The effect of risk management on the bank’s financial stability in the emerging economy

Abstract

In light of the fact that sustainable development and financial stability are now essential to global social and economic progress. Thus, the current study looks into how risk management affects Ethiopian banks’ financial stability between 2017 and 2024 using the generalized moment (GMM) model. The study used financial stability as the dependent variable and liquidity risk, credit risk and operational risk as the independent variables. Moreover, the study used inflation GDP and exchange rate as the control variable. In light of this, the study found that the financial stability of Ethiopia’s commercial banks is significantly impacted negatively by credit risk, inflation, and exchange rates. Whereas GDP and liquidity risk have a significant and positive impact on the financial stability of Ethiopia’s banking industry, apart from them, operational risk doesn’t affect the financial stability of banks in Ethiopia. Thus, the study concluded that macroeconomic features (GDP, inflation, and exchange rate) and risk management factors (credit risk and liquidity risk) significantly affected the financial stability of banks in Ethiopia. Therefore, bank management should establish effective risk management mechanisms like ensuring secure loan granting and, improving the quality of credit appraisal and analysis and, collecting and updating information about customers in a timely and accurate manner, analyzing the risks of the loan plan to provide the expected risks and the bank’s controllability.