Banking Sector Development and Economic Growth: A Bayesian Structural Equation Modeling Approach
DOI:
https://doi.org/10.65072/jeid.v1i1.2Keywords:
banking sector development, economic growth, digital banking, Islamic financeAbstract
In Pakistan’s evolving financial ecosystem, the banking sector functions as a critical intermediary, mobilizing savings into productive investments and facilitating capital accumulation and economic growth. This study empirically examines the interrelationships among key banking sector dimensions—deposits, loans, and investments—bank capital formation, and disaggregated components of economic growth within the context of Pakistan’s digital banking transformation over the period 2004–2024. The analysis employs Bayesian Structural Equation Modeling (BSEM) to capture complex interdependencies and latent relationships using a panel dataset of 12 banks, including conventional, Islamic, and foreign institutions. The model evaluates both direct and indirect pathways through which banking activities influence economic performance, with economic growth operationalized through GDP components such as private consumption, government expenditure, gross investment, and net exports. The results indicate that core banking activities significantly and positively predict bank capital formation. In turn, bank capital exhibits a positive association with private consumption and gross investment, while showing a negative relationship with net exports, suggesting potential trade-offs in resource allocation. Comparative findings further reveal that Islamic banks demonstrate relatively stronger capital retention, whereas foreign banks exhibit higher investment efficiency compared to conventional banks. This study contributes to the financial intermediation literature by advancing the application of Bayesian SEM in an emerging economy context, offering a comparative perspective across different banking systems, and incorporating the role of digital transformation in shaping financial sector dynamics. The findings provide policy-relevant insights for strengthening capital adequacy frameworks and enhancing the effectiveness of digital banking strategies to support sustainable economic growth in Pakistan.
References
Ahmed, F., Hussain, A., Khan, S. N., Malik, A. H., Asim, M., Ahmad, S., & El-Affendi, M. (2024). Digital risk and financial inclusion: Balance between auxiliary innovation and protecting digital banking customers. Risks, 12(8), Article 133. https://doi.org/10.3390/risks12080133
Akinboade, O. A., & Makina, D. (2006). Financial sector development in South Africa, 1970–2002. Journal for Studies in Economics and Econometrics, 30(1), 101–116. https://doi.org/10.1080/10800379.2006.12106402
Ali, A., Zulkhibri, M., & Kishwar, T. (2022). Economic output, monetary policy transmission and the role of Islamic banks: Evidence from Pakistan dual banking system. Journal of Islamic Monetary Economics and Finance, 8(4), 535–550. https://doi.org/10.21098/jimf.v8i4.1486
Allioui, H., & Mourdi, Y. (2023). Exploring the full potentials of IoT for better financial growth and stability: A comprehensive survey. Sensors, 23(19), Article 8015. https://doi.org/10.3390/s23198015
Athar, M., Chughtai, S., & Rashid, A. (2023). Corporate governance and bank performance: Evidence from banking sector of Pakistan. Corporate Governance: The International Journal of Business in Society, 23(6), 1339–1360. https://doi.org/10.1108/CG-06-2022-0261
Bernard Azolibe, C. (2022). Banking sector intermediation development and economic growth: Evidence from Nigeria. Journal of African Business, 23(3), 757–774. https://doi.org/10.1080/15228916.2021.1926857
Challoumis, C. (2024). The effects of taxation policies on capital accumulation and economic development. SSRN Electronic Journal. https://doi.org/10.2139/ssrn.4925684
Fernanda, J., Marley, R., & Suhendra, F. (2024). Exploring the impact of macroeconomic factors on company financial performance: Insights into economic indicators and sectoral heterogeneity. Journal on Economics, Management and Business Technology, 2(2), 73–83. https://doi.org/10.35335/jembut.v2i2.208
Fisher, J. D., Johnson, D. S., Smeeding, T. M., & Thompson, J. P. (2022). Inequality in 3-D: Income, consumption, and wealth. Review of Income and Wealth, 68(1), 16–42. https://doi.org/10.1111/roiw.12509
Gersbach, H., Rochet, J.-C., & Scheffel, M. (2023). Financial intermediation, capital accumulation, and crisis recovery. Review of Finance, 27(4), 1423–1469. https://doi.org/10.1093/rof/rfac046
Huang, X., Ahmad, W., Umair, M., Antohi, V. M., Fortea, C., & Cristache, N. (2025). Foreign direct investment, trade openness and environmental pollution in Pakistan: Does renewable energy mitigate environmental degradation? Frontiers in Environmental Science, 13, Article 1618767. https://doi.org/10.3389/fenvs.2025.1618767
Hussain, S., Rehman, A. U., Ullah, S., Waheed, A., & Hassan, S. (2024). Financial inclusion and economic growth: Comparative panel evidence from developed and developing Asian countries. SAGE Open, 14(1), Article 21582440241232585. https://doi.org/10.1177/21582440241232585
Kanval, N., Ihsan, H., Irum, S., & Ambreen, I. (2024). Human capital formation, foreign direct investment inflows, and economic growth: A way forward to achieve sustainable development. Journal of Management Practices, Humanities and Social Sciences, 8(3), 48–61. https://doi.org/10.33152/jmphss-8.3.5
Manasseh, C. O., Ngong, C. A., Logan, C. S., Okanya, O. C., & Olelewe, C. A. (2024). Financial deepening and economic growth nexus in emerging economies in Africa: Does supply-leading or demand-following hold? International Review of Applied Economics, 38(5), 482–497. https://doi.org/10.1080/02692171.2023.2296506
Murrar, A., Asfour, B., & Paz, V. (2024). Banking sector and economic growth in the digital transformation era: Insights from maximum likelihood and Bayesian structural equation modeling. Asian Journal of Economics and Banking, 8(3), 335–353. https://doi.org/10.1108/AJEB-12-2023-0122
Niepmann, F., & Schmidt-Eisenlohr, T. (2017). International trade, risk and the role of banks. Journal of International Economics, 91(2), 336–352. https://doi.org/10.1016/j.jinteco.2017.03.007
Noreen, M., Mia, M. S., Ghazali, Z., & Ahmed, F. (2022). Role of government policies to fintech adoption and financial inclusion: A study in Pakistan. Universal Journal of Accounting and Finance, 10(1), 37–46. https://doi.org/10.13189/ujaf.2022.100105
Odhiambo, N. M. (2015). Government expenditure and economic growth in South Africa: An empirical investigation. Atlantic Economic Journal, 43(3), 393–406. https://doi.org/10.1007/s11293-015-9466-2
Rani, T., Amjad, M. A., Asghar, N., & Rehman, H. U. (2022). Revisiting the environmental impact of financial development on economic growth and carbon emissions: Evidence from South Asian economies. Clean Technologies and Environmental Policy, 24(9), 2957–2965. https://doi.org/10.1007/s10098-022-02360-8
Saeed, U. F., Kamil, R., & Wiredu, I. (2025). The roles of ICT and governance quality in the finance-growth nexus of developing countries: A dynamic GMM approach. Cogent Economics & Finance, 13(1), Article 2448228. https://doi.org/10.1080/23322039.2024.2448228
Downloads
Published
Issue
Section
License
This work is licensed under a Creative Commons Attribution 4.0 International License (CC BY 4.0).
