Theoretical Definition
A stable financial system efficiently allocates resources, assesses and manages financial risks, maintains employment levels close to the economy’s natural rate, and eliminates relative price movements of real and financial assets to stabilize monetary and economic levels. A financial system is stable when it dissipates financial imbalances that arise endogenously or as a result of significant adverse and unforeseeable events. When stable, the system absorbs shocks primarily via self-corrective mechanisms, preventing the adverse events from disrupting the real economy or spread over to other financial systems. Financial stability is paramount for economic growth, as most transactions in the real economy are made through the financial system.
Without financial stability, banks are more reluctant to finance profitable projects, asset prices may deviate significantly from their intrinsic values, and the payment settlement schedule diverges from the norm. Hence, financial stability is essential for maintaining confidence in the economy. Possible consequence of excessive instability includes: bank runs, hyperinflation, or {stock market crash|stock market crashes]].
Read more about this topic: Economic Stability
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