A financial Stability Index for Jordan

Abstract Financial stability is an important part of the Central Bank of Jordan (CBJ) role in parallel with maintenance of monetary stability. The impact of the global financial crises from 2007-2009 and the economic slowdown has left the Jordanian banking sector in a generally weaker position than before. This paper constructs an index of financial stability of the Jordanian banking sector that will adequately reflects the effects of the crises in 2008-2009 and measure the resilience of the banking sector against negative shocks. The index is based on the aggregation of the fifteen announced soundness indicators into four main categories: (i) Capital Adequacy, (ii) Earnings and Profitability, and (iii) liquidity to build one aggregate composite index. Using two weighting schemes the Financial Stability Index (FSI) proved to be a good indicator of banking reactions to shocks and changing economic conditions. FSI is intuitively attractive as it could enable policy makers to better monitor the banking sector’s resilience to shocks and can help further in anticipating the sources and causes of financial stress to the system. The index of financial stability of the banking sector in Jordan shows that the banking system has been consciously resilient against shocks and negative economic conditions.