Financial Development and Economic Growth: Evidence from Indonesia Before and After the COVID-19 Pandemic

Abstract

During the COVID-19 pandemic, most countries suffered economically. Financial institutions play an important role in enhancing economic growth through intermediation. However, preliminary studies focused on common aspects of financial institutions rather than the banking context, and the majority of the literature was written prior to the COVID-19 pandemic. This study examines the banking sector’s role in short-run and long-run contributions to economic growth from 2009 to 2021. Indicators of the number of banking deposits, offices and public financing were used as proxies to validate the relationship between Indonesian financial development and economic growth (gross domestic product) in the vector error correction model (VECM). The Indonesian bank’s contribution to the country’s economic growth was examined. Data were collected from banks’ annual reports. This study found a strong short- and long-term correlation between financial development and Indonesia’s economic growth. There is a bidirectional relationship between Indonesia’s Islamic Bank (IIB) and GDP. The relationship between the conventional bank and Indonesia’s economic growth is unidirectional. Therefore, policymakers should enhance the intensified mobilisation of loans obtained for capital and productive projects. This study also shows that macroeconomic and microeconomic stability can be improved by enhancing capital inflows and investments in lucrative sectors, as the research goal was to examine the effect of financial development before and after the COVID-19 pandemic, which detriments most countries’ stability. However, future studies need to confirm banks’ contributions to specific sectors such as agriculture and small and medium enterprises due to their strong correlation with developing countries.