Financial Development and Economic Growth: A Non-Linear Affair

Abstract: This thesis analyzes the relationship between financial development and economic growth. We look at the individual growth contributions of the banking sector and the stock markets in terms of size and efficiency, dividing our panel-data into two subsamples according to the development stage. Using the system-GMM approach we find a non-linear relationship between the size of the banking sector and GDP growth in both, emerging markets and developed countries, implying an optimal amount of bank credit in the economy. The growth contribution of stock markets in terms of efficiency behaves differently in emerging markets compared to developed countries. We find no significant impact of improving stock market efficiency in emerging markets, while we find a concave pattern in developed countries - again, implying an optimal amount of liquidity in developed stock markets.