“Determinants of banking sector development in developing and emerging economies: Unveiling the role of economic growth, trade openness, and financial liberalization”

The determinants of financial development in developing and emerging economies are examined in this article. The long-term relationships between banking sector development, financial integration, trade openness, and economic growth are explored using FMOLS-DOLS panel estimations spanning from 1980 to 2021. The critical significance of economic growth, trade openness, and financial liberalization as fundamental drivers of banking system progress is underscored by the results. To investigate this relationship, two specifications are introduced to measure banking sector development: private credits (specification 1) and the ME ratio (specification 2), which is defined as the ratio of M3 to GDP. In the context of specification 1, quantitative outcomes reveal that a 1% increase in economic growth results in a substantial rise of 0.207% in banking sector development according to FMOLS, and 0.972% according to DOLS. Similarly, a 1% increase in trade openness has a noteworthy positive impact of 0.019% on banking development. Furthermore, the results indicate that financial liberalization contributes positively to banking sector development, with an effect of 0.002%. In the context of specification 2, the impact of economic growth is more pronounced, with a significant increase of 0.3187% (FMOLS) and 0.852% (DOLS). However, trade openness (TRADE_OP) manifests a negative impact of –0.392% (FMOLS) and a positive impact of 0.0162% (DOLS). In conclusion, the critical importance of economic growth, trade openness, and financial liberalization in the development of the banking sector in developing and emerging economies is underscored by the empirical evidence. Prudent economic and financial policies, along with strengthened regulation and supervision, are recommended to foster sustainable and resilient financial development in these contexts.


INTRODUCTION
The linkages between financial development, trade openness, financial liberalization, and economic growth have been debated in the realm of international economics.This relationship has been explored by several researchers (Bahajji, Ductor and Grechyna (2015), and Guariglia and Poncet (2008).Within developing and transitioning countries, financial liberalization has been regarded as a means to

LITERATURE REVIEW
It is widely acknowledged in the scholarly literature that the enhancement of financial ease and financial development in specific economies can be facilitated through external financial liberalization and trade openness, as anticipated (Levine & Zervos, 1998).These aspects are of significant importance within the scope of the research, as they are instrumental in shaping the banking sector in these economies and, consequently, are essential for achieving the goal of gaining a deeper understanding of these mechanisms.
Banking development in the context of 287 banks from 37 emerging economies was advanced by trade openness, as demonstrated by Ashraf (2018).This led to heightened bank loans and improved efficiency.However, the role of financial openness remains constrained, as credit costs diminish while banking sector risk escalates.T. Bui and H. Bui (2020) substantiated the positive impact of trade openness on bank lending via risk mitigation and enhanced diversification.
Conversely, Ashraf et al. (2021) unveiled an absence of consensus concerning the impact of economic openness, suggesting an influence on bank funding costs and borrower risk.Postderegulation, financial liberalization exacerbates risk, as discerned by Klomp and de Haan (2014), thus advocating enhanced prudential control.Rajan and Zingales (2003) underscored the combined impact of financial and trade openness on financial development, with variations evident across nations.While Kim et al. (2011) validated a negative impact, Bandura (2022) illustrated a favorable trade openness effect on Sub-Saharan African countries, accentuating the enhancement of institutional quality.
By employing dynamic panel estimation, significant determinants of financial development emerged through financial and trade openness, as noted by Baltagi et al. (2009).This suggests that closed economies should initiate capital account openness and trade to attain banking sector benefits.In India, Murthy et al. (2014) verified a long-term connection between financial development, trade openness, and economic growth.
Utilizing panel data, Ashraf (2018) divulged the roles of trade and financial openness in the banking system development of emerging economies.Beck (2002) emphasized the favorable linkage between financial development and exports, as well as trade balance.Sehgal et al. (2013) manifested a two-way connection between financial development and growth.Sehrawat and Giri (2016) identified cointegration between financial development and growth, while Ouedraogo and Sawadogo (2022) established this relationship for Sub-Saharan African economies.
In an analytical exploration involving developed, emerging, and developing countries, Lemaallem and Outtaj (2023) 2013) corroborated the positive interrelation between private sector credit as a percentage of GDP and total domestic credit to the private sector, underscoring their positive alignment with economic growth.Conversely, the ratio of broad money aggregates to GDP exhibited no favorable connection with economic growth.
Sehrawat and Giri (2016) confirmed the presence of a cointegrating relationship linking financial development and economic growth, employing FMOLS and DOLS estimations in their pursuit.Regrettably, no analogous positive impact surfaced concerning trade openness.Notably, Sub-Saharan African economies were the theater for the positive correlation between financial development and economic growth, as affirmed by the toil of Ouedraogo and Sawadogo (2022) The antecedent findings underscoring the affirmative nexus between the real sector and the financial sector within the UEMOA zone across 1996-2018 were revalidated by Hervé (2021), thus highlighting the pivotal role of governance quality.
To encapsulate, the literature underscores the significance of financial development, trade openness, and economic growth.Furthermore, the literature accentuates the affirmative correlation between financial development, exports, and trade balance (Sarwar et al., 2021), as well as the intricate interplay among financial development, international trade, and economic growth, necessitating special attention in both policy and academic dialogues.A reciprocal relationship linking economic growth and financial development is firmly established.This article aims to investigate the fundamental factors contributing to financial development within these economies.Its goal is to identify elements influencing the evolution of the banking sector.The hypothesis under examination posits a long-term correlation between these variables, suggesting that the development of the banking sector is significantly influenced by financial liberalization, economic growth, and trade openness.

