Are higher interest rates a concern for financial stability in MENA?

Financial stability is a crucial indicator of the financial sector's health, reflecting the system's resilience or vulnerability to crises. This study investigates the impact of macroeconomic variables and financial inclusion on financial stability in Indonesia, utilizing quarterly data from the first quarter of 2012 to the fourth quarter of 2021. Employing the Vector Error Correction Model (VECM), the research examines the influences of these factors in both the short and long term. The findings reveal that macroeconomic variables and financial inclusion significantly affect financial stability in Indonesia across both time frames. Specifically, inflation emerges as a critical factor influencing financial stability in the long term, while interest rates play a pivotal role in the short term. Moreover, financial inclusion, represented by the public's use of banking products and third-party funds relative to Gross Domestic Product (GDP), impacts financial stability both in the long and short term. Conversely, financial inclusion, measured by credit to GDP, exhibits only short-term effects on financial stability. The results underscore the importance of careful consideration by the central bank when formulating monetary policy, particularly regarding interest rate adjustments, due to their immediate impact on financial system stability. Over the long term, maintaining control over inflation rates is imperative to safeguard financial stability. Furthermore, financial institutions, in their role of fostering financial inclusion by distributing credit, must balance the quality of credit with its quantity to avoid negative impacts on the financial system's stability. This study contributes valuable insights for policymakers and financial institutions aiming to bolster Indonesia's financial stability through prudent macroeconomic management and the strategic implementation of financial inclusion initiatives.

This paper explores the effects of excessive financial Euroization on monetary and financial stability by using deviation from interest rate parity (dIRP) as a proxy measure of financial and monetary stability, building on the interest rate parity puzzle theory. We focus on five Central and Eastern European (CEE) EU member countries (Poland, Hungary, the Czech Republic, Romania, and Croatia) from January 2002 to December 2019. The impact of euroization parameters on dIRP is empirically tested by employing the ARDL cointegration model and the Granger causality test. Interest rate differentials and inflation were employed as additional explanatory and control variables. Results show that loan euroization and interest rate differentials greatly impact dIRP in all countries except the Czech Republic, where deposit euroization and inflation have a more significant impact. Furthermore, the causality analysis has shown that there is also a vicious circle where dIRP causes Euroization in the short run. At the same time, greater Euroization, in turn, exacerbates dIRP in the long run. This confirms that Euroization is relevant in explaining the interest rate puzzle, impacts greater dIRP among financial markets, and strives to harmonize interest rates with the euro area to maintain financial and monetary stability.

Financial stability is very important in the economy because financial stability will ensure smooth financial transactions in the economy.This study aims to analyze the effect of P2P lending fintech, payment fintech and macroeconomic variables (inflation, interest rates and exchange rates) on financial stability in Indonesia.This study uses time series data with the period 2018.1-2021.4. Using the Vector Error Correction Model, this research shows that Fintech P2P Lending, Fintech Payments and macroeconomic variables (inflation, interest rates and exchange rates) affect the financial stability in Indonesia only in the long term.Fintech P2P lending in the long term will lead to financial system instability, while Fintech payments in the long term have a positive effect on financial system stability in Indonesia. This has policy implications where through the role of the Financial Services Authority it is necessary to regulate and supervise P2P lending fintech. In addition, considering that payment fintech has a positive impact on financial system stability in Indonesia, through the role of Bank Indonesia, it is necessary to design policies to increase the use of non-cash payment instruments.

The digital economy has significantly transformed economic growth by introducing innovations in payment systems and financial services. The modernization of payment instruments through monetary policy has enhanced the ability to control inflation and ensure financial system stability. This study aims to analyze the effectiveness of monetary policy and the utilization of the digital economy in maintaining financial stability in Indonesia. Using time series data from 2010 to 2024 obtained from the World Bank, this research applies the Vector Autoregression (VAR) method to examine both short-term and long-term relationships among variables, including e-money, money supply, inflation, exchange rate, interest rate, and credit card usage. The results show that e-money has a significant reciprocal influence on the money supply, while inflation is also affected by e-money and interest rates. The impulse response function demonstrates that the interactions among these variables tend to converge towards equilibrium over time. Variance decomposition analysis indicates that in the short term, e-money primarily drives financial stability, whereas in the medium and long term, the money supply plays a dominant role. Overall, the findings suggest that monetary policy, supported by digital economic systems, effectively enhances financial system stability in Indonesia. This research contributes to understanding the dual effect of digital payment innovations and provides recommendations for policymakers to strengthen financial inclusion, economic resilience, and macro-financial stability in the digital era.

