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A new research explores the relationship between stability banking systems and economic growth

A new study by researchers from Indian Institute of Technology, Kharagpur, has looked at how factors like, competition among banking firms and banking stability affect the economic growth of a nation.

Banking systems have become an important part of society and nation building. They provide financial security and economic stability to the citizens of a nation, even when factors like inflation and market crises threaten the economic stability. Banks, especially private sector banks, also perform like many other industries, competing for customers by providing exciting offers, services and competitive interest rates. Today, India has over 200 banks with over 50,000 branches operating in the different states of the country. The different types of banks functioning including, Public sector, Private sector, foreign banks, co-operative banks, small finance banks, and latest to join the club, payment banks.

Recently several banking crises that have emerged around the globe, like the 2007 mortgage crisis in the US, 2008 Bank crisis in the UK and the 2016 Indian banks data breach has created unrest among many citizens. When such a crisis does occur, the government usually steps in to ‘bail out’ the banking firms in trouble, to create banking stability.

So how does providing stability to a bank help with the economic growth of a nation? And should banks be allowed to compete with each other, like other industries do? These were some of the questions that the researchers of the new study wanted to address.

The researchers chose a panel of 32 European countries and examined the link between banking competition, banking stability and economic growth between 1990 and 2014. Using a Vector error-correction model (VECM), a type of mathematical analysis of error correction of multiple time series models, the researchers studied the interaction between the three factors-- banking stability, banking competition and economic growth. Next, using a statistical concept called Granger causality, the researchers came up with estimations of the the relationship between the three variables.

Their results show that, in the short run, the results appear uniform with no changes to economic growth with changes in the other variables. In the long run however, both banking stability and banking competition leads to economic growth.

The researchers conclude saying “Our empirical results show that both banking competition and banking stability are significant long-term drivers of economic growth in the European countries. This study holds important policy implications. Economic policies should recognize the differences in the relationship between both banking competition and banking stability in order to maintain sustainable economic performance of these countries”