Financial development as a concept is multifaceted with no clear measurement or definition. Inference via individual proxies may result in an incomplete understanding of the relationship between financial development and economic growth, since sole proxies are unlikely to capture the true capacity of financial development. To address this issue, this paper utilizes a multiple indicators multiple causes (MIMIC) model to create a more complete measure of financial development. In doing this, we treat banking sector and stock market developments as two latent indicators of financial development and use the MIMIC model to predict them which are used as their proxies. Using data from 101 countries over the period 1990–2014, we use the predicted values of the two latent variables as regressors, among other controls, in the growth regression. We find a robust negative relationship between banking sector development and economic growth, whereas the effect of stock market development on economic growth is positive up to a threshold after which the effect becomes negative.
This is a preview of subscription content, access via your institution.
Buy single article
Instant access to the full article PDF.
Tax calculation will be finalised during checkout.
Subscribe to journal
Immediate online access to all issues from 2019. Subscription will auto renew annually.
Tax calculation will be finalised during checkout.
Financial depth in general refers using private credit as a fraction of GDP as a measure; but the concept of financial development is much broader (see de la Torre et al. 2011 for details).
For details see Levine (2002).
Differently, Rose and Spiegel (2012) used the MIMIC model to examine the causes and consequences of 2008 financial crisis.
See Čihák et al. (2012) for details and various update of the same data set over the years.
For both banking sector and the stock market, we used different indicators to measure depth and efficiency. The results remain qualitatively similar to those reported in the paper.
For details on these indicators and classification, see Čihák et al. (2012).
The reasons for not including accessibility measure as accessibility are completely different from the other measures that have been used.
These income groups are defined in the World Bank database.
In our sample, around 31% of observations has stock market turnover higher than the overall average, whereas 50% of observations is above the median.
Results are not reported here to save space but are available from the authors upon request.
Arcand JL, Berkes E, Panizza U (2012) Too much finance? IMF Working Paper 12/161
Arellano M, Bover O (1995) Another look at the instrumental-variable estimation of error-components models. J Econom 68:29–52
Arestis P, Demetriades P (1997) Financial development and economic growth: assessing the evidence. Econ J 107: 783–799
Arestis P, Demetriades PO, Luintel KB (2001) Financial development and economic growth: the role of stock markets. J Money Credit Bank 33:16–41
Beck T, Levine R (2004) Stock markets, banks, and growth. J Bank Finance 28:423–442
Beck T, Levine R, Loayza N (2000) Finance and the sources of growth. J Financ Econ 58:261–300
Beck T, Buyukkarabacak B, Rioja F, Valev N (2008) Who gets the credit? and does it matter? household vs. firm lending across countries. Policy Research Working Paper Series 4661, The World Bank
Bencivenga V, Smith BD (1991) Financial intermediation and endogenous growth. Rev Econ Stud 58:195–209
Bhide A (1993) The hidden costs of stock market liquidity. J Financ Econ 34:31–51
Blundell R, Bond S (1998) Initial conditions and moment restrictions in dynamic panel data models. J Econom 87:115–143
Bollen KA (1989) Structural equations with latent variables. Wiley, London
Boot AW, Thakor AV (1997) Financial system architecture. Rev Financ Stud 10:693–733
Boyd JH, Smith BD (1998) The evolution of debt and equity markets in economic development. Econ Theor 12:519–560
Calderon C, Liu L (2003) The direction of causality between financial development and economic growth. J Dev Econ 72:321–334
Cecchetti SG, Kharroubi E (2012) Reassessing the impact of finance on growth. BIS working paper number 381
Čihák M, Demirgüç-Kunt A, Feyen E, Levine R (2012) Benchmarking financial development around the World.” World Bank Policy Research Working Paper 6175, World Bank, Washington, DC
Claessens S, Demirgüç-Kunt A, Huizinga H (2001) How does foreign entry affect the domestic banking system? J Bank Finance 25:891–911
de la Torre A, Ize A, Schmukler S (2011) Financial development in Latin America and the Caribbean: the road ahead. The World Bank Latin American and Caribbean Studies
Demetriades P, Law SH (2006) Finance, institutions and economic development. Int J Finance Econ 11:245
