Bank stability and insolvency risk in emerging markets: a dynamic panel approach with PCA‑based Z‑score

This study investigates the factors contributing to insolvency risk in Vietnamese commercial banks across different macroeconomic environments, emphasizing regulatory and stability implications for emerging markets. A composite Z-score, created using Principal Component Analysis (PCA), captures the multidimensional nature of risk. Dynamic panel estimations, particularly the System GMM approach, account for unobserved heterogeneity and potential endogeneity in bank risk. Key findings indicate that bank-specific factors significantly influence insolvency risk. Profitability (return on equity, ROE: −2.881) and capitalization (equity to total assets, ETA: −0.334) strengthen resilience, while lending activity (loan-to-deposit ratio, LDR: −0.171) and bank size (SIZE: −0.793) also contribute to stability. In contrast, inefficiency (cost-to-income ratio, CIR: +0.024) and inflation (INF: +0.040) increase vulnerability, highlighting the impact of internal weaknesses combined with adverse macroeconomic conditions. The regime-dependent estimations reveal that macroeconomic environments affect the relationship between bank fundamentals and insolvency risk. During stable periods (− 0.428) and in response to the COVID-19 shock (− 0.230), the sensitivity of insolvency risk to balance-sheet factors diminishes, suggesting that policy measures can temporarily alleviate risk. These findings have several regulatory and managerial implications, including the need for balanced capital regulation, sustainable profit targets, and prudent lending practices. Moreover, scenario-based macroprudential planning tailored to varying macroeconomic conditions is vital for ensuring financial stability in emerging markets. This study contributes to the literature by introducing a PCA-based composite Z-score as a comprehensive measure of insolvency risk, while also highlighting the influence of regime-specific macroeconomic conditions on risk transmission mechanisms. This enhances the scholarly understanding of financial stability in emerging economies.