Financial sector resilience under political and institutional stress : Macro-financial contagion pathways in EMDEs

Abstract

Political instability and institutional fragility are increasingly recognised as systemic risk factors that undermine financial resilience in emerging markets and developing economies (EMDEs). This study examines how political and institutional conditions influence key dimensions of macro-financial vulnerability such as banking sector soundness, capital flow dynamics, and external balances, using a balanced sample of 36 EMDEs across six major regions over the period 2002–2023. Employing descriptive analysis, correlation matrices, and fixed-effects panel regressions with robust country-clustered standard errors, the study documents that weaker political stability and governance quality are systematically associated with elevated banking stress, constrained credit intermediation, heightened sensitivity of portfolio equity flows, and deteriorating external balances. Portfolio equity inflows respond more sharply to political shocks than foreign direct investment, and external debt accumulation and current account imbalances increase in politically fragile environments. Regional comparisons reveal substantial heterogeneity, with Sub-Saharan Africa and the Middle East and North Africa demonstrating the greatest vulnerability profiles, while East Asia and the Pacific exhibit stronger institutional buffers. These findings highlight the importance of incorporating political and institutional risk indicators into macro-prudential surveillance, stress testing, and capital flow risk management frameworks. The results inform policy makers, regulators, and risk managers on the channels through which governance fragility translates into financial instability, supporting enhanced banking resilience amid geopolitical and institutional uncertainty. This article is also included in The Business & Management Collection which can be accessed at https://hstalks.com/business/.