The effect of corruption on bank profitability

Publication Date02 Jul 2019
DOIhttps://doi.org/10.1108/JFC-09-2018-0102
Pages753-773
AuthorSegun Thompson Bolarinwa,Funmi Soetan
SubjectFinancial risk/company failure,Financial crime
The eect of corruption
on bank protability
Segun Thompson Bolarinwa
Department of Economics, Obafemi Awolowo University, Ile-Ife, Nigeria, and
Funmi Soetan
Department of Economics, Obafemi Awolowo University Faculty of Social Sciences,
Ile-Ife, Nigeria
Abstract
Purpose This paperaims to investigate the effect of corruptionon bank protability.
Design/methodology/approach The paper adopts panel cointegration, differenced generalized
method of moments(GMM) and system GMM.
Findings The empirical results show that corruption is important in explaining the protability of
commercial banks in both developed and emerging countries. While it has mixed effects in emerging
countries,only positive effect is validated in developedcountries.
Research limitations/implications Macroeconomicmeasures of corruption are adopted in the study.
Originality/value The paper contributes to the literature on corruption and bank protability by
reporting evidencefrom both developed and developing countries.Existing papers have only concentrated on
developingcountries.
Keywords Protability, Banking Industry, Corruption, ICRG, Transparency international
Paper type Research paper
1. Introduction
The determinants of bank protabilityhave been extensively studied in nancial economics
and banking literature in past four decades (Short, 1979;Dietrich and Wanzenried, 2014;
Adelopo, Lloydking and Tauringana, 2018). These studies report that rm-specic,
industrial-specic and the macroeconomic variables are signicant determinants of bank
protability (Tan and Floros, 2012;Capraruand Ihnatov, 2015;Garcia and Guerreiro, 2016).
Recently, studies have also accountedthe roles of corruption on bank activities (Park, 2012;
Arshad and Rizvi, 2013;Chen et al.,2015). The work of La Porta et al. (1997) documented
that countries with higher bank government ownership are linked with higher level of
corruption, thus, suggesting a negative effect of corruption on bank protability. In
particular, the effect of corruption on bank protability has attracted the attention of
scholars in recent times(Akins et al.,2016;Toaderet al., 2017;Bougatef, 2017).
The theoretical submissions on the relationship between corruption and bank
protability are mixed. On one hand, a school of thought leads by Gerschenkron (1962)
postulates that corruption may have a positive effect on the economy. This is because it
enables investors and rms to access loans without fullling stringent collateral conditions
for productive investments especially in corrupt and developing countries (Laeven and
Levine, 2009;Chen et al.,2013;Akins et al., 2016). Similarly, grease wheel hypothesis
according to Charumilind et al. (2006) suggests that corruption helps business and
inuential people to access loans without fullling stringent loan conditions in
environments exhibiting a high level of corruption. Likewise, it has been documented that
The eect of
corruption
753
Journalof Financial Crime
Vol.26 No. 3, 2019
pp. 753-773
© Emerald Publishing Limited
1359-0790
DOI 10.1108/JFC-09-2018-0102
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/1359-0790.htm
corruption could increase bank lending,thus, bank protability in the short run particularly
in banking industries exhibiting high-risk aversion (Lalountas et al.,2011;Weill, 2011). On
the other hand, another school of thoughthas documented a negative effect of corruption on
bank protability. It is argued that there is a possibility of diverting loanable funds to bad
projects in an economy exhibiting a high degree of corruption (Bougatef, 2017). This is
because bank managers may approve bad loans just for private benets arising from
bribery and corruption despite the knowledge of the risky nature of such loans. Moreover,
loans involving corruptionare usually characterized by high default and credit risk in bank
portfolio (Khwaja and Mian, 2005;Akins et al., 2016). Thus, a high level of corruption
increases bank non-performing loans,reduces protability and intensify the fragility of the
banking industry (Park,2012).
Empirical studies investigating the effect of corruption on bank protability are very
scarce. Though scanty, these studies have reported mixed and conicting results. While
some studies have reported a negative relationship between corruption andbank activities
and protability (Demirguc-Kunt and Huizinga, 1998;Sheng-Hung and Chien-Chang, 2009;
Asteriou et al., 2016); some othershave specically reported a positive relationship between
corruption and bank protability (Aburime, 2009;Mongid and Tahir, 2011; Arshad and
Rizvi, 2013; Bougatef, 2017). Studies specically investigating the effect of corruption on
bank protability are nascent and inconclusive. Against this background, this paper
contributes to extant literature investigating the relationship between corruption and bank
protability in three ways.First, the study documents a robust evidence by adopting data of
111 banks in 33 African countries where corruption is believed to be prevalent. To the best
our knowledge, nostudy has adopted such data set to investigate the relationship.
Although, corruption is pervasiveamong African countries yet corruption is a universal
problem. Notwithstanding, asides from Asteriou et al. (2016), which studied the effect of
corruption on European bank protability, no study has investigated the relationship in
developed countries. Thus another novelty of the present study lies in the fact that it
documents evidences from both highly corruptand least corrupt countries. It uses 56 banks
from the banking industries of ve least corrupt countries of Denmark, Canada, Sweden,
New Zealand and Norway. Thesecountries are selected from ten least countries in the world
(CPI, 2018). It also uses 111 banks from33 African countries. Thirdly, this work extends the
methodology in the literatureby incorporating the International Country Risk Guide (ICRG)
(2017) measure of corruption. Existing studies have only used two measures of corruption-
The Transparency International Ranking (Arshad and Rizvi, 2013; Bougatef, 2017;Toader
et al., 2017) and the World Bank Governance Index[1](Toader et al.,2017). This reputable
measure has been widely applied forinvestigating corruption in empirical studies (La Porta
et al.,1997;Law et al., 2014;Lawet al.,2018). The rest of the study are structuredas follows.
Section 2 addresses theoretical and empirical literature reviews while Section 3 critically
examines the methodology. Section 4 presents empirical results andits discussion. Finally,
section 5 providesa brief conclusion.
2. Brief empirical review
Empirical studies investigatingthe roles of corruption on bank protability are nascent and
scanty[2]. However, these studies have reported mixed evidences. The rst empirical study
that specically studied the effect of corruption on bank protability was undertaken by
Aburime (2009). Using Transparency Internationals corruption perception index (CPI) and
the Nigerian banking industry as a case study between1996 and 2006, the study reported a
positive relationship between the high level of corruption in the country and bank
protability. Challenged by the empirical results emanating from Nigeria, the relationship
JFC
26,3
754

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