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Abstract
This study is aimed at estimating the causal and dynamic relationship between the banking industry and economic growth of Pakistan. A panel data set of 24 banks was used for the period 2006–2016. Panel unit root, Panel cointegration, and Panel VECM tests were applied to analyze the data. The results reveal that lending capability, bank investments, and innovation have positive and statistically significant impacts on economic growth in short-run as well as in long-run dynamics. The presence of a long-run relationship indicates workable and bilateral policy measures in the banking industry, and short-run dynamics approach consistency in the recurring policies of banks. The results of the study are consistent with economic development theory, which indicates the vital role of the financial sector in the development of emerging economies. The empirical findings suggest that state authorities and banking regulation authorities should remain vigilant at this crucial point in time because excessive banking development in terms of expansion, liberalization, and products may lead to an increase in non-performing loans and a reduction in investment activities, which can slow the process of growth. Evidently, the results suggest that regulatory authorities should focus less on enhancing the size of the banking sector and more on improving capacity building of its functionalities as intermediaries for the achievement of sustainable economic growth.