Banking sector development on economic growth: structural equation approach

Abstract

Banking sector is an important segment of an economy. Financial and regulatory authorities have been stressing the requirements to cope with the unforeseen consequences on financial systems, banks and economic growth globally. This study explores the determinants of the banking sector development (BSD) and direct and indirect effect of the BSD on economic growth of 18 countries for the period of 2006 to 2014. As per the objectives, Two-Step System-Generalized Method of Moment (GMM) estimation used to explore the determinants of the BSD. To explore the direct and indirect effect of the BSD on economic growth, Three Stage Least Square (3SLS) estimation is used. Four indicators of the BSD, (i) bank intermediation (IM) proxied by private credit by deposit money bank to GDP, (ii) bank broad access (BA) proxied by commercial bank branches per 100,000 adults, (iii) bank profitability (PF) proxied by banks return on assets and (iv) bank liquidity (LQ) proxied by banks liquid assets to deposit were identified. Study found that BSD was determined by economic growth (EG), interest rate (IR), trade liberalization (TL), financial liberalization (FL) and governance infrastructure (GVI) explored by the first principal component of the six governance indicators. Results of the direct effect on economic growth indicates that per capita commercial bank branches have significantly influenced to the economic growth. The indirect results showed that human capital development of the selected countries has significantly cared the economic growth effects of the IM and BA out of the four models. Since, improved bank intermediation and bank access have allowed flowing credits and reliable banking facilities to the entrepreneurs and individuals for the investment on skilled labour by way of trainings and higher education opportunities which have ultimately improved the economic growth endogenously. The study suggested that governments and monetary authorities must review the policies towards the hassle-free financial access and prioritize the productive investment ventures when providing bank facilities towards the economic growth.