Financial Sector Development and Economic Performance:The Role of Banks and Stock Market

The ‘consensus’ finding of the research on the relationship between financial development and economic growth is that financial development has apositive, monotonic effect on growth. The present paper proposes that the relationship between financial sector development and the level of real per capita GDP may not be uniform across countries. We empirically explore the causal link between the banking sector, stock market and real per capita GDP in 22 sample countries. To this effect, first we construct weighted average indices for measuring banking sector and stock market development and then relative importance of the variables objectively measured using the technique of Principal Component Analysis. Finally, were late two variables, one each from banking sector and stock market, to the real per capita GDP. The empirical investigation is carried out in a vector autoregression (VAR) framework based on the theory of cointegration and error-correction representation. Our finding neither fully supports the view "that finance leads to economic growth" nor does it totally subscribe to the opinion that finance is "an inconsequential sideshow". The role of banking sector is more prominent as a causal factor for economic performance.