriate policies to understand how banks respond to EPU.