A causal relationship between financial intermediation and economic growth: A case study of South Africa

Abstract

Financial intermediation is responsible for channelling funds throughout the economy and acts as the main source of production in any economy. More specifically, financial intermediation acts as a link between savings and investment in the economy through the successful transfer of saving into investments. With the current persisting contradiction of literature on the role of financial intermediation on economic growth, this study, therefore, examined the causal relationship between financial intermediation and economic growth in South Africa using two methodologies, namely the Autoregressive Distributed Lag Model and the Granger Causality Test. The study used annual data obtained from the World Bank statistical reports which covered periods from 1975-2018 in which forty-three observations were used in the study. To capture this relationship, GDP per capita was used to proxy economic growth. The proxies for financial intermediation include the domestic credit to the private sector by banks as a percentage of GDP (CPS by B to GDP), domestic credit provided by the financial sector as a percentage of GDP (CPS by FS to GDP) and the ratio of broad money to GDP (M2 to GDP), which represents the role of the banking sector and other financial institutions. Domestic market capitalisation of listed domestic companies as a percentage of GDP (MCLC to GDP) and the value of domestic shares traded divided by their market capitalisation (DST to MC) were used to proxy the stock market. The results of the study confirmed a positive relationship between financial intermediation and economic growth in both the short-run and in the long-run, however, this relationship proved to be unilateral and financially led. The results also showed a less significant relationship between financial intermediation and economic growth when the stock market proxies were used to test the relationship.