Banking Sector Development and Economic Growth in Sri Lanka: An Econometric Analysis

Abstract

Purpose: This study aims to explore the role of the banking sector in elevating the economic growth of Sri Lanka by identifying the short-run and long-run relationship between banking sector development and economic growth in Sri Lanka.

Design/Methodology/Approach: This study uses annual data for the period 1960 to 2019 from World Bank's Global Financial Development Database and World Development Indicators. Odedokun's model, which assumes the causation between financial development to economic growth, is employed using the bound test within the ARDL framework.

Findings: The estimated long-term parameter of the banking industry development indicator was found to be positively affected economic growth by supporting supply-led growth model. The estimations of the Error Correction Model provide a broad picture of the short-term relationship, and the results are highly consistent with the results of the long-term model. Granger Causality test found that the banking sector development granger cause to the GDP indicating a unilateral relationship.

Originality: This study differs from the existing studies, which focus on the neoclassical one-sector aggregate production model. Financial development is input along with other real sector variables to identify the short-run and long-run relationship with the help of a newly developed econometric approach.