How corruption affects loan portfolio quality in emerging markets?
| Date | 03 October 2016 |
| DOI | https://doi.org/10.1108/JFC-04-2015-0021 |
| Pages | 769-785 |
| Published date | 03 October 2016 |
| Author | Khemaies Bougatef |
| Subject Matter | Accounting & Finance,Financial risk/company failure,Financial crime |
How corruption affects loan
portfolio quality in
emerging markets?
Khemaies Bougatef
University of Kairouan, Kairouan, Tunisia
Abstract
Purpose – The purpose of this paper is to empirically investigate the impact of corruption on the asset
quality of banks operating in emerging market economies over the period 2008-2012. This issue is of
crucial importance given the role of banking systems in economic development and the worldwide
spread of corruption. Using panel data set of 22 countries, our ndings provide a strong and robust
support to the hypothesis according to which corruption aggravates the problem with non-performing
loans. This evidence suggests that corruption may hinder economic development through the
misallocation of loanable funds. Other results are as follows: economic expansion and capitalization
level improve the loan portfolio quality. By contrast, unemployment deteriorates the debt servicing
capacity of borrower which in turn contributes to lower the bank asset quality.
Design/methodology/approach – The authors use panel data techniques on a sample of 22 emerging
market economies over the period 2008-2012 to test the relevance of corrupt practices on the soundness of banks.
Findings – Their ndings reveal a robust positive relationship between corruption and non-performing
loans (NPLs). This evidence corroborates previous results on the detrimental effect of corrupt practices on
nancial development. The subdivision of our main sample into two groups on the basis of the level of
corruption reveals the importance of the effectiveness of collateral and bankruptcy laws in reducing the effect
of corruption on loan portfolio. Moreover, we nd that the accessibility to more credit information is helpful
only in low corrupt countries since it enhances the soundness of banks by facilitating lending decisions.
Originality/value – The novelty of this paper is to take into consideration the implications of
corruption in investigating the determinants of credit risk.
Keywords Corruption, Emerging markets, Panel data, Non-performing loans
Paper type Research paper
1. Introduction
The role of banking system in enhancing economic growth has been emphasized by a large
body of theoretical and empirical literature (Beck and Levine, 2004;Wilhelm, 2002). The
banking system can serve as a catalyst for industrialization through its contribution in the
creation of new industries in emerging countries (Da Rin and Hellmann, 2002). Given this
importance of banks, policymakers should create the favorable environment that allows
banking system to work well. However, the wide spread of corruption in the majority of
emerging economies may undercut these efforts to effective mobilization and allocation of
resources. Corruption can be dened as a dishonest behavior of an ofceholder seeking
illegitimate private gain. It includes giving or accepting bribes or inappropriate gifts,
laundering money, double dealing, diverting funds, under-the-table transactions and so on.
Corruption may undermine broader efforts to efciently allocate resources. Indeed, it diverts
resources at the expense of vital activities for poverty eradication and sustainable economic
development. One may wonder how some countries could pursue their development process
in the presence of high levels of corruption. Treisman (2000) demonstrates that even though
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How
corruption
affects loan
portfolio
769
Journalof Financial Crime
Vol.23 No. 4, 2016
pp.769-785
©Emerald Group Publishing Limited
1359-0790
DOI 10.1108/JFC-04-2015-0021
corrupt actions undermine growth, countries can at times grow their way out of corruption.
Despite its importance, we point out the scarcity of research on this topic. The plausible
explanation of the relative lack of studies in this area may be the secrecy of corruption, as no
one confesses that he/she is doing unscrupulous practices. In addition, the difculty of
measuring levels of relative corruption in different countries has presented a major obstacle
to conduct empirical research in this area (Treisman, 2000).
The main goal of this study is to investigate the relationship between corruption and
non-performing loans in emerging countries. The novelty of this study consists in the use of
the corruption level besides macroeconomic and bank-specic variables as determinant of
non-performing loans (NPLs). The main motivations behind our choice for this topic is the
fact that the problem of non-performing debts largely represents the most common cause of
bank failure and losses due to the non-repayment of loans pose a serious threat to nancial
stability (Beattie et al., 1995). In addition, the corruption may affect a bank’s performance
through the misallocation of loanable funds from normal projects to bad projects which will
lead to increasing the amount of non-performing loans (Park, 2012).
While the absence of data on bank corruption level makes it necessary to be cautious,
this study does provide an insightful result. We nd that corruption hampers banks to
optimally allocate their resources. Indeed, it aggravates the problem with bad loans, and
this negative impact is more notable for high corrupt countries.
The remainder of the paper proceeds as follows: Section 2 discusses the possible
inuence of corruption on banking industry. Section 3 presents evidence and literature
on the determinants of non-performing loans. Section 4 presents data used in analysis
and develops hypotheses on the predicted role of each variable. The main empirical
results are reported in Section 5, while Section 6 provides some robustness tests.
Section 7 summarizes the results and concludes.
2. Linkages of corruption and bank activity
Corruption may affect the banking system indirectly through saving (Swaleheen, 2008)
or directly through lending (Weill, 2011;Barth et al., 2009;Houston et al., 2011) and the
aggravation of the problems with bad loans (Park, 2012).
Corruption may have an indirect effect on the bank deposits through a channel of
savings. In this regard, Swaleheen (2008) nds that corruption is adversely related to the
gross national saving rate, as corruption distorts the incentives to save and impairs the
ability to save. He demonstrates that corruption may negatively affect saving rate
through its positive correlation with real interest rate.
Weill (2011) nds that corruption hampers bank lending in Russia, and this
detrimental effect is mainly relevant for loans to households and rms in opposition to
loans to government. This lending corruption can be reduced via bank competition and
information sharing. Indeed, information sharing helps to enhance the positive effect of
competition in curtailing lending corruption (Barth et al., 2009). Houston et al. (2011)
demonstrate that the positive link between banking concentration and corruption in
lending may be due to both media state ownership and media concentration. In addition,
the potential monitoring and investigation incentives by media rms are undermined by
state ownership and high market concentration of ownership. As a consequence,
ineffective media monitoring reduces the expected costs of engaging in corruption
practices and, in turn, results in more corruption in lending. Similarly, Beck et al. (2006)
nd that empowering private monitoring of banks is more effective than ofcial
JFC
23,4
770
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