A Proposed Model for the Central Bank to Develop a Composite Index for Measuring Financial Stability in the Republic of Yemen

Abstract

In light of the recent conflicts and instability in Yemen, the need for a 
reliable indicator to measure financial stability has become increasingly 
urgent. Measuring financial stability is essential for economic policymakers 
to design appropriate measures aimed at preserving stability and preventing 
financial crises. 
This study proposes a model for developing a composite financial 
stability index for the Republic of Yemen based on a comprehensive 

framework covering three main dimensions of financial stability: - Banking Stability, which measures the soundness of the banking 
sector, its ability to absorb shocks, and the level of risks it faces. - Macroeconomic Stability Indicators, which assess risks associated 
with key macroeconomic variables, including the fiscal deficit, public 
debt, current account balance, and foreign exchange reserves, while 
also measuring price stability and other key financial indicators. - External Financial Stability, which evaluates the interactions 
between the Yemeni economy and the global economy that may affect 
financial stability. 
Based on a review of the relevant literature, previous studies, and 
international experiences, the researchers identified sixteen sub-indicators as 
the most significant measures of financial stability in Yemen. These sub
indicators were then aggregated into a single composite index using weights 
determined by the researchers. 
The results indicate that financial stability in Yemen has deteriorated 

significantly in recent years due to the ongoing civil war and economic 
challenges. The proposed index identifies the key areas requiring policy 
intervention to improve financial stability, including strengthening the 
resilience of the banking sector through improving asset quality and capital 
adequacy, mitigating macroeconomic risks, enhancing resilience to external 
shocks through the accumulation of foreign exchange reserves, effective 
public debt management, sound supervision and regulation, and maintaining 
price stability through efficient monetary policy management. 
The proposed index provides the Central Bank of Yemen with a 
comprehensive tool for measuring financial stability that can be used to: - Identify vulnerabilities within the financial system and implement 
corrective measures. - Monitor emerging risks and take proactive actions to mitigate them. - Evaluate the effectiveness of policies and measures aimed at 
enhancing financial stability. - Strengthen confidence in Yemen's financial system among investors 
and borrowers. 
The proposed model can assist policymakers in designing appropriate 
measures to ensure a stable and resilient financial system.