Do banks and stock markets spur economic growth? Kenya's experience

Abstract

This paper investigates the dynamic causal relationship between bank–based financial development, stock market development, and economic growth in Kenya - during the period from 1980 to 2012. In order to address the problem of omitted variable bias, the study includes savings and investment as control variables - thereby creating a multivariate Granger–causality model. The method of means–removed average is employed to construct a bank–based financial development index and a stock market development index. Using the newly developed ARDL–bounds testing approach, the empirical results of this study reveal that there is a distinct unidirectional Granger–causal flow from economic growth to bank–based financial development in Kenya. This causal flow applies irrespective of whether the causality is estimated in the short run or in the long run. The study, however, fails to find any causal relationship between market–based financial development and economic growth, and between bank–based financial development and market–based financial development in Kenya. The study, therefore, concludes that the development of the Kenyan banking sector is largely driven by the country's real sector.