Can Financial Development Cause Financial Instability?

The objective of this article consists to identify which determinants of financial development can cause financial instability and if these determinants depend on the economic development degree of the country. Based on a sample of 56 countries, including 22 developed countries and 32 emerging countries over the period of 1960-2014, we test the role of the financial development measured by financial intermediation, financial market capitalization and financial liberalization, on the occurrence of financial instability. Using a dynamic panel techniques, GMM SYSTEM estimator, our results show that financial intermediation increase financial instability in advanced and emerging countries. However, financial liberalization decrease financial instability in developed economies, and increase it in emerging ones, depending on the degree of financial innovation. Additionally, the quality of regulation plays an important role in stabilizing emerging countries. These results have important implications for financial regulation policies