Volatility in the Banking Sector: A Multivariate Study of FPI and Key Economic Indicators

Abstract

The increasing integration of global financial markets has made emerging economies more vulnerable to cross-border capital movements, especially Foreign Portfolio Investment (FPI). In countries like India, where the banking sector forms a critical pillar of the financial system, the volatility induced by sudden FPI inflows or outflows poses a serious challenge to financial stability. Moreover, macroeconomic conditions such as inflation, interest rates, and exchange rate further compound this volatility. Despite the significance of these variables, limited empirical research has holistically examined how FPI and key economic indicators together influence volatility in the banking sector. This study has investigated the impact of Foreign Portfolio Investment (FPI) and key macroeconomic indicators on volatility in the banking sector. Using a multivariate analytical framework, the research has analyzed the interplay between FPI flows and variables such as interest rates, inflation, and exchange rates. The findings reveal that fluctuations in FPI significantly influenced banking sector volatility, often amplifying market uncertainty during periods of economic or political instability. Additionally, macroeconomic indicators play a critical role in shaping investor behavior and sector performance, with all variables exhibiting stronger correlations with volatility. The study concludes that while FPI has enhanced market liquidity, it has also introduced risks that required careful management through effective regulatory oversight and sound economic policy. The insights provided by this research aimed to assist policymakers and financial institutions in developing strategies to mitigate risk and promote stability within the banking sector.