The Causal Nexus between Bank Lending and Economic Growth in Bangladesh: The Vector Error Correction Model Approach

In Bangladesh, banks are crucial for driving economic activities by channeling funds. This makes it essential to understand how bank lending impacts growth. This study offers valuable insights for policymakers to fine-tune financial policies, supporting stable and sustainable development. It delves into the intricate relationship between bank lending and the growth of economy of Bangladesh, emphasizing both short- and long-term effects. This paper looks at the causal relationships between bank lending and economic growth in Bangladesh, focusing on both short-term and long-term effects. To achieve the objectives of this study, time series econometric such as unit root test, Johansen Cointegration test, Vector Error Correction Model (VECM), and Granger causality test are followed. Outcomes from the stationarity test show that all data series become stationary at their first difference. The Johansen Cointegration test confirms a long-term relationship among the variables, while the VECM highlights a bidirectional causal link between bank lending and economic growth over the long term, where causality runs both from GDP to bank lending and vice versa. However, in the short term, no direct causal link is found between GDP and bank lending to the private sector. The study also finds that bank credit may impact GDP indirectly through investment rates, though GDP itself doesn’t immediately affect bank lending in the short run. These insights help shed light on the magnificent role of financial sector in supporting Bangladesh’s economic growth. Its findings can help shape financial reforms to achieve the country’s goal of reaching middle-income status.