Abstract

A more regulated and better working financial sector contributes toward achieving monetary growth based on proficient resource allocation and reducing information asymmetries. Current trends in research highlight the significance of factors determining the financial sector’s development; therefore, this study explores the institutional drivers, which are indispensable for developing the financial industry in the South Asian Association of Regional Cooperation (SAARC) region. Specifically, it examines the impact of institutional factors, trade openness, real output, legal origin, and inflation on the financial sector’s development. By employing the panel data method of generalized method of moments (GMM), the study concluded that trade openness, institutional factors, legal origin, and real gross domestic product (GDP) have a positive and significant impact on financial depth. However, the inflation rate has been found to affect it negatively. Finally, the study presents policy recommendations based on empirical findings.

Highlights

  • Over the past two decades, researchers and policymakers worldwide have developed a renewed interest in developing the financial sector to encounter long-run financial development

  • Ayadi and Gadi (2013), a strong proponent of the stock market and banking sector’s growth, anticipated that the financial sector development is a crucial determinant for catalyzing monetary progression and a significant source of stimulating economic opportunities

  • Since the financial sector development positively impacts gross domestic savings (GDS), Figure 1 reports GDS trends as a gross domestic product (GDP) share, which remained stagnant at 22% from 1995 to 2000

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Summary

Introduction

Over the past two decades, researchers and policymakers worldwide have developed a renewed interest in developing the financial sector to encounter long-run financial development. In the perspective of real output growth, among many policy initiatives, bank and stock market development have been regarded as a pre-condition, in the case of emerging and underdeveloped countries (Levine & Zervos, 1998). Ayadi and Gadi (2013), a strong proponent of the stock market and banking sector’s growth, anticipated that the financial sector development is a crucial determinant for catalyzing monetary progression and a significant source of stimulating economic opportunities. Levine (2003) discussed how finance enhanced development and proposed that the finance-growth nexus works through various channels. The literature demonstrates four competing arguments in favor of finance-growth relation, that is, Financial Services Theory, Market based theory, Law and Finance Theory, and Bank based theory (Merton & Bodie, 1995; Kose et al, 2009).

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