Is the Economic Growth of a Country Explained by the Banking System or the Capital Market? The ARDL Model Applied in the Analysis for Ecuador

Cinthya Alexandra Vélez Salas, ESPOL Polytechnic University, Ecuador,
Silvia Mariela Méndez Prado, ESPOL Polytechnic University, Ecuador,
Vicente Omar Aguirre Quiñonez, ESPOL Polytechnic University, Ecuador,

This study tries to infer the existence or not of a long-term relationship between the economic growth of Ecuador in the period 2001-2016 and the financial system. Using the ARDL model, three representative variables of the financial intermediation market, and three of the capital market are included. The analysis concludes that despite the Ecuadorian capital market is in development, it is the one that has a positive influence on the country's economic growth in the short term. In contrast, in the long-term, this relationship becomes higher but negative. On the other hand, the financial intermediation market has a more significant presence in this economy, but it does not have a positive relationship in the short or long term. Extensive work on data and comparative Latin American economies are expected to be carried out from this work proposal.

CCS Concepts:Social and professional topics → Economic impact; • Computing methodologies → Model development and analysis; • Mathematics of computing → Probability and statistics;

KEYWORDS: Economic growth, capital markets, financial system, ARDL

ACM Reference Format:
Cinthya Alexandra Vélez Salas∗, Silvia Mariela Méndez Prado, Vicente Omar Aguirre Quiñonez. 2020. Is the Economic Growth of a Country Explained by the Banking System or the Capital Market? The ARDL Model Applied in the Analysis for Ecuador. In 2020 The 4th International Conference on E-commerce, E-Business and E-Government ICEEG 2020), June 17-19, 2020, Arenthon, France. ACM, New York, NY, USA,


The economic growth of a country is remarkable because an increase in production increases the income of all the participating sectors. Thereby increasing the spending capacity of families and their standard of living; this is the primary basis for a government to promote the improvement of these indicators and thus reduce world poverty. As mentioned by Ranis et al. 2002 [1], "Economic growth provides the resources that allow us to continuously improve human development."

And not only should emphasize the importance of economic growth, but also the financial system on it. This system allows channeling excess resources to productive activities, connecting savers and investors. For this reason, more and more companies are analyzing new financing sources that would enable them to finance projects that promote increased production, jobs, and even income to the state through the payment of taxes.

According to Palma 2008 [2], when SMEs in their growth/risk ratio matrix is in a stage where risk begins to decrease, and growth rises; they look for sources of private financing such as intermediation markets as follows: companies financial services, capitalization, insurers; and credit establishments such as cooperatives and financial corporations, financing companies and banks; while, when the risk is shallow, and growth is very high, they should seek financing in the Capital Market through the issuance of public offerings; In this one, they raise resources for their investment and financing activities through the issuance of financial instruments such as fixed income, variable and derivative securities. Issuers, investors, exchanges, stock houses, securities deposits, commission companies, risk rating agencies, among others, operate in this market.

The best-known financial intermediaries are public and private credit institutions because they are considered safer and easier to access. Companies build a relationship of trust over time, which allows them to acquire new credits easily. However, this confidence, the lack of information, the inexperience, and the ignorance of real risk could cause that fewer companies decide to enter the capital market, where the main advantage is that by eliminating financial intermediation, interest rates are more attractive. For example, for SMEs, the benchmark credit rate is 10.79% in private banking, while with the negotiation of commercial invoices, they can pay up to 9.75%, with which they obtain a saving of 1.04% [3].

Financial intermediaries in the period 2001-2016 had large participation and growth in GDP, going from 26.6% to 46.84%, among which banks stand out because they concentrate 80% of this participation [4]. Also, in loans granted by banks to the private sector, positive and negative variations are observed concerning GDP. Closing 2016 with a 29.12% share, of which 77.26% corresponds to loans from the commercial segment that are used to finance companies' short-term activities, such as acquiring movable property, working capital, and others [2].

On the other hand, the main participants in the Ecuadorian capital market are the banks and the state. Their participation can distort the efficient allocation of resources, as they are not destined for productive activities [5]. This market went from a 3.84% share to 6.16%, concerning GDP in the period 2001-2016. The derisory intervention can be seen in conclusions that show studies such as those of Ramirez et al. 2017 [6] where they establish the preference of people in the choice of their means of financing; this is; 69% banks, 22% credit unions and only 9% consider the capital market.