Price stability and sustainable economic growth are conventionally considered as key goals of monetary policy. Financial stability is also recognized as the third pillar in the monetary policy objective function after the financial crisis of 2007. Although financial stability “as the third target in the monetary policy objective functions” is evidently inconsistent with the twin conventional monetary policy goals, it mitigates the side effects of financial turmoil impact on the price and growth instability in the macrocosmic environment in the medium term. Financial crises, which have historically created large deviations in the monetary policy goals, necessitate empowering the conventional policy instruments (policy interest rate, monetary aggregate and rate of requirement ratio) with unconventional policy instruments. In this context, unconventional supplementary monetary policy instruments streamline monetary transmission mechanism to achieve asymmetrically triple monetary policy goals through expanding open market operations to non-governmental bonds, facilitating banks’ overnight financing in the payment system, and initiating zero bound interest rate policy. In this research, a Dynamic Stochastic General Equilibrium Model (DSGE-Gertler and Karadi, 2011) is technically utilized to estimate the impact of conventional (interest rate) and unconventional (credit lines) monetary policy instruments on the macroeconomic variables (inflation, output growth, exchange rate and stock market price index), while simulating the macroeconomic variables response to financial instability. The simulation evaluates monetary policy impulse response function based on optimization approach in the context of crisis scenario. Monetary policy rules basically assessed in this paper are introduced in the context of optimization and non-optimization, which include Taylor interest rate rule without financial stability, simple optimization interest rate rule with financial stability, and unconventional monetary policy rule. In this context, Central banks’ line of credits as unconventional tool, which is influenced by the policy maker decisions, injects directly to banking network flow of funds. Central banks, which had sold the public bonds to the families in the form of risk-free investment in the first step, accumulate financial resources in the balance sheet. Accumulated financial resources lend simultaneously to the firms in the second step in the context of unconventional expansionary monetary policy in order to increase banking network leverage ratio, which streamlines credit operations and develops private sector investment. Presumably, central bank intervention is empirically considered inefficient compared to the private sector in the financial intermediaries due to CBs cost inefficiency to find and allocate to the key economic sectors. The DSGE parameters are statistically estimated by the Bayesian approach through using time series for some macroeconomic variables including consumption, private investment, inflation, government expenditure, change in outstanding loan, commercial banks leverage ratio, and stock market return. Given the fact that the Bayesian estimation is technically required to introduce the distribution of parameters as priors, priors are determined through numerical analysis as well as through previous research. The estimation log data density mounted at about 399 and the robustness of estimated parameters has been verified based on test of Brooks and Gelman (1988). In this study, rapid reduction in the quality of capital is considered financial crises shock indicator which influence key macroeconomic variables. Simulation results indicate that unconventional monetary policy affects efficiently real sector sustainability while mitigating financial instability (assets market) in the macroeconomic environment. In this regard, financial stability is evidently accompanied by the lower nominal interest rate and inflation in line with Gertler and Karadi (2011). In other words, although unconventional rather than conventional monetary policy instruments were limitedly utilized amid financial turmoil in Iranian economy, they create sustainable growth along with lower interest rate and inflation in the medium term accompanied by higher household welfare. Utilization of unconventional monetary policy instruments diversifies policy tools and reduces the deviation of conventional policy instruments and target variables (price, output growth and financial stability) in the Iran macroeconomic environment.

