This study conducts a comprehensive reevaluation of the relationship between the banking sector and economic growth, incorporating the influence of the shadow economy. Leveraging panel data from 40 developing nations spanning the period 1991 to 2017, the research employs advanced Panel Nonlinear Autoregressive Distributed Lagged (ARDL-PMG) models. To further scrutinize the short-and long-term dynamics of this relationship, the study also conducts tests for cross-sectional dependence. This research stands as a pioneering effort in integrating the role of the shadow economy into the intricate interplay between banking sector development and economic growth. The findings of the study unveil that adverse shocks to the shadow economy exhibit a positive impact on the long-term association between banking sector development and economic growth, with the converse holding true. Nonetheless, the analysis does not reveal evidence of such asymmetric outcomes, at least in the short term. Furthermore, the study exposes a significant and negative direct influence of the shadow economy’s size on economic growth in both the short and long run. These discoveries hold substantial policy implications for the governments of developing nations, providing valuable insights for informed decision-making in the pursuit of sustainable economic development.