Banking sector and economic growth in the digital transformation era: Insights from maximum likelihood and Bayesian structural equation modeling

Murrar, Abdullah; Asfour, Bara; Paz, Veronica Article Banking sector and economic growth in the digital transformation era: Insights from maximum likelihood and Bayesian structural equation modeling Asian Journal of Economics and Banking (AJEB) Provided in Cooperation with: Ho Chi Minh University of Banking (HUB), Ho Chi Minh City Suggested Citation: Murrar, Abdullah; Asfour, Bara; Paz, Veronica (2024) : Banking sector and economic growth in the digital transformation era: Insights from maximum likelihood and Bayesian structural equation modeling, Asian Journal of Economics and Banking (AJEB), ISSN 2633-7991, Emerald, Leeds, Vol. 8, Iss. 3, pp. 335-353, https://doi.org/10.1108/AJEB-12-2023-0122 This Version is available at: https://hdl.handle.net/10419/334127 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. 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If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by/4.0/ Banking sector and economic growth in the digital transformation era: insights from maximum likelihood and Bayesian structural equation modeling Abdullah Murrar Indiana University of Pennsylvania, Indiana, Pennsylvania, USA and Arab American University Palestine, Jenin, Palestine Bara Asfour Arab American University Palestine, Jenin, Palestine, and Veronica Paz Indiana University of Pennsylvania, Indiana, Pennsylvania, USA Abstract Purpose –In the digital era, the banking sector has transformed into a powerful intermediary, effectively connecting surplus and deficit units. This dynamic landscape empowers savers to secure their finances and generate returns, while simultaneously enabling businesses and individuals to access capital for investment and promoting economic growth. This study explores the relationships among banking development dimensions –represented by primary assets and liabilities, bank capital (core capital and required reserves) and economic growth as measured by components of gross domestic product (GDP). Design/methodology/approach –The study consolidated monthly balance sheets from digital banks over a 20-year period, resulting in an aggregate monthly balance sheet that reflects the financial position of all digital banks in the Palestinian economy. The research employs both maximum likelihood and Bayesian structural equation modeling to measure the causal pathways of the consolidated balance sheet with the individual components of GDP. Findings –The results revealed that bank main assets (investments and loans) and liabilities (deposits) collectively explain for 97% of bank capital. Investments and loans demonstrate significant negative correlations with bank capital, while deposits exhibit a positive impact. This leads to a fundamental conclusion that a substantial proportion of retained earnings within the banking sector is reinvested, fueling expansion and growth. Additionally, the results showed a significant relationship between bank capital and various GDP components, including private consumption, gross investment and net exports (p50.000). However, while the relationship between bank capital and government spending was insignificant in the maximum likelihood estimation, Bayesian estimation revealed a slight yet positive impact of bank capital on government spending. Originality/value –This research stands out due to its unique exploration of the intricate relationship between bank sector development dimensions, primary assetsand liabilities and their impacton bank capital in the digital era. It offers fresh insights by dividing this connection into specific dimensions and constructs, utilizing a comprehensive two-decade dataset covering the digital banks records. Keywords Bank capital, Deposits, Economic growth, GDP components, Loans Paper type Research paper Asian Journal of Economics and Banking 335 JEL Classification —C11, C58, G21, O16 © Abdullah Murrar, Bara Asfour and Veronica Paz. Published in Asian Journal of Economics and Banking. Published by Emerald Publishing Limited. This article is published under the Creative Commons Attribution (CC BY 4.0) licence. Anyone may reproduce, distribute, translate and create derivative works of this article (for both commercial and non-commercial purposes), subject to full attribution to the original publication and authors. The full terms of this licence may be seen at http:// creativecommons.org/licences/by/4.0/legalcode The current issue and full text archive of