Abstract:
Banking sector development (BSD) is deemed to be a fundamental force for the
acceleration of economic growth (EG). Financial sector, including banking sector,
was dramatically hit by numerous scandals which caused the financial crisis and its
consequences have brought a rapid decline in the economic growth of the world
during the past decade. Since then financial and regulatory authorities have been
focusing on innovative solutions to cope with the negative consequences of the
banks’ impact on global economy. Empirical findings have showed that BSD and its
role in EG are still contradictory to each other. However, endogenous growth model
has brought a new perspective for EG which is resulted by investment in human
capital, innovation and knowledge within the economy rather than exogenously.
With this background, this study explores the determinants of the BSD and its direct
and indirect effects on EG for 18 countries during the period of 2006 to 2014. To
explore the results, Two-Step System-Generalized Method of Moment (GMM)
estimation is used to explore the impact of the determinants on the BSD. Then, a
Structural Equation Model (SEM) is developed to represent the direct and indirect
relationship among channel variables, economic growth and BSD estimated by
Three-Stage Least Squares (3SLS) estimation technique. To investigate the
mediating effect of BSD on EG, four channels of physical investment, human capital,
technology and good governance are theoretically identified. Further, four
indicators of the BSD, bank intermediation (IM), bank broad access (BA), bank
profitability (PF) and bank liquidity (LQ), were chosen. The 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. The results indicate
that though bank access (BA) has been improved, economic growth has decreased
while other results are statistically insignificant. However, bank intermediation
(IM) has caused a mediating effect on economic growth in a negative manner, while
bank broad access (BA) has caused a mediating effect on economic growth
positively through human capital. Since, bank intermediation and bank access have
created credit facilities and hassle-free banking facilities towards the business
organizations and individuals out of which they have invested to develop a skilled
labour providing trainings and higher education opportunities which have
ultimately influenced 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 by
banks to become efficient intermediates in the financial systems.