Bank Efficiency, Financial Depth, and Economic Growth

Abstract

The positive relation between financial development and economic growth seems to have weakened in recent years and when analyzing only developed countries. We suggest here that banks' relative ability to intermediate funds cost-efficiently is a quality-based measure of financial development that complements conventional quantity-based measures. We test this quality finance-growth nexus for a comprehensive sample of more than 100 countries during 1996-2005. We find an independent and economically significant effect of higher mean cost efficiency for economic growth, suggesting that the interaction between better banking and deeper capital markets is indeed most beneficial. However, conditional marginal effects imply that the positive effects of deepening capital markets are only significant beyond a certain efficiency threshold of approximately 70 percent.

Keywords: Bank performance, economic growth, bank efficiency

JEL Classification: G21, O16, O47, O52