Impact of Sectorial Distribution of Commercial Banks’ Credit on Economic Growth in Sri Lanka

Abstract

The study attempts to investigate the impact of sectorial distribution of Commercial banks’ credit on economic growth in Sri Lanka from 2004 to 2017. The data of commercial banks’ loans and advances to the agriculture sector, industry sector, personal consumption, and service sector are used to track the sectorial credit distribution to the private sector by commercial banks. The regression analysis, Johansen-Juselius Cointegration test, Granger Causality test, Impulse Response Function (IRF) analysis and Forecast Error Variance Decompositions (FEVD) models are employed to determine the effect of sectorial distribution of Commercial banks’ credit on economic growth in Sri Lanka. The regression results indicate that the commercial bank sectorial credit have significant positive impact on the economic growth except agricultural sector. Agriculture sector has a long run negative relationship with Gross Domestic Product (GDP) while other sectors have positive long run relationship between economic growth. Granger Causality tests showed that there is a unidirectional causality from agriculture sector on GDP. IRFs and Variance decomposition analysis confirmed the statistically significant short run relationship between GDP and agriculture sector. According to the study results, the policy makers could motivate banks to distribute credit amongst the industry and service sectors since it has a positive impact on GDP in the long-run. Moreover, it is possible to use credit distribution to the agricultural sector as a short term mechanism to increase GDP.