Financial stability is considered to be a state in which the financial system i. e. the key financial markets and financial institutional system (banking) is resistant to economic shocks such as a global recession.
A stable financial system is capable of efficiently allocating resources, managing risks and arranging payments. When in financial stability, the system will absorb external and internal shocks using self-corrective mechanisms.
Financial stability is considered paramount for economic growth as most transactions in the modern economy are made through the financial system.
Financial instability leads to banks becoming unwilling to fund profitable projects and reluctant to distribute credit. This could lead to bank runs, hyperinflation or a stock market crash of the bank. Financial stability can also have a severe adverse impact on consumer and business confidence.
The recent banking crisis and 'credit crunch' that accompanied the 2008 global recession stimulated the creation of the Financial Policy Committee (FPC) in the UK. The role of the FPC is to identify, monitor and taking action to remove or reduce systemic risks with a view to protecting and enhancing the resilience of the UK financial system.
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