Finance-growth nexus and effects of banking crisis

Many economists have observed that the financial system has a positive and monotoniceffect on economic growth. In this study we reaffirm the finance-growth nexus. We adopta three-tier approach for the study’s methodology using panel data of 66 countries from1986 to 2005. Firstly, we test for the finance-growth nexus with particular emphasis onfinancial sector indicators that best represent the effective financing activity in theeconomy. Secondly, we examine the financial market type that exacerbates or mitigatesthe effects of a shock (financial crisis). Thirdly, we investigate the causes of financialcrisis by looking at both the macroeconomic and institutional, and micro-leveldeterminants of banking crisis.Our results show that financial development enhances economic growth, more so, in themiddle income countries. We also find that increased domestic private credit and activityreduces the effects of a financial shock on growth. In addition, openness of the economyin low income Sub-Saharan African countries is important for growth even wherefinancial development indicators appear not to influence growth. In most economies theinvestment channel and openness are consistent in explaining economic growth.