Determinants of banking sector development in developing and emerging economies: Unveiling the role of economic growth, trade openness, and financial liberalization

The determinants of financial development in developing and emerging economies are examined in this article. The long-term relationships between banking sector development, financial integration, trade openness, and economic growth are explored using FMOLS-DOLS panel estimations spanning from 1980 to 2021. The critical significance of economic growth, trade openness, and financial liberalization as fundamental drivers of banking system progress is underscored by the results. To investigate this relationship, two specifications are introduced to measure banking sector development: private credits (specification 1) and the ME ratio (specification 2), which is defined as the ratio of M3 to GDP. In the context of specification 1, quantitative outcomes reveal that a 1% increase in economic growth results in a substantial rise of 0.207% in banking sector development according to FMOLS, and 0.972% according to DOLS. Similarly, a 1% increase in trade openness has a noteworthy positive impact of 0.019% on banking development. Furthermore, the results indicate that financial liberalization contributes positively to banking sector development, with an effect of 0.002%. In the context of specification 2, the impact of economic growth is more pronounced, with a significant increase of 0.3187% (FMOLS) and 0.852% (DOLS). However, trade openness (TRADE_OP) manifests a negative impact of -0.392% (FMOLS) and a positive impact of 0.0162% (DOLS). In conclusion, the critical importance of economic growth, trade openness, and financial liberalization in the development of the banking sector in developing and emerging economies is underscored by the empirical evidence. Prudent economic and financial policies, along with strengthened regulation and supervision, are recommended to foster sustainable and resilient financial development in these contexts.