The moderating role of governance, banking regulation, and supervision on shadow economy, financial inclusion, and financial stability nexus: a case of G5 economies

The present study investigates the moderating role of institutional quality, governance, and banking regulation on the nexus of the shadow economy, financial stability, and financial inclusion across G5 economies. In order to accomplish the aforementioned objectives, we have utilised a comprehensive range of econometric tests, including the Breusch-Pagan LM and Pesaran's tests, second-generation unit roots tests, Westerlund cointegration tests, cross-sectional autoregressive-distributed lag (CS-ARDL) estimates, the system generalised method and moments, and the Konya causality test. The empirical outcome reveals that both financial inclusion and the shadow economy increases financial sector instability. However, governance indicators and banking regulation moderate these effects, suggesting their crucial role in stabilising financial sectors. Additionally, the study also confirms that financial inclusion reduces the size of the shadow economy in G5 countries. Furthermore, interaction effects reveal that when governance and banking regulation interact with financial inclusion, it exacerbates the negative impact of financial inclusion on the shadow economy, implying that it assists in reducing the size of the shadow economy. The Konya bootstrap causality test confirms bidirectional causality among the shadow economy, financial stability, financial inclusion, and economic growth. This research underscores the importance of effective governance and regulatory frameworks in managing financial stability and promoting inclusive growth, offering significant insights for policymakers and researchers alike.