Financial stability an essential element of economic stability, growth

Jordan's experience in dealing with the global financial crisis and its repercussions was a proof of the strength of the Jordanian banking sector and the soundness of its foundations. This has resulted in a sound and healthy banking sector that has managed to withstand the most severe financial crisis in contemporary history. 

According to the stress tests conducted by the Central Bank of Jordan (CBJ) regularly to measure the ability of banks to withstand shocks, the Jordanian banking system has been able to withstand the shocks and high risks, which is indicated and reinforced by the indicators of safety and financial stability of the banking sector in Jordan. For example, the capital adequacy ratio of banks in Jordan reached 16.9 per cent at the end of 2018, which is higher by a comfortable margin than the 12 per cent defined by the CBJ, and higher than the percentage determined by the Basel Committee amounting to 10.5 per cent. 

The Jordanian banking system has achieved high and safe liquidity levels, with a legal liquidity ratio of 131.9 per cent, and good profitability, with a return on assets of 1.2 per cent and a return on equity of 9.6 per cent during 2018. The existence of a strong and robust banking system is an essential component of financial stability, which is a prerequisite for macroeconomic stability and economic growth.

The concept of financial stability refers to the situation in which the financial sector is able to hedge against internal and external crises and, in the event of crises, continue to perform its function of directing financial resources to investment opportunities efficiently and maintaining efficient payments. 

The Jordanian economy is a dynamic, growing economy full of businesses that are starting, expanding, succeeding, as well as failing: Standard functions of the normal business cycle. 

A financial system is considered stable when financial institutions and financial markets are able to provide households, commu­nities and businesses with the resources, services and products they need to invest, grow and participate in a well-functioning economy. Data indicate that credit facilities provided by the banking sector in Jordan grew by 5.3 per cent in 2018 and by 2.4 per cent in the first five months of 2019.

At the same time, the risk reduction mechanisms associated with the process of granting credit and liquidity, market risk and operational risk, should be kept in mind, taking into account the appropriateness of growth in asset values ​​with growth in the real economy and the growth of sustainable employment opportunities.

Financial stability is not about preventing failure or stopping people or businesses from making or losing money. It is just helping to create conditions where the system keeps working effectively, even with such events.

Financial stability is about meeting the needs of average households and businesses to borrow money to buy a house or a car, or to save for retirement or an education. Likewise, businesses need to borrow money to expand, build factories, hire new workers and make payroll. All these things require a functioning financial system that works best when most people do not even think about it very much. Consumers and businesses just know that they can finance large expenses, like the construction of a factory, or that their savings are safe, or that they will be able to get short-term loans to make payroll.

The concept of financial stability is not limited to how to deal with financial crises at the time of their occurrence, but mainly works to rehabilitate the financial sector to absorb these crises, reduce the likelihood of them and reduce the chances of transmission of their repercussions to the components of the main domestic financial sector and then to the other economic sectors in the country. This requires considerable transparency and good governance in the financial institutions and markets. It also needs linking the macroeconomic indicators with those of the banking safety, achieving the discipline of performance in the financial markets and ensuring that the systems of payments, settlement and clearing, at the time of crises, function efficiently.

Achieving sustainable economic stability necessarily requires an advanced and stable financial sector capable of channelling savings to finance productive investment opportunities capable of generating more employment and raising productivity levels to the maximum possible levels. Stabilising the financial sector can, therefore, be seen as a stepping stone towards economic stabilisation.

On the other hand, financial stability requires monetary stability being reflected in the ability of the monetary sector to stabilise the general level of prices at target levels, which range about 2 per cent in developed countries and to a slightly higher levels in developing countries and emerging economies. It also requires a clear structure of interest rates in line with local and international economic developments, and with an appropriate degree of efficiency to regulate the quantity and prices of credit conditions in a manner that supports economic growth and prevents the concentration and accumulation of credit risk, especially in the sectors most vulnerable to volatility.

The relationship between monetary policy and financial stability is illustrated by the impact of monetary policy instruments on interest rates on the ability of companies operating in the economy to service their debts to banks, as well as the impact of developments in interest rates on the prices of financial assets and commodities. The state of complementary between the role of the financial sector and the role of monetary policy emphasises that financial stability cannot be achieved in isolation from economic stability.

The writer is director general of the Association of Banks in Jordan. He contributed this article to The Jordan Times