The Fragility of Prosperity: How Economic Sophistication Undermines Banking Resilience in Advanced Economies

ABSTRACT

This study examines the complex relationships between productive sophistication, societal well‐being, corporate sustainability practices and the stability of the financial sector across three major Western countries. Using extensive panel data from 320 publicly traded financial institutions in Canada, the United Kingdom and the United States between 2010 and 2022, we analyse both micro‐level equity performance measures (buy‐and‐hold returns) and macro‐level stability indicators ( z ‐scores) to evaluate banking sector health. Our framework, based on Hofstede's cultural typology, confirms that the selected countries share similar institutional and behavioural traits, reducing concerns about unobserved structural differences biasing our results. Through rigorous econometric analysis using ordinary least squares and feasible generalised least squares for robustness, we find a surprising paradox: while advanced productive structures promote national prosperity, they also create vulnerabilities within the banking system. Specifically, we observe a strong negative link between economic complexity indices and both types of bank performance, indicating that the features enabling advanced economies, such as sectoral interdependencies, rapid innovation and complex financial products, also introduce coordination challenges and contagion risks that banks struggle to absorb. Conversely, indicators of national happiness and ESG (Environmental, Social and Governance) scores consistently correlate with greater financial stability, suggesting that social trust and responsible governance act as buffers against systemic risks. Notably, we develop and empirically test a new interaction between a country's well‐being and investor climate sentiment, which shows counterintuitive negative effects on banking outcomes. This suggests that optimism combined with climate‐related fears can lead to sentiment‐driven mispricing, weakening rather than strengthening financial resilience. Our study advances the literature in three key ways: first, by highlighting economic complexity as a crucial macro‐structural factor influencing banking risk; second, by demonstrating that ESG and societal happiness serve as stabilisers in complex economies; and third, by identifying the limits where positive social conditions do not automatically translate into financial stability. These insights carry important policy implications, indicating that efforts to strengthen financial sectors should incorporate sustainability initiatives, well‐being considerations and targeted regulation to address systemic risks inherent in highly developed economic systems.