this journal is available on Emerald Insight at: https://www.emerald.com/insight/2615-9821.htm Received 8 December 2023 Revised 14 February 2024 1 April 2024 4 April 2024 5 April 2024 Accepted 14 April 2024 Asian Journal of Economics and Banking Vol. 8 No. 3, 2024 pp. 335-353 Emerald Publishing Limited e-ISSN: 2633-7991 p-ISSN: 2615-9821 DOI 10.1108/AJEB-12-2023-0122 Downloaded from http://www.emerald.com/ajeb/article-pdf/8/3/335/9503154/ajeb-12-2023-0122.pdf by ZBW German National Library of Economics user on 16 December 2025 Introduction Digital banking development has transformed the way individuals and businesses manage their finances. These innovative services leverage digital technology to provide customers with a convenient and efficient way to access and manage their accounts, conduct transactions, and engage with their banks (Profinch, 2023). With digital banking, customers can perform a wide range of tasks from the comfort of their smartphones, tablets, or computers, eliminating the need for physical visits to bank branches (Gavriluk, 2023). This accessibility is particularly advantageous in today’s fast-paced world, where time and convenience are highly valued. Moreover, with digital platforms, banks can reach a broader audience, making it easier for individuals and institutions to deposit their savings, and for businesspeople and manufacturers to secure loans. This expanded reach not only increases the liquidity available for loans, but also enhance economic growth by reducing geographical limitations and transactional barriers (Feyen et al., 2021). Therefore, the development of digital banking has had a significant impact on increasing bank deposits, loans, and investments (Tantoco, 2021). A bank’s primary assets consist of loans and investments, while its primary liabilities involve deposits from both individuals and institutions (Bhattacharyay, 2015). The amount attributed to the bank owner’s equity, or capital, is essentially the difference between the total assets and total liabilities (Suresh and Paul, 2014). An increase in bank capital enables the bank to engage in more investments, extend additional loans, and pursue new avenues of development (Kim and Sohn, 2017; Furlong, 1992). Consequently, bank capital serves as a true and representative indicator of a bank’s developmental and growth prospects (Kishan and Opiela, 2000). The question at hand pertains to whether the banking sector with its digital development can contribute to economic growth as indicated by GDP (Batrancea et al., 2021), and, if so, in what dimension of growth. In the existing literature, the relationship between banking sector development and economic growth is not straightforward (Odhiambo, 2014). Several researchers have identified a positive correlation between banking sector development and economic growth (Levine and Zervos, 1998;Nyasha and Odhiambo, 2015;Alkhazaleh, 2017; Ye and Zhao, 2019;Islam et al., 2019). On the other hand, some researchers have found a negative relationship (Shen and Lee, 2006;Naceur and Ghazouani, 2007;Petkovski and Jordan, 2014;Nwani and Jacob, 2016). In essence, the impact of banking sector development on economic growth remains a subject of debate and may vary depending on specific circumstances and factors. Many of these studies have assessed banking sector usingspecific indicators such as bank size, return on equity, return on investment, liquid liabilities, operating profit rate, and credit to the private sector, bank capital to assets ratio as evidenced by the works of Petkovski and Jordan (2014),Tripathy and Pradhan (2014),Imam and Kpodar (2016),Abusharbeh (2017),Batrancea et al. (2022). However, it’s noteworthy that none of the previous studies have systematically explored banking sector development in terms of its major components, including banking major assets (loans and investments), major liabilities (deposits), and owner equity (bank capital as an intermediary). Moreover, there has been limited attention given to understanding the relationship between banking sector development and the individual components of GDP. GDP is composed of various elements, including consumption, government spending, investment, and net exports. Our hypothesis suggests that advancements in the banking sector, especially through digital banking, have a significant and measurable impact on the different components of GDP, thereby influencing overall economic growth. Analyzing the impact of banking development on each of these GDP components can provide a more comprehensive understanding of the