Financial sector development in East Africa: Determinants, trend, and regional progress

This study examines the determinants, trends, and regional progress of financial sector development in seven East African countries from 1990 to 2023. Grounded in financial development theory, a composite index of financial development (FSDI) is constructed using Principal Component Analysis (PCA) to capture multidimensional aspects of financial access, depth, efficiency, stability, and liberalization. The study employs dynamic heterogeneous panel estimators, including mean group, pooled mean group, dynamic fixed effect, fully modified ordinary least square, canonical co-integration regression, feasible generalized least square, along with augmented mean group and common correlate effect mean group estimators to analyze both short-run and long-run relationships with economic and institutional factors. Results reveal significant disparities, with Kenya recording the highest index (0.72) and Sudan the lowest (0.22); followed by Burundi (0.66), while Rwanda, Ethiopia, Uganda, and Tanzania exhibit moderate development (0.49–0.30). In the long run, financial development is positively influenced by government consumption, bank deposits, gross domestic savings, corruption control, and remittances, whereas high lending interest rates constrain growth. In the short run, economic growth and bank deposits remain key contributors. Methodologically, the study contributes by integrating PCA-based index construction with dynamic heterogeneous panel estimation, providing robust insights into country-specific and regional dynamics. Policy recommendations include promoting domestic savings and investment, strengthening governance and anti-corruption measures, improving formal financial inclusion, managing interest rates prudently, and harnessing remittance flows to foster a more inclusive, resilient, and sustainable financial sector across East Africa.