Demirgüç-Kunt A, Levine R (2008) Finance, financial sector policies, and long-run growth. World Bank Policy Research Working Paper No. 4469, World Bank, Washington, DC
Demirgüç-Kunt A, Córdova EL, Pería MSM, Woodruff C (2011) Remittances and banking sector breadth and depth: evidence from Mexico. J Dev Econ 95:229–241
Do Q-T, Levchenko AA (2004) Trade and financial development. Policy Research Working Paper Series 3347, The World Bank
Goldberger AS (1972) Structural equations methods in the social sciences. Econometrica 40:979–1001
Hanh PTH (2010) Financial development, financial openness and trade openness: new evidence. FIW working paper no. 60
International Monetary Fund (2015) Pan-African banks: opportunities and challenges for cross-border oversight, prepared by a staff team led by Charles Enoch et al., Washington, D.C., International Monetary Fund
Jansen MC, Murphy KJ (1990) Performance pay and top-management incentives. J Polit Econ 98:717–738
Joreskog KG, Goldberger AS (1975) Estimation of a model with multiple indicators and multiple causes of a single latent variable. J Am Stat Assoc 70:631–639
Joreskog KG, Sorbom D (1999a) LISREL 8: structural equation modeling with the SIMPLIS command language. Scientific Software International, Lincolnwood, p 9
Joreskog KG, Sorbom D (1999b) LISREL 8 user’s reference guide. Scientific Software International, Lincolnwood
King GR, Levine R (1993) Finance and growth: Schumpeter might be right. Q J Econ 108:717–737
La Porta R, Lopez-de-Silanes F, Shleifer A, Vishny RW (1998) Law and finance. J Polit Econ 106:1113–1155
Levine R (1997) Financial development and economic growth: views and agenda. J Econ Lit 35:688–726
Levine R (2002) Bank-based versus market-based financial systems: which is better? J Financ Intermed 11:398–428
Levine R (2005) Finance and growth: theory and evidence, chap 12. In: Aghion P, Durlauf S (eds) Handbook of economic growth, vol 1, vol 1. Elsevier, Amsterdam, pp 865–934
Levine R, Zervos S (1998) Stock markets, banks and economic growth. Am Econ Rev 88:537–558
Levine R, Loayza N, Beck T (2000) Financial intermediation and growth: causality and causes. J Monet Econ 46:31–77
Loayza N, Ranciere R (2006) Financial development, financial fragility and growth. J Money Credit Bank 38:1051–1076
Lucas R (1988) On the mechanics of economic development. J Monet Econ 22:3–42
Merton RC, Bodie Z (1995) A conceptual framework for analysing the financial environment. In: Crane DB et al (eds) The global financial system: a functional perspective. Harvard Business School, Boston
Miller MH (1998) Financial markets and economic growth. J Appl Corp Finance 11:8–14
Pesaran MH, Smith RP (1995) Estimating long-run relationship from dynamic heterogeneous panels. J Econ 68:79–113
Pesaran MH, Shin Y, Smith RP (1999) Pooled mean group estimation of dynamic heterogeneous panels. J Am Stat Assoc 94:621–634
Rajan RG (2005) Has financial development made the world riskier? NBER working paper no. 11728
Rioja F, Valev N (2004) Does one size fit all? An examination of the finance and growth relationship. J Dev Econ 74:429–447
Rodrik D (2008) Second-best institutions. Am Econ Rev 98:100–104
Rodrik D, Subramanian A (2009) Why did financial globalization disappoint? IMF Staff Papers 56:112–138
Rose AK, Spiegel MM (2012) Cross-country causes and consequences of the 2008 crisis: early warning. Jpn World Econ 24:1–16
Rousseau PL, Wachtel P (2002) Inflation thresholds and the finance–growth nexus. J Int Money Finance 21:777–793
Rousseau PL, Watchtel P (2011) What is happening to the impact of financial deepening on economic growth? Econ Inq 49:276–288
Saksonova S (2014) The role of net interest margin in improving banks’ asset structure and assessing the stability and efficiency of their operations. Proc Soc Behav Sci 150:132–141
Stiglitz J (1985) Credit markets and the control of capital. J Money Credit Bank 17:133–152
Stulz R (2002) Financial structure, corporate finance, and economic growth. In: Demirguc-Kunt A, Levine R (eds) Financial structure and economic growth: cross-country comparison of banks, markets and development. MIT Press, Cambridge, pp 143–188
Tobin J (1984) On the efficiency of the financial system. Lloyds Bank Rev 153:1–15
Conflict of interest
We declare that we have no conflict of interest.
This article does not contain any studies with human participants or animals performed by any of the authors.
Springer Nature remains neutral with regard to jurisdictional claims in published maps and institutional affiliations.
We would like to thank Bertrand Candelon, Editor-in-Chief and an anonymous referee for helpful comments.
About this article
Cite this article
Cave, J., Chaudhuri, K. & Kumbhakar, S.C. Do banking sector and stock market development matter for economic growth?. Empir Econ 59, 1513–1535 (2020). https://doi.org/10.1007/s00181-019-01692-7
- Financial development
- Economic growth
- Multiple indicators multiple causes