state of the economy and its performance in different areas. It can shed light on how banking sector development influences consumer behavior, government fiscal policies, investment decisions, and trade dynamics, all of which contribute to overall economic growth. AJEB 8,3 336 Downloaded from http://www.emerald.com/ajeb/article-pdf/8/3/335/9503154/ajeb-12-2023-0122.pdf by ZBW German National Library of Economics user on 16 December 2025 The purpose of this research is to investigate how banking sector development influences economic growth, focusing on the following objectives: (1) To evaluate how deposits, loans, and investments within the banking sector contribute to the overall banking sector capital. (2) To analyze the impact of bank capital on the various components of GDP, including consumption, government spending, investment, and net exports. In essence, this study aims to uncover the relationships between banking sector development, capital accumulation, and their effects on the different aspects of economic growth, providing valuable insights into these critical interconnections. The outcome of this research are anticipated to be highly valuable for both commercial bank executives and policymakers, especially those working within central banks and ministries of finance. The research findings are geared towards optimizing the banking sector’s contribution to economic growth. Furthermore, this study adds to the existing body of literature on the banking sector by addressing the ongoing debate surrounding the extent and mechanisms through which the banking sector impacts economic growth across various economic dimensions. It aims to shed light on these intricate relationships and provide a deeper understanding of the banking sector’s role in shaping a country’s economic landscape. The subsequent sections of this study are structured as follow: Section 2 covers the theoretical framework review. Section 3 introduces and defines empirical model. Section 4 explains the research methodology. Section 5 forms the heart of study by presenting analyzing. and discussing the findings. Section 6 represents the conclusion of the research. Lastly, practical policy implications and future research directions will be formulated. Theoretical framework The development of the banking sector and its association with various economic factors have garnered significant attention from academic researchers and policymakers. Existing research has generally indicated the presence of a relationship, whether positive or negative, between banking sector development and economic growth. Bank assets, liabilities and capital as indicators for banking development Banking assets can be categorized into two main types: loans and investments (Suresh and Paul, 2014). Loans are a primary income source for banks, representing the money lent to borrowers (Bhattacharyay, 2015). Investments, on the other hand, are securities held by banks to generate income or manage liquidity (Gitman et al., 2015). The growth of banking assets serves as a significant indicator of economic activity. An increase in borrowing by businesses and consumers suggests economic expansion. However, rapid asset growth may also indicate excessive risk-taking, potentially increasing banks’vulnerability to losses. Bank liabilities can be categorized into two main types: deposits and other liabilities (Suresh and Paul, 2014). Deposits represent the funds entrusted to the bank by depositors, while other liabilities include borrowings from other institutions, repurchase agreements, and accrued expenses (Bhattacharyay, 2015). The growth of bank liabilities is a key indicator of public confidence in the banking system. When depositors have trust in their banks, they are more motivated to deposit their funds with them. However, excessive growth in bank liabilities can also expose banks to liquidity risk, which is the risk of being unable to meet their obligations to depositors. Bank capital represents the difference between a bank’s assets and its liabilities (Bhattacharyay, 2015). Capital is important because it helps to protect depositors and other creditors from losses (Suresh and Paul, 2014). The level of bank capital is an important indicator of a bank’s financial strength (Furlong, 1992). A higher level of capital means that a bank is better able to bear losses without having to resort to bailout by the government or other creditors (Rose and Hudgins, 2008). Asian Journal of Economics and Banking 337 Downloaded from http://www.emerald.com/ajeb/article-pdf/8/3/335/9503154/ajeb-12-2023-0122.pdf