Introduction/Main Objectives: Central Bank Digital Currency (CBDC) is an electronic form of banknotes, but different from virtual currency or cryptocurrency which are not issued by the state, the CBDC issued and guaranteed by the central bank. The aim of this study is to investigate the impacts of CBDC on financial stability using a Vector Auto-regressive model. The endogenous variables in the VAR estimation contain the Central Bank Digital Currency Attention Index (CBDCA), composite stock price index, real exchange rate, and interest rate (BI7DRR). Background Problems: The presence of CBDC will change the objective of Bank Indonesia and influence the structure of the monetary policy, which is no longer focused on achieving a low and stable inflation rate but on achieving price stability. Novelty: Although CBDCs will be launched worldwide, there are a limited number of empirical studies that have analyzed their impact on financial stability, especially for the case study in Indonesia. In this paper, we also use the Vector Error Correction Model (VECM) model with stochastic volatility and Impulse Response Function to make a forecast and see the impacts of shocks on the financial variables. Research Methods: In this study, we used monthly time series data from January 2019 – January 2023. In order to find the correlation between CBDC and the financial market we used the Granger causality model and impulse response function analysis. Finding/Results: The results of this study prove that CBDC has a positive correlation with the real exchange rate, and financial markets such as stock or bond prices have a positive response to shocks in CBDC. Conclusion: In this study, we used monthly time series data from January 2019 – January 2023. We use empirical tests to examine the CBDC attention index in relation to index attention, exchange rates, interest rates and IHSG. Our empirical results show that in Granger causality there is no causal relationship between CBDC and other macroeconomic variables. whereas in the IRF analysis, the response to the CBDC shock tends to be stagnant, the FEVD results show short-term and long-term shock fluctuations in the CBDC and other variables. These results indicate that CBDC does not have a significant effect on the macroeconomic variables used as indicators of financial system stability, but on the contrary, people's attention to CBDC depends on the condition of the variables in the financial system. On the other hand, the development of CBDC depends on economic conditions. The uncertainty surrounding CBDC plays an important role in indicating that the introduction of CBDC brings significant changes to the economy.

Forecast Targeting and Financial Stability: Evidence from the European Central Bank and Bank of England

The objective of this research is to develop a financial system stability index and analyze the internal and external factors that we expect to affect the stability of the Indonesian financial system. We measured the single model of financial system stability index (FSSI) from year 2004M03 to2014M09 in Indonesia, and compiled a single quantitative measure based on aggregate internal factors and external factors to capture and predict the shocks of the financial system stability. Stability parameters were composed of composite indicators on different bases. In addition, we developed a comprehensive index component associated with the relevant market conditions, including banking soundness index, financial vulnerability index, and regional economic climate index. Results stated that US economic growth and economic growth of ASEAN countries positively affected financial stability. In addition, current account, exchange rate, inflation, interest rate were shown to negatively affect financial stability. The results of this study imply that internal factors have a strong influence on the financial stability. Therefore, the central bank should give a fast and correct response to the changes of external and internal financial environment, especially for internal factors through monetary policy.

The question whether central banks should bear responsibility for financial stability remains unanswered. In connection with the use of interest rates, it is therefore not clear whether and how the Taylor rule should be augmented by an additional financial stability term. This paper reviews the normative and positive literature on Taylor rules augmented with exchange rates, asset prices, credit, and spreads. These measures have evolved as common indicators of financial (in)stability in the Taylor rule literature. In addition, our own analysis describes the development of these indicators for the core and the periphery of the Eurozone. Given the high degree of heterogeneity between euro area countries, the conclusion here is that an interest rate reaction to instability by the European Central Bank would be inappropriate in times of crisis. However, this conclusion is somewhat weakened if there is no crisis.

Financial system stability is necessary to ensure a sustainable economic development. It undertakes 3 major functions: (i) payment system, (ii) financial intermediation, and (iii) managing risk. Data showed that the Indonesian economy experienced a negative correction in the event of financial instability, e.g bank panic in 1992, Asian financial crisis (1997), and Sub-prime mortgage crisis (2008). Therefore, it is necessary in having a method of financial stability index measurement, which in turn can be used to predict the direction of future financial stability. This research was conducted in order to provide an option incalculating the index of financial stability of Indonesia by two methods, namelyAggregation with Variance Equal Weight with Principal Component Analysis (PCA). The results show that the trend of Indonesian financial stability index which constructed through these two techniques have similar trend with a different magnitude. PCA method was employed in making reductions on variable dimensions without losing the information on the movement of the variable’s variation. There are four sectors to be included in the index. Those four sectors are banking sector, money market sector, capital market sector,and monetary sector. We found that the contribution of the financial performance of banks in Indonesia and the interest rate is the highest among other sector to the Indonesia financial stability.

PurposeThis paper aims to examine the relationship between monetary policy and market interest rates. This paper examines the efficiency of interest rate channel used in monetary regulation as well as implementation of monetary policy under low interest rates. This paper examines and reviews the scientific literature published over the past 30 years to determine primary research areas, to summarize their results and to identify appropriate measures of monetary policy to be used in practice in changing economic environment.Design/methodology/approachThis paper reviews 94 studies focused on the relationship between monetary policy and market interest rates in terms of meeting the goals of macroeconomic regulation. The articles are selected on the basis of Scopus citation and bibliometric analysis. A major feature of this paper is the use of text analysis (data preparation, frequency of terms and collocations use, examination of relationships between terms, use of principal component analysis to determine research thematic areas). Using the method of principal component analysis while studying abstracts this paper reveals thematic areas of the research. Thus, the conducted text analysis provides unbiased results.FindingsFirst, this paper examines the whole complex of relationships between monetary policy of central banks and market interest rates. Second, this research reviews a wide range of literature including recent studies focused on specific features of monetary policy under low and negative rates. Third, this study identifies and summarizes the thematic areas of all the researches using text analysis (transmission mechanism of monetary policy, efficiency of zero interest rate policy, monetary policy and term structure of interest rates, monetary policy and interest rate risk of banks, monetary policy of central banks and financial stability). Finally, this paper presents the most important findings of the studied articles related to the current situation and trends on the financial market as well as further research opportunities. This paper finds the principal results of studies on significant issues of monetary policy in terms of its efficiency under low interest rates, influence of its instruments on term structure of interest rates and role of banking sector in implementation of transmission mechanism of monetary policy.Research limitations/implicationsThe limitation of the review is examining articles for the study period of 30 years.Practical implicationsCentral banks of emerging economies should apply the instruments and results of the countries' monetary policies reviewed in this paper. Using text analysis this paper reveals the main thematic areas and summarizes findings of the articles under study. The analysis allows presenting the main ideas related to current economic situation.Social implicationsThe findings are of great value for adjusting the monetary policy of central banks. Also, these are important for people because these show the significant role of monetary policy for the economic growth.Originality/valueUsing text analysis this paper reveals the main thematic areas (transmission mechanism of monetary policy, efficiency of zero interest rate policy, monetary policy and term structure of interest rates, monetary policy and interest rate risk of banks, monetary policy of central banks and financial stability) and summarizes findings of the articles under study. The analysis allows defining the current ideas relevant to the monetary policy of developing countries. It is important for central banks because it examines the monetary policy problems and proposes optimal solutions.

Financial liberalization will affect the stability of the financial system due to excessive risk. Liberalization effort in Islamic banks players raises the issues of the ability of how Islamic banks can survive in the financial liberalization regime. Financial liberalization induced competition and thus impact on financial stability due to excessive risk taking. Malaysia is operating in dual financial system, the effect of mediating roles of competition and interest rate between financial liberalization is expected to be vary at some extend due to shariah constraint. This paper aims to analyze the effect financial liberalization and financial stability. Structural equation model – Partial least square (PLS-SEM) is used to analyze the research model with a comprehensive data set covering the Islamic banks over 1994 -2017. The empirical results denote a significant negative impact of financial liberalization on Islamic banks' financial stability in Malaysia. Lastly, it can be concluded that this study has an implication for policymakers and the banking industry
 Financial liberalization will affect the stability of the financial system due to excessive risk. Liberalization effort in Islamic banks players raises the issues of the ability of how Islamic banks can survive in the financial liberalization regime. Financial liberalization induced competition and thus impact on financial stability due to excessive risk taking. Malaysia is operating in dual financial system, the effect of mediating roles of competition and interest rate between financial liberalization is expected to be vary at some extend due to shariah constraint. This paper aims to analyze the effect financial liberalization and financial stability. Structural equation model – Partial least square (PLS-SEM) is used to analyze the research model with a comprehensive data set covering the Islamic banks over 1994 -2017. The empirical results denote a significant negative impact of financial liberalization on Islamic banks' financial stability in Malaysia. Lastly, it can be concluded that this study has an implication for policymakers and the banking industry

