Implications of Fiscal Irresponsibility on Financial Stability

The connection between fiscal policy and financial stability has a two-direction nature. Irresponsible fiscal policy will initiate the consequences on the financial system, while crisis ituations in financial institutions will sometimes require government intervention. The goal of this paper is to research the nature of this relation in only one direction – from fiscal policy toward financial stability. The following channels of risk transmission are analyzed in theory: the exposure to government debt; the correlation between credit ratings of sovereign and financial institutions; the usage of government securities as collateral in numerous financial transactions between central banks and financial institutions and between financial institutions in private markets; the possibility of a government giving implicit and explicit guarantees which influence risk perception in the financial system; the macroeconomic environment as a reliable indicator of the way in which fiscal policy is conducted; atypical measures of fiscal policy that have direct effect on the financial balances of financial institutions. In addition, the problem is presented from another angle by analyzing this relation on the example of the EU countries. The importance of this topic is illustrated on Montenegro and Serbia case, as developing countries. It is concluded that the key risk to financial stability in these countries is situation in the macroeconomic environment, having in mind the most important consequences of fiscal irresponsibility.