METHODS
The empirical analysis of this study focuses on assessing the influence of financial integration, trade openness, and economic growth on the development of the banking sector in both developing countries (Panel A) and emerging economies (Panel B).Panel A comprises 34  This article employs a cross-sectional regression-based approach to examine banking sector development.The impact of financial and trade liberalization policies, along with economic policies, on banking system development is investigated.The following model is utilized: where FD it -the development of the banking sector; GDP it -the gross domestic product per capita; tradeop it -the trade openness; LIBFIN it -the financial liberalization; X it -a set of control variables; ε it -the error term; i = 1, 2, 3, ..., N -the number of countries; t = 1, 2, ..., T -the number of periods.
To explore the long-term relationship, two specifications for banking sector development are in-troduced.In the first specification (1), PC (private credits) is treated as an endogenous variable.In the second specification (2), the ratio ME (broad money supply: M3/GDP) is maintained as an endogenous variable, serving as an indicator of banking sector development.

RESULTS
The results of the unit root tests conducted by Levin, Lin, and Chu (LLC) and Im, Pesaran, and Shin (IPS) on the panel data, both at levels and first differences, are presented in Tables 2 and 3 for  Interestingly, the inclusion of the "Inter" variable in Specification 2 demonstrates its significant negative impact (-0.366*), underscoring the crucial role of coordinated policies between the real and financial sectors in enhancing banking sector development in developing economies.Specification 2 reveals more significant These findings confirm and enrich the hypotheses put forth in the research, highlighting the intricate interplay between trade openness, economic growth, financial liberalization, and capital account openness, as well as the crucial importance of simultaneous policy coordination in shaping the trajectory of banking sector development in developing countries.Note: *, ** and *** -significance at 1%, 5%, and 10%, respectively.
The results obtained from the analysis of Table 8: Panel B -Long-run elasticity provides valuable insights into the relationship between various economic factors and the development of the banking sector (D(CP)), as well as the broader money supply (D(ME)) in emerging economies.In Specification 1, several significant coefficients offer noteworthy economic interpretations.The positive coefficient of LGDP (0.960***) highlights that higher rates of economic growth stimulate banking sector development.However, the coefficient of TRADE_OP (-0.032**) lacks significance, indicating a potentially limited role of trade openness.The negative coefficient of LIBFIN (-0.003) suggests that financial liberalization does not have a significant impact on banking sector development.INSTAECO presents a positive coefficient (0.017) without significance, suggesting a limited effect of economic instability.Conversely, the significant positive coefficient of DP (0.043***) underscores the importance of effective governance in banking sector development.
In Specification 2, new insights are revealed.The negative coefficient of LGDP (-0.050*) indicates an inverse relationship between economic growth and the banking sector.The coefficient of TRADE_ OP (-0.006*) suggests that trade openness could slightly limit the broader money supply.The positive coefficient of LIBFIN (0.098*) confirms that financial liberalization plays a positive role.The negative coefficient of D(TXC) (-0.008**) highlights the potential negative impact of a restrictive exchange rate policy.The positive coefficient of KAOPEN (0.194*) emphasizes the positive effect of capital account openness.The negative coefficient of INSTAECO (-0.026*) indicates that economic instability could impede banking sector development.The positive coefficients of DP (0.011*) and FDI (0.031*) support the notion that governance and foreign direct investments are favorable factors for banking sector development.The "Inter" variable has a significant negative impact (-0.0006), reinforcing the importance of coordination between policies in the real and financial sectors for banking sector development.
In light of these results, it is important to emphasize that these findings confirm and enrich the research hypotheses.Overall, Trade openness, economic growth, financial liberalization, and governance appear to play key roles in the development of the banking sector in emerging economies.Coordinated policies and capital account openness also emerge as important determinants.
The findings thus support the necessity of targeted economic and financial policies to promote a robust and balanced development of the banking sector in these emerging economies.

