This study aims to determine the effect of financial deepening on economic growth. It also investigates the role of the two political systems (i.e. democracy and monarchy) in supporting the effect between the two factors.
This paper adopts a dynamic panel regression model, i.e. generalized method of moments to answer the hypotheses. This paper uses data from 44 Islamic countries that are members of the Organization of Islamic Cooperation (OIC) for the period from 2010 to 2019.
This paper finds that financial deepening has an inverted U-shaped effect on economic growth. This means that financial deepening will only be effective at a certain threshold, if exceeded, it weakens economic growth. This negative effect is due to several reasons, such as high inflation, money supply, unproductive credit allocation and government policies. Furthermore, the political system facilitates the effect of financial deepening on economic growth. This finding becomes more valid as it is free from the endogeneity effect using two-stage least square tests.
The proxies used for economic growth and financial deepening in Islamic countries require refinement to improve their relevance and applicability. Furthermore, due to the unavailability of an easily accessible political system index, this paper is forced to use dummy variables.
The primary outcome of this research is to advocate for the establishment of effective governance within each member country of the OIC countries.
This study addresses the need to understanding how the effectiveness of the political system enhances financial deepening, thereby fostering economic growth.
