Measuring the financial stability sentiments and evaluating their impacts on financial soundness, financial stability, and the macroeconomy of Pakistan

Abstract

This paper measures the Financial Stability Sentiments Index (FSSI) for the economy of Pakistan, an interesting country case due to its resilient banking sector. We used a Natural Language Processing technique to quantify these sentiments from annual financial stability review reports published by the State Bank of Pakistan, central bank of Pakistan. The index captured events of high and low financial stress in Pakistan, such as the Global Financial Crisis and recent tightening by the Federal Reserve. Regarding the information content of our index, it serves as a leading indicator for selected indicators of financial soundness in Pakistan. Further, asymmetric analysis of the impact of financial stability sentiments on financial stability showed that improvements in the FSSI lead to a higher distance-to-default for two sets of diverse banking institutions in Pakistan, indicating improved financial stability as bank assets far outweigh their obligations. Finally, the index shows an intuitive and significant impact on selected financial soundness indicators as well as the real macroeconomic variables in Pakistan.