Determinants of Ethiopian banking sector development: a 30-year empirical analysis with ARDL model

This study examines the determinants of Ethiopia's banking sector development (BSD) through New Institutional Economics (NIE) lenses. The study uses 30 years of secondary data (1994–2023) from the Global Financial Development Database, the National Bank of Ethiopia, and the World Bank. The dependent variable, BSD, was measured using indicators of depth, access, and efficiency. Independent variables include GDP per capita, inflation, fiscal policy, trade openness, remittances, political stability, regulatory quality, and urbanization. The Autoregressive Distributed Lag (ARDL) model was used to analyze short and long run relationships among variables. The NIE perspective reveals how institutional misalignments between formal policies and informal norms shape BSD outcomes. The study's findings revealed that GDP per capita has significant positive impact on BSD both in the short-term (β = 0.2723, p = 0.0029) and long-term (β = 0.1959, p = 0.0001). Remittances showed significant positive influences in both short-term (β = 0.089151, p < 0.05) and long-term (β = 0.0641, p < 0.05). Inflation exhibited a short-term significant positive effect (β = 0.0622, p < 0.05). Urbanization revealed a significant negative effect in both short-term (β = −0.3155, p < 0.05) and long-term (β = −0.4957, p < 0.05); while regulatory quality showed a significant negative long-term impact (β = −10.57, p < 0.05). The findings of this study offer valuable policy insights. These findings underscore the need for institutional reforms that align formal banking systems with Ethiopia's socio-cultural context to advance BSD. Policymakers need to focus on improving financial infrastructure in rapidly growing cities. The government should identify and implement better strategies to enhance formal remittance flows. Banking regulations should strike a careful balance between maintaining financial sector stability and fostering banks’ innovation and growth. Maintaining stable inflation and GDP per capita growth was found to be crucial for sustainable banking development. On the other hand, the insignificant connection between political stability, fiscal policy, and trade openness with BSD suggests that these areas require consideration of informal financial norms, and structural reforms to better support the sector. By focusing on these specific areas, Ethiopia can build a more robust banking system that contributes to SDGs.