Abstract
This study examined the relationship between financial innovation and economic growth in Bangladesh, India, Pakistan, and Sri Lanka for the period Q1 1975 to Q4 2016. The autoregressive distributed lag (ARDL) bounds test was used to gauge long-run relationships, and the nonlinear ARDL (NARDL) test was used to explore asymmetry between financial innovation and economic growth in the sample of Asian countries. The findings from the bounds tests revealed long-run cointegration between financial innovation and economic growth in the sample countries. Furthermore, NARDL confirmed that positive changes in financial innovation linked positively with economic growth and vice versa in the long run. In the short run, however, the study found mixed behaviors in the case of positive and negative changes in financial innovation. To investigate directional causality, the Granger causality test under an error correction model was employed. The Granger causality results supported the feedback hypothesis in both the long run and short run. Thus, financial innovation boosts economic growth in the long run by stimulating financial service expansion, financial efficiency, capital accumulation, and efficient financial intermediation, which are essential for sustainable economic growth.
Highlights
In Schumpeter’s development theory, finance and efficient financial institutions are crucial for sustainable economic growth, assuming that credit, money, and finance influence innovation processes (Knell 2015)
We found that financial innovation (FI), trade openness (TO), gross capital formation (GCF), and domestic credit to private sector (DCP) explained economic growth in Bangladesh by 86%, India by 79%, Pakistan by 89%, and Sri Lanka by 83%, and the remaining variation was explained by the error correction term
The present study investigated long-run cointegration between financial innovation and economic growth along with a set of macroeconomic variables for the period Q1 1975 to Q4 2016
Summary
In Schumpeter’s development theory, finance and efficient financial institutions are crucial for sustainable economic growth, assuming that credit, money, and finance influence innovation processes (Knell 2015). Financial innovation assists financial development through the expansion of financial services by offering new financial products, optimizing economic resource mobilization through efficient payment mechanisms, reducing investment risks, and accelerating capital formation. The supply-leading hypothesis suggests that financial innovation can positively affect a country’s economic growth (Beck 2010) This hypothesis suggests that financial innovation in a financial system accelerates economic growth by expediting the process of capital accumulation, enhancing efficiency in financial institutions, improving financial services, and making financial intermediation more efficient. The demand-leading hypothesis suggests that economic growth attracts financial innovation in an economy This hypothesis suggests that the expansion of economic activities, real sector development, and increased domestic and international trade place pressure on financial systems to improve payment mechanisms, make financial institutions more efficient, and diversify financial assets to reduce investment risks. Financial innovation expedites the overall performance of financial systems through the emergence of new financial institutions, financial instruments, and new channels for providing services to an economy (Bourne and Attzs 2010)
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