Banking stability constitutes a critical foundation for preventing systemic financial risk and maintaining macroeconomic stability. Against the backdrop of evolving global income structures, the expansion or contraction of the middle-income group has become a key factor shaping aggregate demand, saving behavior, and financial stability. This paper therefore adopts the income share of the middle-income group as a core indicator to characterize the income distribution structure and investigates how changes in this share affect banking stability and its underlying transmission mechanisms.

Theoretically, this paper extends the financial fragility framework of Kumhof and Rancière (2015) by incorporating endogenous saving decisions of the middle-income group and an explicit banking sector, thereby constructing a general equilibrium framework linking income, saving, credit, and default. The model reveals that a decline in the income share of the middle-income group may simultaneously trigger two opposing mechanisms. Empirically, this paper tests the theoretical predictions using a panel dataset covering 58 countries over the period 2005–2022. A two-way fixed effects model with nonlinear terms is employed, complemented by instrumental variable and system GMM estimations to mitigate potential endogeneity concerns. In addition, a data-driven K-means clustering approach is used to classify countries according to the income structure and savings level, allowing for an examination of heterogeneous effects. The results indicate a significant nonlinear relationship between the income share of the middle-income group and banking stability. When the income share is relatively high or declines only moderately, the income effect associated with credit expansion tends to dominate, and banking stability may improve temporarily. However, once the income share falls to a sufficiently low level, default risk accumulates rapidly, the loss effect becomes dominant, and banking stability deteriorates significantly. Grouped regressions further show that in countries with lower middle-income shares, further declines are associated with a much faster deterioration in banking stability, reflecting heightened financial fragility.

This paper contributes to the literature in three ways: First, it extends research on banking stability by introducing an income-structure perspective and providing a unified framework linking household income distribution to financial stability. Second, it documents the nonlinear and stage-dependent relationship between the income share of the middle-income group and banking stability using cross-border evidence. Third, it offers policy implications for macroprudential regulation, suggesting that income distribution reforms and financial development should be jointly evaluated with careful attention to the interaction between middle-income group dynamics, saving buffers, and credit expansion.