Corruption and banking soundness: does natural resource dependency matter?

Published date28 May 2021
Date28 May 2021
Subject MatterAccounting & finance,Financial risk/company failure,Financial crime
AuthorHamid Kordbacheh,Seyedeh Zahra Sadati
Corruption and banking
soundness: does natural resource
dependency matter?
Hamid Kordbacheh and Seyedeh Zahra Sadati
Alzahra University, Tehran, Iran
Purpose The natural resources curse theoryargues the higher dependency on natural resources leads to
many socio-economic problems.The purpose of this study is to examine the relationship between corruption
and banking soundnessand also to compare the extent of this effect betweenthe two groups of rich and poor
in natural resourcescountries.
Design/methodology/approach To this aim, the authors apply a panel data set comprised of 98
countriesfrom 2012 to 2015.
Findings The results showthat nations with a higher level of corruption havepoorer banking soundness.
The authors also f‌ind that by consideringthe resource curse theory and the effect of natural resource rents in
the model, the adverse impact of corruption on banking soundness is more substantial in countries with a
higher naturaldependency level (rich in natural resources).
Originality/value Though studies have been conducted on corruption and banking soundness, this
paper, by using resources cursetheory, articulates that corruption is one of the most critical factors affecting
banking soundness and has a destructive effect on the health of the banking system and the economy of
almost all countries, especially in natural resource-based economies. This study will appeal to banks
authorities, governments,policymakers, oversight f‌inancial institutionsand those who have a vested interest
in regulating f‌inancial crimes globally.They can prevent f‌inancial and banking crises by cooperating in the
f‌ight againstcorruption worldwide.
Keywords Corruption, Panel data, Natural resources, Non-performing loans, Banking soundness,
Resources curse theory, Cross-sectional data, Banking crises, Agency theory, Economic development
Paper type Technical paper
1. Introduction
Generally, corruption is the abuse of public off‌ice for privategain. Among the many forms
of corruption, this def‌inition focuses on political corruption as public off‌icials seek
illegitimate personal growth through bribery, extortion, cronyism, nepotism, patronage,
graft and embezzlement,which prevails among some types of corruption (Park,2012).
Almost all countries have signs of corruption, and it exists in all stages of economic
development. As the banking system is a channel that transfers the impact of corruption on
economic growth, it leads to a lower economic growth level (Son et al., 2020). Corruption is the
primary reason resource-rich countries perform poorly in their economies (Kolstad and Wiig, 2009).
As corruption has become a common target for international organizations, national
governments, non-governmental organizations and other entities, it weakens political
legitimacy, stability, economic development and social welfare. It seems that the lower level of
corruption had a positive impact on the economy and bank stability. It is also associated with
fewer credit losses and more moderate credit growth (Toader et al., 2018).
The analysis of banking and f‌inancial crises indicatesthat the starting point for many of
these crises at the national and internationallevels is the deterioration of the banksbalance
Corruption and
Journalof Financial Crime
Vol.29 No. 1, 2022
pp. 293-308
© Emerald Publishing Limited
DOI 10.1108/JFC-01-2021-0004
The current issue and full text archive of this journal is available on Emerald Insight at:
sheets and the banking system (Frederic, 2012;Laeven and Valencia, 2012;Schoen, 2017).
Corruption is one of the criticaldeterminants of bank loansquality, which causes increased
non-performing loans and signif‌icantlydecreases the quality of bank loans and, ultimately,
leads to deterioration in bank balance sheets and a reduction in banking soundness (Park,
2012;Tran et al.,2017;Bougatef, 2015). As a result, it can make the banking system more
vulnerable to a f‌inancial crisis. Therefore, one of the most important factors preventing
banking crises is maintainingbanking soundness and recognizing thefactors that affect it.
The natural resources curse theoryargues that in natural resource-based economies, the
extraction of naturalresources by government off‌icials and their dominance and easy access
to the vast f‌inancial resources resulting from the export of natural resources lead to the
formation of a large rentier state (Boutilier, 2017). According to the rentier state theory [1],
the abundance of natural resources leads to weak andpredatory institutions (Aslaksen and
Torvik, 2006;Auty and Gelb, 2001;Bagaji et al., 2011;Mähler, 2010;Waldner and Smith,
2014). It raises corruption [2], rent-seeking (Tullock, 2001) and the weakness of democracy
(Collier and Hoeff‌ler, 2009;Persson and Tabellini, 2006), which are prominent signs of
institutional weakness and are the main differentiators between cursed and non-cursed
countries (Boutilier, 2017;Butkiewicz and Yanikkaya, 2010). In countries where there are
powerful, organized groups and a honey pot,those groups all seek their rent share
(Boutilier, 2017). Therefore,given the above reasons, it can be argued why rent-seeking and
corruption behaviors are morecommon in countries rich in natural resources. Rentier states
with a weak institutional system could increase f‌inancial institutionsineff‌iciency in this
group of countries (Gazdarand Cherif, 2014;Khan et al.,2019;Law and Azman-Saini, 2012).
As many countries with abundant natural resources do not have developed f‌inancial
markets, their banking system accounts for a large share of their f‌inancing [3]; this could
help increase the negative impact of corruption in these countries on the banking systems
The remainder of the paper is organized as follows. Section 2 includes the research
background and a literature review on the relationship between natural resources,
corruption and banking soundness. Section 3 describes the data and the variables used.
Section 4 describes the empirical econometric models and the results. Section 5 tests the
robustness of earlier analyses using alternative indicators. Finally, in the last section,
conclusions and the results derivedare presented with some policy implications.
2. Literature review
Agency theory is one of several theoreticalapproaches that have been taken to explain how
f‌inancial crises are formed (Johnson and Droege, 2004). In an economic system, asymmetric
information is an obstacle to the eff‌icient transfer of funds from savers to households and
f‌irms with high investment opportunities. Economists are often referred to this barrier as
f‌inancial friction (Giovannini et al., 2013;Hahm and Mishkin, 2000;Mishkin, 1990;Ramos-
Tallada, 2010). As economic friction increases, it becomes more diff‌icult for lenders to
determine the credibility of borrowers. In this situation, they have to apply for higher interest
rates to secure themselves against the probability of non-payment of loans to increase the credit
spread. Credit expansion means the difference between th e interest rate on a business loan and
the interest rate on a fully secured asset that is safe for reimbursement (Leitão, 2016).
In this context, the existence of corruptionin the economy can exacerbate the problem of
agency. In a widespread corruptionsystem, the issue of adverse selection in borrowing and
lending is more acute. The authoritiesleverageoverpayment of facilities (which is one of the
most critical aspects of such corruption) and inadequate screening of loan applicants
because of the spread of bribery and embezzlement among the experts and management

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