by ZBW German National Library of Economics user on 16 December 2025 In the context of bank sector development, previous researchers indicated bank development by (ROA), Return on Equity (ROE), and credit facilities (King and Levine, 1993;Imam and Kpodar, 2016;Abusharbeh, 2017;Lay, 2020). However, measuring bank development through bank capital presents a more comprehensive and robust approach compared to relying solely on metrics like Return on Assets (ROA) and Return on Equity (ROE). This is because bank capital summarizes a holistic view of a bank’s financial position, covering not only the outcomes of its assets and liabilities but also its owner equity (Bhattacharyay, 2015;Suresh and Paul, 2014). In essence, it offers a more complete representation of the bank’s overall financial health. As a result, bank capital serves as a more reliable indicator of banking development and growth, providing a well-rounded perspective on a bank’s capacity to support economic activities and contribute to the financial stability of the broader economy. The literature on bank assets suggests that they are essential for understanding a bank’s ability to generate income and support economic activities through lending and investment practices (Batrancea, 2021). Studies by Berger and Bouwman (2009) highlight how bank assets, particularly loans and investments, act as core driver of growth which facilitating liquidity in the market and enabling businesses to expand and grow. This perspective is supported by Demirg€ uç-Kunt and Levine (2001), who argue that the diversity and volume of banking assets are indicative of the sector’s strength and its ability to support economic growth. On the bank liabilities side, deposits play a key role in the banking sector’s development by providing the primary source of funding for banks’lending activities. The literature emphasizes the importance of deposits in maintaining the liquidity and stability of banks, thereby ensuring their ongoing ability to contribute to economic development. According to Diamond and Rajan (2001), the ability of banks to attract and retain deposits is crucial for their operational stability and for increase confidence among customer and investors. This view is resonated by Gorton and Winton (2003), who note that a healthy growth in deposits is often associated with an increase in customer trust and a stable economic environment, both of which are essential for stabilized banking development. Capital adequacy, the third dimension, is recognized in the literature as a critical measure of abank’s financial health and its resilience against potential shocks (Mendy et al., 2023). The capitalbase of banks not onlysupports their lending and investment activitiesbut alsoacts as a shieldagainst losses, thereby ensuringthe stability of the overall financial system (Huu Vu and Thanh Ngo, 2023). Research by Floreani et al.(2023)demonstrates that adequate bank capital is fundamental to risk management and is essential in promoting confidence among depositors and investors. Furthermore, the relationship between capital adequacy and regulatory frameworks, as discussed by Gr zeta et al.(2023), recognizes the role of bank capital in supporting banks’operational practices with broader economic objectives. These discussions conclude that bank assets, liabilities, and capital are not only indicators of individual banks’ performance but also the overall sector’s contribution to economic development. Relationship between banking sector development and economic growth Economic growth refers to the increase in the production of goods and services within an economy (Petkovski and Jordan, 2014). In many cases, economic growth is quantified by measuring the change in a nation’s GDP over a specific period (Timsina, 2014). Policymakers, government officials, and analysts commonly employ GDP as a key indicator to assess the overall health of a nation’s economy and to analyze growth trends in both the short and long term (Alkhazaleh, 2017). A well-functioning financial system is crucial for economic growth, as it facilitates the flow of funds from savers to borrowers, thereby enabling investment and innovation. AJEB 8,3 338 Downloaded from http://www.emerald.com/ajeb/article-pdf/8/3/335/9503154/ajeb-12-2023-0122.pdf by ZBW German National Library of Economics user on 16 December 2025 Bank capital, which refers to the financial resources held by banks to absorb losses, plays a critical role in ensuring the stability and resilience of the financial system (Kishan and