This paper explores the interaction between monetary policy and prudential regulation in an agent-based modeling framework. Firms borrow funds from the banking system in an economy regulated by a central bank. The central bank carries out monetary policy, by setting the interest rate, and prudential regulation, by establishing the banking capital requirement. Different combinations of interest rate rule and capital requirement rule are evaluated with respect to both macroeconomic and financial stability. Several relevant policy implications were drawn. First, the efficacy of a given capital requirement rule or interest rate rule depends on the specification of the rule of the other type it is combined with. More precisely, less aggressive interest rate rules perform better when the range of variation of the capital requirement is narrower. Second, interest rate smoothing is more effective than the other interest rate rules assessed, as it outperforms those other rules with respect to financial stability and macroeconomic stability. Third, there is no tradeoff between financial and macroeconomic stability associated with a variation of either the capital requirement or the smoothing interest rate parameter. Finally, our results reinforce the cautionary finding of other studies regarding how output can be ravaged by a low inflation targeting.

The international financial and economic crisis highlights that central banks should go beyond their traditional emphasis on low inflation to adopt an explicit goal of financial stability. Our paper addresses this highly topical issue of macro-prudential framework with the focus on effectiveness of monetary policy in affecting some financial stability indicators, in the experience of several Central and Eastern European countries during 2003M01–2012M06. Using a Structural Vector Autoregressive model and impulse response function, we analyze the impact of short-term interest rates upon industrial production, loan to deposit ratio for the banking system, stock prices and exchange rate (proxy variables for financial stability). We want to test if the interest rate is conducive to financial stability. Our empirical results show that the effectiveness of the short-term interest rate in affecting selected asset prices depends on monetary policy strategy. In the case of the Czech Republic, Hungary, Poland and Romania, the interest rate instrument used for inflation targeting is conducive to financial stability. Among countries with a fixed exchange rate regime, only in Bulgaria does transmission of the foreign interest rate impulse to domestic variables promote financial stability. Additionally, our results show that in Latvia and Lithuania adjustments to the monetary policy of the European Central Bank (ECB) are not in accordance with country-specific conditions. The paper contributes to a policy debate on the design of macro-prudential polices in the aftermath of the boom-bust cycle experienced by the Central and Eastern European countries in the second half of the last decade.

This study aims to empirically analyze the impact of profitability (PRFT), leverage (LEVG), liquidity (LIQD), firm age (FAGE), interest rate (INTR), firm value (FVAL), firm size (FISZ), and COVID-19 (COVD) on the financial stability (FSTA) of real estate companies listed on the Indonesia Stock Exchange from 2012 to 2024. Using secondary data, the research adopts a purposive sampling method to select companies based on predefined criteria, with the final sample drawn from 83 registered real estate firms. The F-statistic test was performed, and the results were identical for Model 1 and Model 2, confirming that all independent variables—PRFT, LEVG, LIQD, FAGE, INTR, FVAL, FISZ, and COVD collectively influence financial stability (FSTA). In Model 1, the individual significance test (t-test) revealed that LEVG, LIQD, FAGE, INTR, FVAL, and FISZ significantly affect FSTA, while PRFT and COVD do not. Conversely, in Model 2, PRFT, LEVG, LIQD, FAGE, FVAL, and FISZ were found to significantly impact FSTA, whereas INTR and COVD showed no effect. Finally, in Model 3, PRFT, LEVG, and LIQD do not mediate their respective effects on FSTA. The research model remains robust despite two adjustments to the independent variables. The first adjustment incorporates the Financial Stability Index (FISI), while the second adjustment still incorporates FISI, but COVD is removed.