Unveiling the Macroeconomic Drivers of Financial Development: Evidence from Malaysia

Financial development is crucial in a country’s growth by promoting economic expansion and alleviating poverty. As the financial sector advances, it increases access to financial services, allowing for better risk diversification. However, the annual growth of domestic credit in Malaysia has decelerated during the past decade. A subsequent decline in annual Gross Domestic Product (GDP) growth in Malaysia, attributed to the economic shock experienced during the specified period, leads to less demand for financial services. Therefore, examining macroeconomic variables that impact financial development in Malaysia is essential. This study focuses on key indicators such as economic growth, real interest rates, and inflation, analysing their effects on financial development. It also considers control variables like Trade Openness (TO) and Human Capital (HC) to prevent biased results. Using ARDL estimation on 42 years of annual data from 1980 to 2022 shows that economic growth (LNGDP), real interest rates (LNRIR), and human capital (LNHC) positively influence financial development (LNFD). Conversely, inflation (LNINF) has a significant negative effect. Policymakers are encouraged to maintain a stable macroeconomic environment that supports growth, such as low inflation, manageable interest rates, and a sound banking system. These conditions will help channel economic expansion into financial sector development.