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Banking sector stability and economic growth in post‐transition European Union countries

Economic growth is considered to be an essential means for poverty alleviation and improving countries' well‐being. Disturbances and instability in the banking sector may jeopardize financial stability and generate adverse, considerable and long‐lasting consequences therefor. This study analyzed the dynamic and causal effects of various indicators of banking sector stability on economic growth by employing new generation panel cointegration and causality tests in post‐transition European Union countries over the period 1998–2016. Taking into account cross‐sectional dependence between countries, the presence of heterogeneity in the errors, endogeneity and structural breaks, the long and short run analyses revealed the cointegration relation between the variables, the statistically significant positive effect of banking sector stability on economic growth and the efficiency of the error correction mechanism. The causality analysis disclosed the opposite causality direction between the particular banking sector stability indicators and economic growth, suggesting that banking sector stability is a complex, hierarchically structured multidimensional construct. Its different dimensions require different policy responses aiming at preventing future shocks and mitigating the adverse effects, while encouraging economic growth.

Banking sector stability, economic growth, panel cointegration and causality analysis, structural breaks, post-transition EU countries

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