Determinants of banking sector development in India: ARDL bound testing approach

This study explores a wide range of macroeconomic policy variables in order to evaluate their relevance as determinants of banking sector development in India during 1980–2013. Two econometric techniques- Principal Component Analysis to construct financial liberalization index and ARDL bound testing approach to evaluate the determinants of banking development have been applied. The empirical results of the study indicate that except the GDP growth rate, all other explanatory variables including inflation, real interest rate, financial liberalization and trade liberalization have significant impact on India's banking sector development. The empirical results of the study also suggest that the variables like trade openness and financial liberalization have a positive impact on banking sector development, while other variables including real interest rate and the rate of inflation were found be negatively affecting banking sector development in India during the period of study. As the findings of this study have important policy implications it calls for a serious and consistent effort by the Government to promote trade openness. This move not only helps to improve India's foreign trade but also expands the size and activity of banking sector in India. As our study suggests that financial liberalization and banking system development are strongly associated positively, it is an imperative on the part of Indian policy makers to take fasten the reforms pace in the financial sector. These measures would help improve the state of Indian banking besides acting as a catalyst to foster economic growth, and job creation.