Does microfinance cause banking sector development and economic growth? An application to Mongolia

This study analyzes the long- and short-run relationships between microfinance sector development, bank-based financial sector development, and economic well-being in Mongolia using a secondary dataset covering 40 quarters between 2006q4 and 2016q3. We construct a separate index for banking sector development and for microfinance sector development, and use the growth rate of quarterly GDP per capita as a proxy for economic well-being. A cointegration analysis, based on the autoregressive distributed lag (ARDL) bounds testing approach, indicates that there is at least one cointegrating relation among microfinance development, banking sector development, and economic growth in Mongolia. The study also suggests that there is a bidirectional relationship between the microfinance and banking sectors in the short run. However, in the long run there is an unidirectional positive causal relationship from microfinance to the banking sector. The microfinance sector thus has become an integral part of the bank-based financial sector of Mongolia. However, neither microfinance development, nor banking sector development, appear to contribute to economic growth in Mongolia.