IISES International Academic Conference, Rome

FINANCIAL STABILITY INDEX FOR THE FINANCIAL SECTOR OF PAKISTAN

IRAM NAZ

Abstract:

This study aims to develop a financial stability index for the financial sector of Pakistan by using the financial reports for the period of 2001 to 2011. Specifically, we constructed three different classes of indices in this study based on variance-equal weighted approach, linear probability approach, and logistic approach. We also assessed the prediction accuracy of the financial stability index. All indices indicate 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 the index constructed by employing coefficients of logistic model performed preeminent in predicting distressed and non-distressed banks. Moreover, the findings of the study suggest that return on assets and return on equity when employed in the financial stability index in a stepwise manner the results are similar to both profitability indicators have the same behavior. Finally, it concludes that the financial stability indices developed in this study would help the decision makers to detect and avoid instability in the future.

Keywords: financial stability Index, financial sector, financial stress, financial crises, financial stability