DISCUSSION
The intricate relationships between financial development, trade openness, economic growth, and various policy measures are comprehensively examined by the findings of this study.An alignment with existing knowledge is ensured, and a significant contribution is made in several respects.forth by Sehrawat and Giri (2016), suggesting that while trade openness may offer certain benefits, its direct impact on domestic credits provided by banks might be limited.This underscores the need for prudent assessment of trade policies to ensure a harmonious interplay between trade openness and banking sector development.Conversely, the adverse impact of exchange rate policies (D(TXC)) on domestic credits is well established.Fluctuations and instability in exchange rates introduce uncertainties that curtail credit supply for both banks and borrowers.Moreover, an overvalued national currency exerts a negative influence on corporate incomes, resulting in reduced credit demand due to diminished competitiveness in the international market.
The emphasis on the crucial importance of sound governance and robust institutional quality, reflected in the positive impact of the LIBFIN variable, aligns with the broader recognition in the literature of the central role of institutions in financial development, as emphasized by Abdlkarim and Atef (2009).
Furthermore, the study's results underscore the potential risks associated with uncontrolled financial liberalization, echoing concerns raised by Rajan and Zingales (2003).This underscores the pressing need for prudent regulatory measures to mitigate risks and ensure stability of the banking sector in the face of increased financial openness.
In summary, the empirical findings confirm a significant correlation between banking sector development, economic growth, and financial liberalization.However, no significant relationship is observed with trade openness, aligning with the conclusions of Sehrawat and Giri (2016) The ratio of monetary mass, serving as an indicator of banking system development in terms of credit provision by banks, is negatively affected by trade openness, financial liberalization, and capital account opening.Such policies can lead to volatile capital flows within developing economies, exposing banks to increased risks and financial instability.Consequently, banks may adopt a more cautious approach in credit provision, resulting in a reduction in the ratio of monetary mass.
Furthermore, economic instability, such as financial crises or significant GDP fluctuations, negatively affects banking system development.
Pressures on bank stability arise, leading to increased reluctance in extending credit and contributing to a decrease in the ratio of monetary mass, reflecting banking system development.
In summary, the ratio of monetary mass, representing banking system development in developing economies, is negatively influenced by trade openness, financial liberalization, capital account opening, and economic instability.Conversely, economic growth has a positive effect by stimulat- ing credit demand and promoting an increase in the ratio of monetary mass.
The FMOLS analysis results in the two specifications highlight a variety of effects of explanatory variables on the monetary mass ratio (ME) in emerging economies.In Specification

CONCLUSION
This study investigates the interplay between banking sector advancement, opening policies, and economic policies in developing and emerging nations.The empirical findings emphasize that the orchestrated implementation of financial and trade opening policies, coupled with stable economic and macroeconomic measures, profoundly impacts the expansion and enhancement of banking institutions and operations in these regions.However, the adoption of concurrent opening policies heightens susceptibility to external perturbations.Consequently, it becomes imperative to acknowledge the attendant risks and institute apt mitigation strategies.Striking a harmonious equilibrium that places emphasis on stability, healthy competition, and comprehensive financial inclusivity can optimize the advantages derived from these policies while concurrently mitigating potential risks.
2023; Kong et al., 2021; Qamruzzaman, & Jianguo, 2020; Pan et al., 2019).Additionally, the pivotal role of financial development in post-trade and financial liberalization economic recovery has been emphasized by researchers such as Usman et al. (2021), Redmond and Nasir (2020), affirmed the existence of a long-term relationship connecting internal and external financial liberalization, trade openness, and growth.Uddin et al. (2013) discerned a positive correlation between the financial sector and growth in the context of Kenya.A parallel approach to analysis was undertaken by Ashraf (2018), utilizing a panel dataset encompassing 287 major banks across 37 emerging nations during the 2000-2012 timeframe.The pivotal roles of trade and financial openness in emerging economies' banking system development were thus illuminated.Notably, financial liberalization curbs credit costs, while trade openness propels a streamlined banking sector.This symbiotic tradefinance relationship was corroborated by Wajda-Lichy et al. (2020) across eight countries.Beck (2002) spotlighted the positive nexus between financial development, exports, and manufactured goods' trade balance.Similarly, Baltagi et al. (2009) underscored trade's formidable influence on financial development.However, more recent findings by D'Onofrio and Rousseau (2017) fail to validate this positive trade impact during the initial globalization wave, spanning 1850-1929, across 17 countries.Comprehensive analyses encompassing VAR and VECM methodologies unveiled that trade liberalization lacks a direct favorable impact on broad money aggregates.Recent work by Shafiei et al. (2023) echoes the positive association between trade openness and banking system development.Via dynamic panel estimation techniques, Baltagi et al. (2009) unearthed the statistical significance of financial and trade openness in shaping financial development.Evidently, a negative correlation emerges between the extent of financial openness and the marginal implications of trade liberalization, underlining the necessity for closed economies to intensify capital account openness and trade for maximal banking sector advancement.
The inquiries by Oroud et al. (2023) and Nguyen et al. (2022) lend credence to the affirmative relationship between financial development and economic growth within emerging economies.
The positive effects of capital account opening (D(KAOPEN)) on domestic credits extended by banks (D(CP)) in developing economies are clearly highlighted by the results of the long-term elasticity estimation in Panel A, in accordance with the observations ofBaltagi et al. (2009).This underscores the significance of capital account opening in facilitating increased access of banks to additional sources of funding.

