Role of Financial Sector in

Economic Growth

Noureen Adnan

Outline

• Introduction• Financial development index & growth• Existing Literature• My contribution• Variables• Data, sources & methodology• Empirical results• Conclusion

2

Introduction

Developed Financial System

Promote Savings , offers hedging and diversification

Promote Savings , offers hedging and diversification

More funding to Private sector

More funding to Private sector

Reduce information, monitoring & transaction costs

Reduce information, monitoring & transaction costs

Economic Growth

Economic Growth

3

Financial Development index and Economic Growth (2008)

Authors Date

Number of Countries

Data Range

Frequency

Methodology Main results

Goldsmith 1969

35 1860-1963 Annual Cross country regressions

Rough parallelism viewed Positive

Atje & Jovanovic

1993

40 1960-1985 Annual Cross country regressions

Positive in favor of market based

financial system

Levine & Zervos

1996

41 1976-1993 Annual Cross country regression

Positive in favor of market based

financial system

Ross Levine 1997

77 1960-1989 Annual Cross country regressions

Positive

Levine & zervos

1998

24 1976 Averaged1997-851986-93

Pooled dataCross country

regression

Positive

Ross Levine 1999

71 1960-1995 Annual Cross country regression

positive

Existing Literature

Existing Literature Authors Date Number

of Countries

Data Range

Frequency Methodology Main results

Rajan & Zingales 1998 41 1980-1990

Annual RegressionsFixed effects

Positive

Claessens et al 2000 80 1988-1995

Annual Cross country regressions

Financial liberalization

positively effect growth

Carkovic &Levine 2002 40-54 1975-1988

5 yr average

Generalised Method of Moments

Cross country regressions

Strong positive

Arestis & Luintel 2001 5 1972-1999

Annual Vector auto regressive (VAR)

Positive in favor of bank based

financial system

Caporale et al 2004 7 1977-1998

Annual Cross country regressions

Positive in favor of market

based financial system

James & McKibbon 2006 Malaysia 1960-2001

Annual Cointegration testsLikelihood Ratio Tests

Lagrange Multiplier Tests

Reverse causality Found

No Long run relationship

My contribution

•Length of data

•Examined at levels

•Stationary series

•Growth rates

Variables

Financial development indicators

Bank: is the extent to which the central bank versus commercial banks is distributing credit

Depth: Depth measures the size of financial intermediaries and it is equal to the liquid liabilities of the financial system divided by GDP.

Privy: is the allocated credit to private enterprises divided by GDP.

Turnover ratio: is the total value of shares traded on country’s stock exchange divided by the stock market capitalization.

Value traded Ratio: is the ratio of total value of shares traded on a country’s stock exchanges divided by GDP

Financial development indicators

ESDS Data SetsIMF International Financial Statistics World Bank Development Indicators

• GDP (constant dollars)

• GDP per capita

• Banking Development indicators

• Inflation

• Fiscal to GDP (Government final consumption expenditure )

• Trade to GDP (sum of exports and imports to GDP)

Other Data Sources

• Ross Levine’s Data Sets

• Rogoff’s Data Sets

Sample

• Panel data sets

• 1960-2006

Methodology

• Panel data fixed effects, least square dummy

variables

• IPS unit root tests

• Two stage least squares

Variable Expected signs

Bank +

Depth +

Privy +

Turnover Ratio +

Value traded ratio +

Model used for LSDVGit = αi + β’ Fit + ξit i= 1, …, N ; t= 1, …, T

Control Variable Expected signs

Inflation -

Trade to GDP +

Fiscal to GDP +

Exchange Rate regimes +

LSDV ResultsDependent Variable Real GDPFinancial indicators & control variables

All Low income Low mid income

Upper mid income High income

C 25.0527* 24.8963* 24.6573* 24.8815* 26.1523*

(0.0000) (0.0000) (0.0000) (0.0000) (0.0000)

Bank 0.1580* 0.0310 0.2811* 0.1519 1.0464*

(0.0003) (0.5879) (0.0009) (0.1354) (0.0001)

Depth 0.2490* 0.2905* 0.2848* 0.3381* 0.4050*

(0.0000) (0.0035) (0.0000) (0.0000) (0.0000)

Privy 0.0778* 0.0277 -0.0674** 0.1608* 0.1385*

(0.0003) (0.6850) (0.0488) (0.0010) (0.0001)

Turnover Ratio -0.0501* -0.0859* -0.0963* 0.0396** -0.1242*

(0.0000) (0.0006) (0.0000) (0.0494) (0.0000)

Value Traded Ratio 0.0945* 0.1823* 0.1065* 0.0213 0.1224*

(0.0000) (0.0000) (0.0000) (0.1759) (0.0000)

