Financial Sector Deepening and Economic Growth: Evidence from Turkey

Abstract

This paper analyzes the effects of financial sector deepening on economic growth using a province-level data set for 1996-2001 on Turkey. This period is associated with a weakly regulated and relatively unsupervised expansion of the banking sector which led to the 2001 financial crisis. Contrary to findings in the previous literature, our results indicate a strong negative relationship between financial deepening-both public and private-and economic growth. In light of the developments in the period of analysis, this result is not surprising, as the main function of the banking sector at that time was to provide financing for the Turkish Treasury, which channeled these funds to the government-albeit mainly for rent distribution purposes. However, it is important to note that the growth of private banking sector needs yet to be examined separately, as government ownership of banks may distort the development of the banking sector as a whole. Yet, it is possible to conclude that financial development may not always contribute to economic growth, and the conditions under which such a contribution takes place should be investigated further.Financial sector; Economic growth; Panel data; GMM; Turkey