Table 1 .
Levin, Lin, and Chu (2002) on the link between financial development, opening policies, and economic policy Pesaran and Shin (IPS) (2003) andLevin, Lin, and Chu (2002)are employed to test for the stationarity of the panel data series under consideration.
The relationship between financial development and trade openness exhibits direct and indirect effectsThe impact of financial integration, trade openness, and economic policies on banking system development is examined in the study.This is achieved by employing the dynamic ordinary least squares (DOLS) model estimation methodology developed by McCoskey and Kao (1998) and the fully modified ordinary least squares (FMOLS) model introduced by Phillips and Hansen (1990) and further refined by McCoskey and Kao (1998), Phillips and Moon (1999), and Pedroni (2001).It has been demonstrated by Kao and Chiang (2001) that both techniques yield asymptotically normally distributed estimators with zero means.Significant importance is attached to the utilization of the Kao panel cointegration test (1999) in this study, as it allows for the determination of the existence of a long-term equilibrium relationship among the variables.This test is well-suited for bivariate systems and exhibits superior performance when combined with Augmented Dickey-Fuller (ADF) tests as compared to Dickey-Fuller (DF) tests, as observed in Kao's simulations.Additionally, this test assumes sequential convergence to infinity (T → ∞ followed by N → ∞).Prior to conducting the cointegration analysis, attention is directed toward ensuring data stationarity and computing descriptive statistics.The second-generation unit root tests proposed by Im, base, while data from the World Bank (IBRD.IDA) are used and accessed via the World Bank 2022 database.Additionally, information regarding capital account openness (KAOPEN) is obtained from the Chinn-Ito Index 2020 database, published by Menzie Chinn and Hiro Ito.

Table 2 .
panel A and panel B. It is observed in these tables that all variables in the study are non-stationary, except for the variables CP, ME, TX, and KAOPEN in panel A. In panel A, the variables CP, ME, and TX have been transformed into differences to achieve stationarity.As a result, all variables are stationary, enabling the application of the Pedroni cointegration test.Unit root test in Panel A Note: * and ** -significance of stationary panel data at 5% and 10%, respectively.

Table 3 .
Unit root test in Panel BDescriptive statistics of all variables are presented in Tables4 and 5, respectively for panel A and panel B. In panel A, high average values are observed for private sector credit (CP), macroeconomic instability (ME), and trade openness (TRADE_OP).

Table 4 .
Descriptive statistics of variables, Panel A

Table 5 .
Descriptive statistics of variables, Panel B

Table 7 .
Panel A -Long-run elasticity

Table 8 .
Panel B -Long-run elasticity 1, economic growth (LGDP variable) supports banking sector development, while trade openness (TRADE_ OP variable) poses challenges.In Specification 2, which considers simultaneous financial and trade openness, the effects of economic growth are more nuanced, but strong governance (LIBFIN variable) and appropriate policies (DP variable) promote banking sector growth.In conclusion, sustained economic growth and robust governance are essential for banking sector development in emerging economies.However, challenges may arise from trade and financial openness (Ashraf, 2018; Khan et al., 2021; Caporale et al., 2022).Prudent policies are imperative to encourage sustained economic growth, strengthen governance, mitigate risks associated with trade openness, and promote controlled financial openness.Finally, this study contributes to the ongoing debate on the intricate relationships between financial development, trade openness, and economic growth.By drawing parallels with existing literature, it provides a deeper understanding of the multifaceted dynamics at play and offers valuable insights to shape future policies that facilitate sustainable banking sector development in emerging and developing economies.