Opiela, 2000). The financial intermediation hypothesis suggests that banks play a central role in channeling savings into productive investments, and higher levels of bank capital enhance this intermediation process by reducing the risk of bank failures and encouraging lending (McKinnon, 2010). Moreover, the risk management hypothesis emphasizes the importance of bank capital in mitigating financial crises. Higher bank capital cushions banks against losses during economic downturns, enabling them to continue providing credit and prevent a credit crunch that could stifle economic growth (Berger and Christa, 2013). Numerous studies have found a positive relationship between bank development and economic growth (Abusharbeh, 2017;Alkhazaleh, 2017;Hussain and Kumar Chakraborty, 2012;Lay, 2020;Guru and Yadav, 2019;Ozturk and Ullah, 2022). This suggests that higher levels of bank capital can contribute to faster economic growth. The strength of the relationship between bank capital and economic growth can vary across countries, depending on factors such as the level of financial development, institutional quality, and macroeconomic conditions (Levine et al., 2000). Bank capital plays a crucial role in facilitating trade finance, which is essential for businesses to engage in international commerce (Niepmann and Schmidt-Eisenlohr, 2013). When banks have adequate capital levels, they are more willing to extend credit to exporters and importers, thereby raising cross-border trade and boosting net exports, a component of GDP. Batrancea et al. (2022) found that the growth of the GDP serving as a proxy for economic growth, was influenced by the ratio of bank capital to assets over three decades in several countries, including Bolivia, the Czech Republic, Estonia, Malaysia, Peru, Poland, and Thailand. Additionally, well-capitalized banks can provide hedging instruments to mitigate foreign exchange risks, further encouraging international trade (Gitman et al., 2015). Bank capital is a key determinant of investment, another component of GDP. When banks have sufficient capital, they are more confident in their ability to absorb losses and maintain lending during economic downturns (King and Levine, 1993). This confidence leads banks to extend more credit to businesses for investment purposes, driving economic growth. Moreover, well-capitalized banks are better equipped to monitor and evaluate investment projects, reducing the risk of misallocation of capital and promoting productive investments (Bhattacharyay, 2015). Bank capital influences private consumption, a significant component of GDP, by affecting household borrowing capacity (Santomero, 1997). When banks have sufficient capital, they are more likely to approve loans to consumers, allowing them to purchase goods and services, thereby stimulating consumption-driven economic growth. Additionally, wellcapitalized banks can offer lower interest rates on consumer loans, further enhancing households’purchasing power and improving consumption. Bank capital plays a less direct role in influencing government spending, another component of GDP. While banks do not directly finance government expenditures, they can indirectly affect government borrowing capacity (J acome et al., 2012). Well-capitalized banks are more likely to purchase government bonds, providing a source of financing for government spending (Gitman et al., 2015). Additionally, a well-functioning financial system, underpinned by adequate bank capital, can boost tax revenues, providing the government with more resources for spending. Model development This research evaluates the causal relationship by examining, in the first round, the relationships between the (loans, investment, and deposits) as exogenous variables, and the bank capital as an endogenous variable. In the second round, the bank capital is an exogenous variable and the four GDP components are endogenous variables. Asian Journal of Economics and Banking 339 Downloaded from http://www.emerald.com/ajeb/article-pdf/8/3/335/9503154/ajeb-12-2023-0122.pdf by ZBW German National Library of Economics user on 16 December 2025 The predictors of the Bank Capital (CAPÞin the model are the following exogenous variables: Investments ðc1Þ, Deposits ðc2Þ, Loans ðc3Þ. These exogenous variables represent the direct causal effects in the model on the Bank Capital (CAPÞ. This relationship represents all effects which are determined by sums of products of structural coefficients, and it is illustrated in the following equations (1) and (2): CAP ¼ α 1c1þ α 2c2þ α 3c3þ ε 3(1) CAP ¼X 3 n¼1 α ncnþ ε i(2) Furthermore, the model includes four additional endogenous variables (GDP dimensions). The arrow links the first level three exogenous variables to level of Bank Capital (CAPÞ, and then, it links Bank Capital (CAPÞ(second level exogenous variable) to Private Consumption (PCÞ, Government Spending (GSÞ, Gross Investment (GIÞ,and Net Exports (NEÞsuggesting the indirect linkage. Hence, to estimate the total effect on the Private Consumption (PCÞ, we sum up the effects of the three exogenous variables (first level exogamous) on the Bank Capital (CAPÞ, and Bank Capital (CAPÞin the (second level exogamous) itself on the Private Consumption (PCÞ. The mathematical formulas for the total effect on Private Consumption (PCÞ, are denoted in equations (3) and (4): PC ¼β1* CAPþ ε 1(3) PC ¼β1 α 1c1þβ1 α 2c2þβ1 α 3c3þ ε 3þ ε 1(4) Also, to estimate the total effect on the Government Spending (PCÞ, Gross Investment (GIÞ,and Net Exports (NEÞ; we follow the same logic in Private Consumption (PCÞcase. The mathematical equations for the total effect on Government Spending (GS) are denoted in equations (5) and (6). The mathematical formulation for Gross Investment (GIÞ,are represented in equations (7) and (8), and mathematical formulation of Net Exports (NEÞare denoted in equations (9) and (10). GS ¼γ1* CAPþ ε 2(5) GS ¼γ1 α 1c1þγ1 α 2c2þγ1 α 3c3þ ε 2þ ε 1(6) GI ¼κ1* CAPþ ε 4(7) GI ¼κ1 α 1c1þκ1 α 2c2þκ1 α 3c3þ ε 4þ ε 1(8) NE ¼ ν 1* CAPþ ε 5(9) NE ¼ ν 1 α 1c1þ ν 1 α 2c2þ ν 1 α 3c3þ ε 5þ ε 1(10) Since it is not obvious what combinations of parameters measure the indirect effect on Private Consumption (PCÞ, we suggest to evaluate the fraction of the total effect of Private Consumption (PCÞ, which is explained by the Bank Capital (CAPÞand the fraction of the total effect of Private Consumption (PCÞ, which is owed to the Bank Capital (CAPÞ. Specifically, in order to quantify the degree to which the Bank Capital (CAPÞmodifies the effects of the first level three exogenous variables—Investments ðc1Þ, Deposits ðc2Þ, and Loans ðc3Þ, on Bank Capital (CAPÞ, we calculate the fraction of output response for which Bank Capital (CAPÞ would be sufficient in the case of Private Consumption (PCÞ, which is embodied in the following mathematical equations: AJEB 8,3 340 Downloaded from http://www.emerald.com/ajeb/article-pdf/8/3/335/9503154/ajeb-12-2023-0122.pdf by ZBW German National Library of Economics user on 16 December 2025 CAP PC ¼P 3 n¼1 α ncnþ ε i β1* CAPþ ε 1 (11) CAP PC ¼ α 1c1þ α 2c2þ α 3c3þþ ε 3 β1 α 1c1þβ1 α 2c2þβ1 α 3c3þ ε 3þ ε 1 (12) Following on the same logic as performed previously for the fraction of output response in the case of the Government Spending (GSÞ, Gross Investment (GIÞand Net Exports (NEÞ, we can also calculate the same fraction of output response for which the level of Bank Capital (CAPÞ would be sufficient in the case of the Government Spending (GSÞ, which is denoted in mathematical equations (13) and (14), Gross Investment (GIÞas showed in mathematical equations (15) and (16), and Net Exports (NEÞ, as represented in mathematical equations (17) and (18): CAP GS ¼P 3 n¼1 α ncnþ ε i γ1* CAPþ ε 1 (13) CAP GS ¼ α 1c1þ α 2c2þ α 3c3þþ ε 3 γ1 α 1c1þγ1 α 2c2þγ1 α 3c3þ ε 2þ ε 1 (14) CAP GI ¼P 3 n¼1 α ncnþ ε i k1* CAPþ ε 1 (15) CAP GI ¼ α 1c1þ α 2c2þ α 3c3þþ ε 3 κ1 α 1c1þκ1 α 2c2þκ1 α 3c3þ ε 4þ ε 1 (16) CAP NE ¼P 3 n¼1 α ncnþ ε i v1* CAPþ ε 1 (17) CAP NE ¼ α 1c1þ α 2c2þ α 3c3þþ ε 3 ν 1 α 1c1þ ν 1 α 2c2þ ν 1 α 3c3þ ε 5þ ε 1 (18) Methodology In this research, secondary data were gathered from reputable sources including the Palestinian Central Bureau of Statistics (PCBS), the Association of Banks in Palestine (ABP), and the Palestinian Monetary Authority (PMA). The PCBS functions as the official Palestinian statistical agency, tasked with the essential role of providing reliable statistical data both domestically and on the global stage. Conversely, the PMA serves as the emerging central bank of Palestine. These organizations serve as crucial sources of data and insights for this research, ensuring the reliability and credibility of the information used in the study. Data and sample The study relied on monthly and quarterly reports issued by the Palestinian Monetary Authority (PMA) that detail the performance of the banking sector (PMA, 2023a). These Asian Journal of Economics and Banking 341 Downloaded from http://www.emerald.com/ajeb/article-pdf/8/3/335/9503154/ajeb-12-2023-0122.pdf by ZBW German National Library of Economics user on 16 December 2025 reports contain valuable data, including