Evaluating the Interrelationship between Actions of Latvian Commercial Banks and Latvian Economic Growth

Abstract

This paper aims to evaluate the existence of the interrelationship between Latvian commercial banks’ operations on the economy, based on economic theory and the analysis of banks’ retained earnings, credit growth and economic growth trends.The existence of this interrelationship was tested using Granger causality and Johansen co integration tests. The analysis was based on quarterly data from 2001 to 2015. The study reviewed several indicators for banking developments to establish their relevance for GDP growth: credit to non-banks, non-bank deposits and bank retained earnings. This paper finds that the empirical link between bank retained earnings and GDP growth is more robust that between credit growth and GDP growth, although this does not mean that credit growth is not important. The relationship is bidirectional – GDP growth has a significant effect of bank retained earnings and vice versa. The implication for banks is to continue optimizing their asset and liability structure and adjust to both current unprecedented monetary accommodation and its eventual unwinding.