Assessing the Impact of Monetary Policy on Financial Stability through Non-Performing Loans

This study investigates the relationship between monetary policy and financial stability by examining non-performing loans (NPLs) as a key indicator of credit risk in nine Southeast European countries over the period 2007–2022. The empirical framework is built on an unbalanced panel dataset and employs fixed effects (FE) estimation, feasible generalized least squares (FGLS), and panel-corrected standard errors (PCSE) to address potential econometric challenges and enhance the robustness of results. The findings reveal that lending interest rates are a significant determinant of NPLs, indicating that tighter monetary conditions increase repayment burdens and amplify credit risk. By contrast, the official exchange rate does not show a consistent effect on loan performance, a result that may reflect relative stability in currency markets and the presence of regulatory safeguards in the region. An unexpected but noteworthy outcome is the negative association between unemployment and NPLs, which could be attributed to more cautious borrowing behaviour in periods of economic uncertainty and the role of government support mechanisms. These results highlight the complex transmission channels through which monetary policy interacts with financial stability, while also underscoring the importance of country-specific conditions in shaping these dynamics. The study contributes to the literature by providing evidence from a region marked by transition, crisis episodes, and external vulnerabilities, offering insights into how monetary policy can be calibrated to safeguard the resilience of the banking sector.