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Does Nepal's Financial Structure Matter for Economic Growth?

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  • Ram Sharan Kharel Ph.D.

    ()

  • Dilli Ram Pokhrel Ph.D.

    ()
    (Nepal Rastra Bank)

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    Abstract

    Despite causality debate, a number of empirical literatures (Pagano, 1993 and Levine, 1997, among others) suggest a positive relationship between financial sector development and economic growth. Moreover, there remains further debate whether the country's financial structure exerts differential impact on economic growth. Empirical studies across the countries (Rajan and Zingales, 1999 and Arestis et. al. 2004) suggest that banking sector plays a key role in some countries while the capital market has a lead position in others for enhancing economic growth. In this context, this paper investigates the relative merits of banking sector vs. capital market in promoting economic growth in Nepal. The empirical results using Johansen's cointegrating vector error correction model based on aggregate annual data from 1993/94 to 2010/11 suggest that banking sector plays a pivotal role in promoting economic growth compared to capital market in Nepal. The role of capital market seems to be insignificant. It may be either the size of market is too small to seek the relationship or it is weakly linked to real economic activities. Our result is consistent with the earlier findings in other countries and it has two important implications. First, the policy should focus on banking sector development by enhancing its quality and outreach as it promotes economic growth. Second, in line with the banking sector, the scope of capital market should be further expanded to real economic activities to channelize its impact on growth.

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    Bibliographic Info

    Paper provided by Nepal Rastra Bank, Research Department in its series NRB Working Paper with number 10/2012.

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    Length: 13 pages
    Date of creation: Jul 2012
    Date of revision:
    Handle: RePEc:nrb:wpaper:nrbwp201210

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    Web page: http://www.nrb.org.np/ecorev/
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    Keywords: Financial Structure; Bank vs. Capital Market-based Financial System; Economic Growth; Error Correction Model;

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    References

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    1. Arestis, Philip & Demetriades, Panicos O & Luintel, Kul B, 2001. "Financial Development and Economic Growth: The Role of Stock Markets," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 33(1), pages 16-41, February.
    2. Ross Levine & Norman Loayza & Thorsten Beck, 2002. "Financial Intermediation and Growth: Causality and Causes," Central Banking, Analysis, and Economic Policies Book Series, in: Leonardo Hernández & Klaus Schmidt-Hebbel & Norman Loayza (Series Editor) & Klaus Schmidt-Hebbel (S (ed.), Banking, Financial Integration, and International Crises, edition 1, volume 3, chapter 2, pages 031-084 Central Bank of Chile.
    3. Johansen, Soren & Juselius, Katarina, 1990. "Maximum Likelihood Estimation and Inference on Cointegration--With Applications to the Demand for Money," Oxford Bulletin of Economics and Statistics, Department of Economics, University of Oxford, vol. 52(2), pages 169-210, May.
    4. Allen, Franklin & Gale, Douglas, 1999. "Diversity of Opinion and Financing of New Technologies," Journal of Financial Intermediation, Elsevier, vol. 8(1-2), pages 68-89, January.
    5. Tadesse, Solomon, 2002. "Financial Architecture and Economic Performance: International Evidence," Journal of Financial Intermediation, Elsevier, vol. 11(4), pages 429-454, October.
    6. Veronika Dolar & Césaire Meh, 2002. "Financial Structure and Economic Growth: A Non-Technical Survey," Working Papers 02-24, Bank of Canada.
    7. Pagano, Marco, 1993. "Financial markets and growth: An overview," European Economic Review, Elsevier, vol. 37(2-3), pages 613-622, April.
    8. Ross Levine, 1997. "Financial Development and Economic Growth: Views and Agenda," Journal of Economic Literature, American Economic Association, vol. 35(2), pages 688-726, June.
    9. Johansen, Soren, 1988. "Statistical analysis of cointegration vectors," Journal of Economic Dynamics and Control, Elsevier, vol. 12(2-3), pages 231-254.
    10. Levine, Ross & Zervos, Sara, 1996. "Stock markets, banks, and economic growth," Policy Research Working Paper Series 1690, The World Bank.
    11. Demirguc-Kunt, Ash & Levine, Ross, 1996. "Stock Markets, Corporate Finance, and Economic Growth: An Overview," World Bank Economic Review, World Bank Group, vol. 10(2), pages 223-39, May.
    12. Johansen, Søren & Juselius, Katarina, 1992. "Testing structural hypotheses in a multivariate cointegration analysis of the PPP and the UIP for UK," Journal of Econometrics, Elsevier, vol. 53(1-3), pages 211-244.
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