The impact of financial systems on economic growth in European Union member countries

Abstract

Abstract As the economy develops, self-financed capital investments are less frequent, being replaced by financing through banking intermediation and later through capital markets. The development of financial systems has a positive effect on the mobilization of resources, improving corporate governance and risk management, leading to economic growth. The preponderance of previous research papers shows a positive relationship between financial development and economic growth. Studies using cross-sectional methodologies discover almost unanimously a positive link between financial development and economic growth, while studies with methodologies based on time series, panel data or case studies reach different conclusions depending on the period considered, the countries’ initial level of development and the structure of the financial systems. The purpose of this paper is to investigate the impact of financial systems on economic growth using panel regressions based on annual data regarding measures of financial development for the member countries of the European Union, for the period 1990-2020. The findings show that the development of the financial systems, through the activity of banks and capital markets, has a positive effect on the allocation of resources, the mobilization of savings and the efficient management of risks, leading in turn to economic growth if there is a correlation between the funds invested and the output of the real sector. The paper’s contribution to the field refers to the study of the long-term relations between the financial systems and the economic growth using data for all European Union countries, the findings helping to formulate public policies.