Financial Intermediation And Economic Growth: A Comparative Study

This study undertakes theoretical and empirical investigation into the link between financial intermediation development and economic Growth. The current study seeks to find answer about the causality between financial intermediation and growth as a comparative study between Sri Lanka and China for the period since1978. Moreover, it seeks s to identify basic determinants of financial intermediation and economic growth. This study investigates the impact of financial intermediation on economic growth by examining the commercial banking sector. The conceptual framework of the study assumes that financial intermediation promotes economic growth. The findings of the study will enrich empirical literature and provide guidelines for rational policy formulation and implementation in order to develop financial development for achieving sustainable economic growth.The study incorporates macro approach to capture the available empirical data. The empirical data covered the period1978-2009. The non availability of some Chinese data caused to limit the study period from1990-2009. Moreover, the study had to use some proxy variables to represent financial intermediation variables due to lack of data. The analysis of the study will broadly carried out on the basis of deductive research methodology. That is the investigation will start with formulation of the relevant theoretical framework and match the theory with available information. Accordingly, study develops a general model for financial intermediation and growth and subsequently this model applies to country specific analysis for the comparative purpose. The final results are obtained using time series econometrics analysis which involves unit root, cointegration and causality tests.The theoretical literature on financial intermediation classified under traditional and modern theory of financial intermediation and growth. Although, traditional theories do explain an important thing about finance-growth link but fails to identify other important factors in financial intermediation in the current global environment. And those factors are taken into account in the modern theories of financial intermediation and growth. As such, study highlights the importance of more integrated approach in order to explain finance-growth nexus in developing countries. The development of general model on financial intermediation provides the basis for the integrated approach. Further, literature identified two basic approaches on finance-growth nexus, namely supply leading and demand following approach. It can be seen that literature has given more support to the supply leading approach which highlight the causality runs from finance to growth.The development of financial sector is impressive during the post liberalization period in both countries. There is a dramatic expansion in the financial sector via institutional development, market and instruments. Further, the policy changes in the financial sector with more market orientation contributed positively to the financial development in both countries. The comparative analysis reveals that financial sector development in China is higher than Sri Lanka. The study reveals that economic growth occurred with the rapid structural transformation after implementing economic and financial reforms in both countries. But, China has maintained leading growth rate throughout the period of study.The study develops an index system using principle factor component analysis in order to measure the level of financial intermediation development for the comparative purpose. It reveals that the level of financial development is high in China compared with Sri Lanka. But, most keen feature is that the relevant index for China has continuously declined while moderate growth in Sri Lanka.The findings of the study confirmed that broad money to GDP ratio, national savings, real interest rate, external assets, public borrowings, interest rate spread, and inflation rate as major determinants of financial intermediation in Sri Lanka while for China, all the above variables except interest rate spread and inflation are significant in determining financial intermediation development. Moreover, study confirmed a weak positive relationship between financial intermediation and economic growth in Sri Lanka. But, unlikely to the hypothesis, financial intermediation negatively related to growth in China based on the data set used in the study. Moreover, real investment, government expenditure, foreign trade has far more positive impact on growth performance in both countries. But, the causality test confirmed that government expenditure and inflation rate granger caused to economic growth but, there is no causal impact from financial intermediation to growth in both countries. The present study is an innovative one on financial intermediation and economic growth between China and Sri Lanka. The literature on financial intermediation is classified into traditional theory and modern theory on a rational basis and finally tries to integrate literature through general model. The development of general model is stylized contribution of this study aiming to explain country specific variation of financial intermediation by general to specific approach. And it also invented an index system to measure financial intermediation development for the comparative purpose.Finally, study highlights the future line of research on this line of thinking. Accordingly, it highlights the importance of having study on micro level financing, role of non banking sector in financial intermediation, measuring the efficiency of the financial system during the reform period, importance of stock market development in economic growth and more extensive study on macro environment and financial development.