Financial Intermediation and Economic Growth: Empirical Evidence from the EU

Abstract

Although the relationship between financial intermediation and economic growth has been widely investigated in both theoretical and empirical literature, there is still no consensus regarding its existence, intensity, direction, or functional form (linear vs. nonlinear). This study aims to empirically assess the nexus between financial development and economic growth in the 28 member states of the European Union (EU28) over the period 2000- 2021. Motivated by the recent Draghi Report (2024), which underscores the urgency of building a more integrated and efficient financial system to sustain long-term growth in the EU, our analysis explicitly explores the potential nonlinearity of this link. Using a panel data approach and applying the System Generalized Method of Moments (System GMM), we address endogeneity concerns and account for dynamic effects. Our results reveal a negative impact of the linear component of financial development on economic growth, while the squared term exhibits a positive and statistically significant effect. This U-shaped pattern suggests that the benefits of financial development materialize only after surpassing a certain threshold level. These findings carry important policy implications, particularly in the current context where the EU’s financial sector is considered underdeveloped relative to other major global economies, emphasizing the need for structural reforms to enhance its catalytic role in promoting sustainable growth.