It must also be considered that 90% of Ecuadorian companies are family members [7], so for all the above, there must be a fear of losing control of their companies. That fact predisposes decision-making and prevents the efficient expansion of their capital or even venture into new industries.

In this context, the study aims to establish which market is most relevant in the development of the Ecuadorian economy, so it will implement the model widely used by Nyasha & Odhiambo 2017 [8] in different economies, which will allow inferring which is most beneficial for the growth of the country. It is argued that using the ARDL model is appropriate to verify long-term relationships and consider the importance and analysis of each variable. Finally, it exposes the results obtained in the process and contrasted with the reality of the Ecuadorian economy to achieve the study's conclusions.


Being the theory of Schumpeter 1991 [9], the one that marked the beginning of the existence of a relationship between economic growth and the intermediation market. Some studies follow this line proposing there is a positive relationship between these variables. Other works lean towards the non-existence of a relationship and the existence of a relationship, but negative [8]. In Ecuador, there are some studies on this topic, such as the thesis of Rojas 2009 [10] analyzing how the banks' sector influences economic growth. They concluded the presence of a negative relationship between the variables. Also, it exposes that in Latin America, they do not adequately guide surpluses towards long-term productive activities, which contribute more to economic growth.

Recently, it has been widely used in the ARDL model approach [11] to examine the link between these variables. Fase & Abma 2003 [12], Carvajal & Hernando 1997 [13], Martínez-Ventura 2008 [14] among others as examples. They analyze the brokerage market and economic growth; However, these studies do not consider the importance of the capital market in the analysis as the works carried out by Nyasha & Odhiambo infer that this sector contributes more to each of the analyzed economies. The study they apply differs from other studies since they include both areas in the model, but through an average of the most representative variables of each industry; That effect is the result of no consensus, indicating which variable represents each industry the most.

In economies such as Brazil [15], South Africa [16], and Australia [17], it is observed that the predominant sector is the one that, in the end, has the most significant influence on economic growth. Simultaneously, in countries like the United Kingdom [18] and Kenya [8], the analysis showed the opposite. Even though intermediaries are the ones with the most participation, they also generate a negative influence in both the short and long term in growth. At the same time, the sector that concentrates the least is the one that contributes the most and in a positive way. The results obtained by Nyasha & Odhiambo with the application of this approach are shown in a condensed manner in Table 1. These studies are relevant, carrying out a more extensive and detailed analysis by including both sectors. It also allows us to consider the concentration of one market or another does not necessarily determine who contributes the most to its economy and invites the analysis of other economies to see the contributions of these variables in its growth.

Table 1: Nyasha & Odhiambo - studies of economic growth and financial system
year Economy Predominant sector
Impact on economic growth
2015 [16] South Africa X   X  
2016 [18] United Kingdom X     X
2016 [17] Australia X   X  
2017 [8] Kenya X     X
2017 [15] Brazil   X   X
Source: Journal of African Business, Contemporary Economics, Global Economy Journal, South East European Journal of Economics and Business
Prepared by the authors


ARDL models are characterized because, unlike other dynamic models, this allows variables that have a different order of integration $ \le I( 1 )$ and allows working with small samples [11].

They have been mainly used to determine the existence of long-term relationships between time series; in this, the dependent variable is explained by the lagged values of itself and by successive lags of the explanatory variables [8]. Their utility has been influential, as it has been used in different sectors, like the determinants of Health spending or the relationship between carbon dioxide and agriculture. It has been implemented in economic research worldwide to determine relationships between economic growth and energy consumption, immigration, tourism, foreign direct investment, and quality of employment.

At the stage of the model's Building, the explanatory variable is the economic growth of Ecuador denoted as (Y), which corresponds to the rate of real GDP (at constant 2007 prices). That is a measurement frequently used to study the variations that experience the production or productivity of an economy, considering this rate as an indicator of evolution. This evolution is shown in figure 1. its growth rate went from 1.09 to -1.23, evidencing the effects on the economy as a result of variables like currency appreciation, reduced oil price, and the earthquake of April 2016 [19].