information on the volume of bank loans, deposits, and investments. The PMA data was sourced from the monthly and quarterly financial reports submitted by all digital banks operating within the Palestinian economy. These banks are categorized into various groups, including national and international banks, as well as Islamic and conventional banks. The utilization of this comprehensive dataset from the PMA reports ensured a thorough and inclusive analysis of the banking sector’s activities and contributions to the Palestinian economy. Among the crucial reports, the consolidated balance sheet stands out as one of the most vital resources (PMA, 2023b). This comprehensive report amalgamates the financial data of all active digital banks at the main account level and is updated on a monthly basis. It serves as a valuable tool for gaining insights into the collective financial position of all Palestinian digital banks. Furthermore, the PMA releases a series of detailed reports that delve deeply into specific facets of the banking sector (PMA, 2023c). These reports cover a wide range of aspects, including deposit types, currency breakdowns, loan maturity profiles, sectoral distribution, loan sizes, investments, cash reserves, and various other critical financial metrics. Together, these reports present a comprehensive perspective of the Palestinian digital banking sector, serving as rich resources for researchers and policymakers. Conversely, the Palestinian Central Bureau of Statistics (PCBS) plays a key role by issuing a range of periodic reports that span across all economic sectors (PCBS, 2023a). Notably, the GDP breakdown by component report, which separates Private Consumption, Government Spending, Gross Investment, and Net Exports holds particular significance (PCBS, 2023b). These reports undergo a strict process of exchange and verification, involving multiple Palestinian institutions such as the Ministry of Finance, the Ministry of Economy, and the Palestinian Central Bureau of Statistics itself, before their official release. This collaborative validation process serves as a crucial step in ensuring the accuracy and reliability of the data presented in these reports. Technical method Prior researchers have employed various statistical methodologies to assess the relationship between banking sector development and economic growth. Some have utilized regression analysis and Granger causality tests (Tripathy and Pradhan, 2014;Islam et al., 2019). Others, such as Chien and Hu (2008),Acquah-Sam and King (2014),Lee et al. (2018), have selected more complex approaches such as Structural Equation Modeling (SEM). SEM is particularly relevant when there are multiple dependent variables in the analysis (Streiner, 2005). This technique exceeds multiple regression by concurrently conducting multiple regression analyses and generating an overall model fit assessment. In evaluating the model’s fit, the SEM method employs various goodness-of-fit indexes including chi-square statistics, GFI, RMSEA, CFI, NFI, and RMR (Singh and Wilkes, 1996). These methods collectively provide a comprehensive toolkit for exploring the intricate relationships between banking sector development, economic growth. In this study, SEM method is employed to examine the relationships among the variables, specifically the impact of main assets (loans and investments) and the primary liability (deposits) on bank capital, followed by an assessment of the influence of bank capital on the components of GDP. Maximum likelihood method of estimation is used in this research as it is the default in most structural equation modeling software (Streiner, 2005). The minimum number of cases for maximum likelihood estimation should be at five times the number of free parameters including error terms (Golob, 2003). The number of observations in this research is 164 records that meets the requirement as the estimation model contains 13 variables including the error terms. AJEB 8,3 342 Downloaded from http://www.emerald.com/ajeb/article-pdf/8/3/335/9503154/ajeb-12-2023-0122.pdf by ZBW German National Library of Economics user on 16 December 2025 In summary, the study contributes to both theory and practice by confirming the banking sector’s central role in economic growth, and by demonstrating the strategic reinvestment decisions made by banks that shape their impact on the broader economy. Theoretical contribution This research makes several theoretical contributions to the fields of banking, finance, and economic development. Firstly, it provides empirical