Financial Deepening, Banking Infrastructure, and Regional Labor Absorption: Panel Evidence from Indian States

This study empirically examines how state-level financial deepening and banking infrastructure affect labor absorption across the 36 Indian States and Union Territories during the period of 2022–2025. The paper applies a Two-Way Fixed Effects panel econometric model with cluster-robust standard errors to assess the semi-elasticity of the Worker Population Ratio (WPR) with respect to aggregate commercial bank credit and operational branch footprints. The diagnostic tests indicate that unobserved heterogeneity among states accounts for 98.29% of the composite error variance, supporting the choice of fixed effects estimation over pooled models. Even though the static level models generate positive yet statistically insignificant semi-elasticities over the short four-year panel horizon due to low temporal variation, our first-differenced dynamic model shows that the annual growth of credit has a statistically significant positive within-state co-movement with regional labor absorption. The results suggest that while accumulated banking infrastructure and static credit stocks reflect a baseline structural capacity to alter total employment levels, the dynamic annual growth of credit provides immediate labor liquidity that supports short-run labor absorption. Strategies targeting state-specific credit provision mechanisms and financing for labor-intensive sectors are recommended to optimize regional workforce absorption capacity.