Financial Intermediaries Versus Financial Markets: A South African Experience

Abstract

In this paper, a dynamic causal relationship between stock market development, bank-based financial development and economic growth in South Africa is examined during the period 1980:1-2007:3, using a trivariate Granger causality model. The study attempts to answer two critical questions. Does financial sector development Granger cause economic growth? Which sector leads in the process of financial development in South Africa – bank-based sector or stock market sector? Using a cointegration-based error-correction mechanism, the empirical results reveal that there is a distinct unidirectional causal flow from stock market development to bank development. The results also indicate that there is a bi-directional causal relationship between stock market development and economic growth.  Similar results were also found on the causality between bank-based financial development and economic growth. The study, therefore, concludes that whilst both financial development and economic growth Granger cause each other, the development of the financial sector in South Africa is largely driven by the stock market activities.