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Economic Change and Restructuring

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17-03-2023

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

Authors: Kishwar Ali, Hu Hongbing, Chee Yoong Liew, Du Jianguo

Published in: Economic Change and Restructuring | Issue 3/2023

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Abstract

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.

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Table 10 shows that EPU index data is only available for these countries and not for others.

The availability of the EPU index and other bank-level data determines the time frame for our study sample.

World Bank Global Financial Development Database (country-level) and DataStream, Bankscope (bank-level).

DataStream (BankScope), and World Bank Global Financial Development Database.

World Bank Global Financial Development Database.

A higher Z-score suggests that banks are more sustainable, as it is inversely connected to the probability of a bank going bankrupt. A high Z-score indicates a lower risk of insolvency or increased banking stability. we use the natural logarithm of Z-Score to normalize the data.

High value suggests a ratio of NPL to gross loan, more risky loan portfolio or high credit risk.

In our study, we used the natural logarithm transformation of NPL; and the arithmetic mean approach was used to convert the monthly EPU index into an annual index, as previous studies utilized this method (Danisman et al. 2021; Hu and Gong 2019; Shabir et al. 2021).

To aggregate measure QOG, we apply PCA and overall, the six QOG dimensions of the WGI, which are Control of corruption, government effectiveness, the rule of law, political stability, and regularity quality, and developed a composite governance, QOG- index.

We use the SELDPM robust techniques at the macroeconomic, bank, and market structure level. As can be seen in Appendixes tables, we didn't notice any significant changes in our outcome.

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Title: Governance perspective and the effect of economic policy uncertainty on financial stability: evidence from developed and developing economies
Authors: Kishwar Ali
Hu Hongbing
Chee Yoong Liew
Du Jianguo
Publication date: 17-03-2023
Publisher: Springer US
Published in: Economic Change and Restructuring / Issue 3/2023
Print ISSN: 1573-9414
Electronic ISSN: 1574-0277
DOI: https://doi.org/10.1007/s10644-023-09497-6

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