Financial Stability Indicators and Public Debt Developments

Abstract

This paper investigates the inter-linkages between financial stability and fiscal policy. It analyzes the effect of selected financial stability indicators on the probability of future debt deterioration, controlling for several macroeconomic variables. We find significant evidence that a fragile banking system can put at risk public finances. Weak bank profitability, low asset quality and a weak capital base increase the fragility of the banking system, thus, raising the probability of future fiscal troubles.

Keywords: Bank profitability; capital adequacy; asset quality; fiscal policy

JEL Classification: E44, E58, G21, G28, E61, E62, H61, H62, E32