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Financial stability refers to a state where the financial system functions effectively and efficiently. This encompasses the stability of financial institutions, markets, and infrastructure that support the economy. In a financially stable environment, institutions can operate without significant disruptions, ensuring that capital flows smoothly. Furthermore, financial stability is vital for maintaining investor confidence and enabling economic growth.

The other options, while related, do not capture the full essence of financial stability. For instance, the ability of the economy to maintain full employment is an important economic goal but does not solely define the stability of the financial system. Having zero failed loans is not a realistic or necessary condition for financial stability, as some level of loan defaults can occur in healthy financial systems. Lastly, the condition where all borrowers can repay debts on time is an ideal scenario that does not always reflect the operational reality of a dynamic financial system.