evidence of the positive relationship between banking sector development, as represented by bank capital, and economic growth. This finding supports and extends prior research conducted in different economies and regions. By demonstrating the significant impact of bank capital on gross investment and private consumption, this study confirms the essential role of the banking sector in driving economic growth. Secondly, the research contributes to the understanding of the complex relationship between banking sector development and trade dynamics. The negative relationship between bank capital and net exports highlights the trade deficits in developing countries. It underscores the importance of considering trade dynamics when assessing the impact of banking sector development on various components of economic growth. Additionally, this study underscores the functions of the banking sector in an economy. It highlights how banks serve as crucial intermediaries by providing credit and banking services that facilitate a wide range of economic activities, from wholesale and retail trade to imports and exports, as well as gross investment. This understanding supports the notion that a thriving banking sector plays a pivotal role in raising economic development across diverse economic sectors. Furthermore, the research aligns with fundamental accounting principles by illustrating how changes in banking sector assets (investments and loans) are accompanied by corresponding adjustments in capital (retained earnings) and liabilities (deposits). This observation adds a financial perspective to the study’s theoretical contributions, emphasizing the interconnectedness of banking sector components. Finally, this study contributes to a more holistic understanding of the banking sector’s role in economic development. It bridges gaps in existing research by integrating financial management principles with macroeconomic impacts, offering a strong theoretical framework. This framework can inform both future academic inquiries and practical policy formulation. Such policies are designed to leverage the banking sector’s capabilities to support sustainable economic growth. Practical implications The findings carry several practical implications that can guide policymakers, banking institutions, entrepreneurs, investors, and economic stakeholders. Policymakers can use the empirical evidence presented in this study to inform their decisions regarding the banking sector’s role in economic development. Recognizing the positive impact of bank capital on gross investment and private consumption. Policymakers may consider policies that encourage and support the growth and stability of the banking sector. Measures such as regulatory frameworks that promote banking sector development can be adopted to stimulate economic growth. Further, given the observed negative relationship between bank capital and net exports, trade policies should be designed with an understanding of the role of the banking sector in trade dynamics. Policymakers may explore strategies to enhance banking services that support export-oriented industries, such as providing favorable loan terms and financial instruments for exporters. These findings can also be applied to developing economies facing trade deficits. Policymakers and banking institutions in such countries can consider tailored approaches to banking sector development to address trade imbalances and support Asian Journal of Economics and Banking 349 Downloaded from http://www.emerald.com/ajeb/article-pdf/8/3/335/9503154/ajeb-12-2023-0122.pdf by ZBW German National Library of Economics user on 16 December 2025 economic growth. Therefore, developing financial infrastructures, such as export credit agencies or guarantee schemes, could also be beneficial. Furthermore, banking institutions can take strategic actions based on the understanding that loans, investments, and deposits are critical determinants of bank capital. They may focus on prudent risk assessment and diversification strategies to optimize their loan and investment portfolios. Banks could also explore innovative deposit mobilization strategies to grow their capital, which, in turn, could fund further investments and loans, creating a worthy cycle of growth. Furthermost, the study’s insights could inspire educational and capacity-building initiatives to enhance financial literacy, enabling entrepreneurs and consumers to make more informed financial decisions that contribute to economic growth. 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