Banking and economic growth : case of the Gambia

This research advances four theoretical approaches in an attempt to relate the banking activities to the real economic activities. It starts with the Schumpeter’s circular flow of creditary production that argues that the banks start the production cycle for offering the credits that enable the entrepreneurs to purchase labor and capital. The banks increase the savings mobilization and allocate the scarce savings to the productive investments. Second, we develop a benchmark from the Broaddus’ competitive model to analyze the competitiveness and efficiency in the banking industry. The third theoretical approach incorporates a credit market in IS/LM analysis and discusses the credit constraint as an analogy to a quantity constraint of the neo-Keynesian theory. This approach also analyzes the impacts of the interaction between the monetary policy and the fiscal policy on the endogenous macroeconomic variables. We finally modify Tsurus’ model to show that banks’ mobilized savings could be spent on the maintenance of the banks rather than being channeled to the productive investments, and as a result a bank-based economy could perform worse than a nonbank-based economy. We then estimate and test the hypothetical relationships between the banking and the real economic activities, and estimate and analyze the banks’ credit market functions and the credit constraint hypothesis. We use Johansen Vector Error Correction Methods, VECM, for all the estimations, and hence the analysis is focused on the long run relationships and the adjustments towards the equilibrium. We also conduct an explorative survey into the public’s relationships with the banks. The research finds that the banks’ credit to the private sector is vital for the real economic activities of output and capital accumulation, it is found to be Granger causal for these activities, and it is a weakly exogenous variable in the equilibrium systems that do not include private sector investments; while, the bank liabilities are found to be an endogenous variable. The interest rate is found to slightly influence the decision of the public to save in the banks; the public see the credit facilities biased towards the consumption financing than investment financing. The lending interest rate has a small effect on the credit supply. The banks’ credit supply is inelastic with respect to the lending interest rate, and there is weak credit constraint in the credit market. The banking industry is found to be uncompetitive and inefficient; and the increased transaction costs of the bank credit market are associated with increased prices in the economy. These increased transaction costs are also found to cause the public to hold increased real money balances. The banks’ credit and lending capacity are found to depend on the private sector investments, increases in the private sector feed back onto both the banks’ credit and lending capacity. The banks lag behind the developments in the private sector; thus they are not promoters or engines of growth for the private sector.