Figure 1
Figure 1: Economic growth Ecuador 2001-2016 (Source: ECB, Prepared by the authors)

The main characteristic of this model is that it relates economic growth to the intermediation and capital markets. Since there is no clear consensus of which variables best represent each sector, it is prepared an index with the most representative of each industry, which allows obtaining a complete picture of these variables in the economy [8]. This index is a simple average of the variables of the eliminated mean values which is defined as $Xm = \frac{{[ {X - mean( X )} ]}}{{[ {ABS(mean( X )} ]}}$ , where ABS (z) is the absolute value of $( z )$ and for $X( {mean} )$ was used the average value of the data from 2001 to 2016 of each variable. Finally, the index of each sector will be the same $Average\ Xm$ .

The variables to be considered are:

Trading market (BFD) are : ✓ M2.- money supply that includes cash and checking and savings accounts

✓ M3.- add term deposits to M2

✓ Loans granted to the private sector.

All the variables of the study are expressed as a percentage of GDP to determine the relative impact.

Capital markets (MFD) are: ✓ Market capitalization. - measures the size of the market

✓ The total value of the shares and

✓ Rotation rate. - both measure the liquidity of the market

The model also incorporates macroeconomic aggregates such as investment (INV), savings (SAV) and trade openness (TOP); These allow studying the evolution of an economy and have a positive relationship with growth.

Gross capital or investment formation allows the identification of sectors that increase productive capacity in a given period and generate more production and work. Public savings can be presented as a surplus or deficit; the first one is when the income that comes from tax collection and other activities is higher than its expenses in social investment and infrastructure, while the opposite is known as deficit [20]. On the other hand, trade openness shows the country's dynamics with the rest of the world. An increase in this indicator reflects the most efficient use of resources.


Once the stationarity of the selected variables was confirmed, joining their cointegration as well. The ARDL model [11] was estimated to obtain the long-term dynamics of economic growth with their explanatory variables.

The coefficients each long-term variable for this model, and their respective signs are shown in the following equation:

\begin{equation*} Y = 32.37 - 2.6208*BFD - 2.1901*MFD - 1.0968*INV - 1.1696*SAV + 0.3124*TOP \end{equation*}

According to the sign, their relationship is positive or negative, and the magnitude of th eir impact follows the size coefficient.

These results allow to generate the ECM or error correction model [21], with the scenario V (constant and trend without restrictions), this model introduces the error correction term as a new variable to reaffirm cointegration, relating the long-term equilibrium relationship with the short-term behavior. The Error Correction Term (EC) indicates the speed with which any short-term mismatch returns to equilibrium in the long term. That effect should be negative and highly significant [22]. In this analysis, the EC can be observed as CointEq (-1), which is harmful and has a coefficient of -1.181163. The result described means 118.11% of any movement in an imbalance in the short term corrects within a period with a significance level of 1%.

Finally, in figure 2, it shows the adjusted regression line, it fits the data very well, so with the obtained results, we can get efficient conclusions.

Figure 2
Figure 2: Fitted regression line (Source: ECB -BM -BVG – FIAB, Prepared by the authors)


With a significance of 10%, INV and TOP have a positive impact on GDP in the short term; however, it showed that SAV has a negative effect, contrary to what is established by economic theory. Pozo 2016 [23] exposes the changes that occurred in the study period on the calculation of this variable. The effect described could be a factor for the results obtained, showing how the economy contracts in the short term by 1.47 times and 1.7 in the long-term when there is a variation of one unit of the variable SAV.

The BFD does not present a direct relationship with the growth of the Ecuadorian economy, neither in the short nor long term, the impact being more significant in the short-term (-19.46). These results are in line with Rojas 2009 [10] findings in his analysis of Banks and economic growth.

Regarding the capital market, a positive relationship with economic growth is evident, but only in the short term where it has an impact of 0.33 times, while in the long- term the effect is more significant but negative (-2.19), which could be due to the distortions that this market presents.

With these results and the exposed background, it could be inferred that the capital market is more notable in the Ecuadorian economy, with its attractive interest rates and better terms. Its participants' savings become more attractive, thus promoting the productive activities of the country in the long-term. However, the background showed the broad participation of public institutions and banks in this sector, so these possible distortions outline a new research topic, which allows confirming whether the positive impact found is due to these distortions that present the capital market.


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Cinthya Alexandra Vélez Salas is the corresponding author of this paper.

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