Financial intermediation and economic growth: evidence from Sri Lanka

Abstract

Introduction :

The importance of commercial banks in generating growth within an economy has been widely discussed by various scholars. Commercial banks are mainly involved in financial intermediation, which is the channeling of funds from surplus unit to deficit units of the economy, thus transforming bank deposits into loans or credits. The role of credit on economic growth has been recognized as credits that are obtained by various economic agents to enable them meet operating expenses. Business firms obtain credit to purchase seeds, fertilizers, erect various kinds of farm buildings. Therefore, the credit funds are made available for investment in productive capital (Chinwoke et al. 2014).

Soon after financial liberalization in Sri Lanka in 1977, the government introduced financial sector development policies. This created a competitive environment in the financial sector. In this context, a dramatic change can be seen within the commercial banking system. The number of commercial banks have increased while financial intermediation of commercial banks shows an upward trend. However, the growth performance of Sri Lanka during the post liberalization period is higher than the pre liberalization period. Although the country was able to maintain an average five percent growth rate, it was not consistent throughout the period. The data related to economic growth reveals high fluctuation. The existing literature identifies a positive relationship between financial intermediation and economic growth (Rexiang and Rathnasiri, 2008; Donald et al., 2000; Chinwoke et al., 2014). However, the quantitative assessment of the relationship between financial intermediation and economic growth is inadequate and limited in the context of Sri Lanka. Thus, this study attempts to fill this gap by investigating financial intermediation and economic growth in Sri Lanka.