Developing a Financial Stress Index for the Nigerian Financial System

Due to the huge economic and social cost of the global financial crisis (GFC) on the financial system, central banks and other stakeholders in charge of managing financial stability have focused their efforts on the development of instruments and methodologies that will be useful in identifying, assessing, and monitoring potential vulnerabilities in the financial system. Prominent among these efforts is the construction of a composite index known as the financial stress index (FSI). The FSI is a single aggregated indicator constructed to measure the vulnerability of the financial sector to both internal and external shocks. This study employed the variance equal weighing (VEW) and the principal component analysis (PCA) to construct an FSI for the Nigerian financial market. The result of the analysis shows that financial stress can be identified by the FSI. The study recommended regular assessment of the financial system so that potential threats can be detected early and measures put in place to mitigate their impact.