Inflation -0.0207* -0.0063 -0.0197** -0.0268** -0.0200

(0.0010) (0.7139) (0.0311) (0.0416) (0.1405)

Fiscal_GDP -0.0094* -0.0049 -0.0116* -0.0104* -0.0169*

(0.0000) (0.1997) (0.0002) (0.0196) (0.0051)

Trade_GDP 0.0045* 0.0051* 0.0011 0.0060* 0.0037*(0.0000) (0.0000) (0.2464) (0.0000) (0.0000)

Exchange rate regime 0.0229* -0.0685 0.0063 0.0128 0.0555*

(0.0337) (0.1947) (0.7709) (0.6191) (0.0001)

All the variables are in terms of natural log

LSDV ResultsDependent Variable Dlog Real GDPFinancial indicators & control variables

All Low income Low mid income

Upper mid income High income

C 0.0657* 0.0282 0.0779* 0.1395* 0.1319*

(0.0000) (0.4259) (0.0000) (0.0000) (0.0000)

Bank 0.0373* 0.0104 0.0921* 0.0654 0.2622*

(0.0007) (0.4340) (0.0008) (0.1523) (0.0000)

Depth -0.0543* -0.0659*** -0.1543* 0.0188 -0.0629*

(0.0004) (0.0849) (0.0000) (0.5159) (0.0043)

Privy 0.0049 -0.0215 0.0391** -0.0330 0.0099

(0.6425) (0.5230) (0.0368) (0.1672) (0.5052)

Turnover Ratio -0.0033 -0.0082 -0.0048 0.0094 -0.0145*

(0.2760) (0.3354) (0.3993) (0.1170) (0.0077)

Value Traded Ratio 0.0071** 0.0095 0.0075 -0.0017 0.0134*

(0.0113) (0.2299) (0.1762) (0.7557) (0.0022)

Inflation -0.0047* -0.0068** -0.0071* -0.0002 -0.0023

(0.0011) (0.0578) (0.0086) (0.9560) (0.2824)

Fiscal_GDP -0.0014* 0.0004 -0.0002 -0.0031* -0.0052*

(0.0016) (0.6847) (0.7677) (0.0016) (0.0000)

Trade_GDP 0.0001*** 0.0006* 0.0000 0.0000 0.0000

(0.0959) (0.0049) (0.9382) (0.6993) (0.8687)

Exchange rate regime -0.0092* -0.0137 -0.0197* -0.0217* -0.0030

(0.0000) (0.3457) (0.0002) (0.0004) (0.1596)

All the variables are in terms of natural dlog

Two stage least squaresDependent Variable Dlog Real GDPFinancial indicators & control variables

All Low income Low mid income

Upper mid income High income

C -0.0045 -0.0710 0.1033 0.0334 -0.009824

(0.8595) (0.7676) (0.3653) (0.5949) (0.9115)

Bank 0.1097 -0.0908 -0.0410 0.3371 0.916967

(0.1187) (0.7292) (0.7625) (0.1231) (0.0252)**

Depth -0.2179 -0.2051 -0.7148 -0.1263 -0.283306

(0.1293) (0.6474) (0.3464) (0.3643) (0.3055)

Privy 0.2476* 0.2673 0.2769*** 0.1205 0.171019

(0.0031) (0.7159) (0.0654) (0.2259) (0.2505)

Turnover Ratio 0.0019 0.0054 0.0308 0.0325 0.007211

(0.9253) (0.961) (0.3787) (0.2129) (0.8093)

Value Traded Ratio 0.0132 -0.0775 -0.0515 -0.0249 -0.013821

(0.6629) (0.6644) (0.3708) (0.5647) (0.7223)

Inflation 0.0008 -0.0006 0.0019 0.0015 -0.000463

(0.4037) (0.9144) (0.5796) (0.6294) (0.8683)

Fiscal_GDP 0.0003 0.0005 -0.0002 -0.0000329 0.000411

(0.1557) (0.532) (0.8157) (0.8847) (0.3074)

Trade_GDP 0.0062 -0.0250 -0.0324 -0.0066 0.010118

(0.2871) (0.8001) (0.385) (0.6444) (0.2825)

Exchange rate regime -0.0054 0.0680 0.0058 0.0011 -0.000979

(0.2217) (0.6743) (0.6925) (0.8816) (0.8889)

All the variables are in terms of natural dlogAll variables are instrumented by their lagged values

Conclusion

It is found that the level of financial

development positively effect the level of

growth during the period of 1960 – 2006,

whereas the endogeneity could not be proved .

Future Aims

Construction of financial development index by using principal component .