Sustainable financial systems and a new approach to financial stability

Abstract

Ambiguity in the definition of financial system stability and paradigm development causes a lack of unambiguous methods for measuring the stability of the system. Among the commonly used quantitative methods for assessing financial stability are early warning systems, macro-stress testing, and financial stability indices. However, it is essential to note that the approaches to developing these measures have changed over time. The classic paradigm of stability was based on a basic pillar of the financial system: the market (private) financial system. An important aspect of the classical paradigm was monetary stability and the need to comply with the first two conditions. Stability analysis was conducted on a short time horizon, and groups of stakeholders did not consider social and environmental effects, only economic ones. To sum up, the financial system was based on short-term maintenance of its efficient functioning to achieve financial value (including profit) and on its ability to facilitate and support effective functioning and efficiency of the economy. The main objectives of the chapter are as follows: (1) to identify environmental, social, and governance (ESG) risk that matters for sustainable financial systems; (2) to define and provide a methodological approach for sustainable financial systems; and (3) to provide recommendations for designing a sustainable financial system.