The Role of Bank Lending in Driving Economic Growth: Evidence from Sri Lanka

Abstract

This study investigates the role of bank lending in fostering economic growth in Sri Lanka over the period 1991–2023. As a critical financial intermediary, bank lending facilitates the allocation of capital toward productive investment and economic development. Despite its importance, empirical evidence on the causal impact of bank credit on Sri Lanka’s economic performance remains limited. Using the Autoregressive Distributed Lag (ARDL) Bounds Testing approach, the study examines the short-run and long-run dynamics between Gross Domestic Product (GDP) growth and key financial and macroeconomic variables, including bank lending rates (BLR), private-sector credit, credit-deposit ratio (CDR), inflation (INF), labour force participation, trade openness, and gross capital formation. The findings reveal that credit to the private sector (CPS) unidirectionally drives GDP growth (GDPG), while the reverse relationship is not significant, confirming that bank lending is a key driver of economic expansion rather than merely responding to growth. Other variables, such as trade openness, the CDR, and labour force participation, exhibit bidirectional causality with GDP, highlighting complex feedback mechanisms within the economy. These results underscore the importance of enhancing access to credit and improving the efficiency of lending mechanisms. The study concludes with policy recommendations aimed at reinforcing the banking sector’s role in promoting sustainable and inclusive economic growth in Sri Lanka.