ECONOMIC ACTIVITY AND BANK EFFICIENCY IN EU COUNTRIES

Abstract

The performance of the financial sector is of paramount importance in the development of an economy. The financial sector serves as the primary conduit between those who save and those who invest. By virtue of the information available regarding both groups of economic agents, this conduit facilitates the reduction of information asymmetries and enables more expedient investment targeting in specific sectors deemed crucial for economic growth. For decades, research has been conducted on the relationship between the financial sector and economic growth in individual countries or groups of countries with the aim of providing governments with recommendations on specific measures that will improve the welfare of economic agents and achieve higher economic growth. It also examines whether there is a link between economic growth and financial sector development, or vice versa, from economic growth to financial sector development. In light of the pivotal role of financial intermediaries in the economic advancement of nations, this study seeks to examine and evaluate the extent to which the financial sector in EU countries fosters economic growth, or vice versa. Furthermore, the study examines and assesses the extent to which the financial sector contributes to economic growth, in addition to the direction of the relationship between the two. The data set encompasses the period between 2010 and 2022. In order to achieve the objectives of the study, a panel model is applied to the EU countries. Two indicators are employed to capture financial sector activity: namely, banking efficiency and market capitalisation. The non-parametric DEA method is employed for the purpose of more fully capturing and characterising the EU banking sector, with the objective of measuring banking efficiency. This study eschews the use of traditional indicators in favour of a more complex indicator, namely technical efficiency, which is measured by DEA. This approach allows for the conversion of inputs and outputs into a single measure of bank efficiency. In order to account for the growing role of capital markets in the decades following the global financial crisis of 2008, the estimated models include market capitalisation as an additional factor. The results of the balanced panel model estimation confirm that the EU countries are characterised by the "supply-side hypothesis", i.e., financial intermediaries are important for economic development, and the estimated relationships are positive. However, the models highlight the pivotal role of the banking sector in driving economic growth in the older EU countries, as market capitalisation has been demonstrated to have a limited impact on economic growth in these countries. This suggests that those responsible for economic policy should prioritise the improvement of the banking sector and encourage banks to play a more active role in intermediation, with the aim of achieving economic growth.