The Mediating Effect of Institutional Governance on Banking Depth and Economic Performance

This study examines the impact of banking depth on economic performance in 47 Asian economies from 1980 to 2022, with a focus on the mediating role of institutional governance. Using feasible generalized least squares (FGLS) models and structural equation modelling (SEM), we find that banking depth positively affects both economic development (GDP per capita) and growth (ΔGDPPC). Institutional governance—measured by government effectiveness, regulatory quality, and political stability—enhances this relationship, underscoring the importance of institutional context in Asia. Specifically, control of corruption, rule of law, and voice and accountability fully mediate the impact of banking depth on economic growth, suggesting that improvements in banking depth alone are insufficient without strong institutional support. Additionally, the results highlight the nuanced role of institutional quality across different income groups: while economic growth in higher-income countries is broadly supported by institutional quality, these same governance structures may not optimally enhance the positive impacts of banking depth and size development on the economy. In contrast, the effects of banking on growth in lower-income countries become volatile when institutional quality is considered, emphasizing the need for targeted institutional reforms. Our findings contribute to the existing literature and highlight the need for tailored institutional reforms to maximize the economic benefits of financial sector development and institutional strengthening in Asia.