Financial Reforms and Corruption: Which Dimensions Matter?

Published date01 June 2020
AuthorChandan Kumar Jha
Date01 June 2020
Financial Reforms and Corruption:
Which Dimensions Matter?*
Madden School of Business, Le Moyne College, Syracuse, NY
This paper investigates the effects of reforms in different dimensions of the
nancial sector on corruption in a panel of 82 countries. It nds that several,
but not all, of the policies targeted toward liberalizing nancial sector reduce
corruption. Specically, entry barriers, directed credit, securities market
development, and the extent of banking supervision are signicantly nega-
tively associated with corruption. The effects of reforms in different dimen-
sions of the nancial sector also depend on the quality of the governance
(bad versus good governance) and whether the country is an advanced or a
non-advanced economy. Finally, a stronger democracy and better law and
order are found to be associated with lower corruption.
JEL Codes: D73; G28; K42; O16
Accepted: 29 May 2018
The empirical literature identies a wide range of positive effects of nancial
liberalization on economic outcomes, such as investment and economic growth
(see Levine 2005 for a review of related literature).
Corruption, on the other
hand, has opposite effects on the economy and it adversely affects investment
and economic growth (Mauro 1995). Linking these two strands of literature,
Ahlin and Pang (2008) show that nancial development and the absence of
corruption are substitutes for growth. Furthermore, Boerner and Hainz (2009)
argue that the lack of economic and nancial reforms weakens the political sup-
port for anti-corruption measures and, using a probabilistic voting model, show
that economic liberalization improves the support for anti-corruption policies.
Hence, looking at the relationship between nancial reforms and corruption
* I would like to thank Louis-Philippe Beland, Trina Biswas, Satadru Das, Maxwell Means, Bibhu-
dutta Panda, Luiza Pogorelova, Sudipta Sarangi, Ishita Tripathi, Gregory Upton, and an anonymous
referee for their constructive comments. I gratefully acknowledge Le Moyne Colleges Research and
Development Grant for nancial support.
1 Note that although it is commonly viewed that nancial liberalization increases the likeli-
hood of banking crisis, the evidence suggests otherwise. For example, Angkinand et al. (2010)
nd that this is true only up to a partial level after which an increase in liberalization reduces
the probability of a crisis. Moreover, Shehzad and De Haan (2009) show that reforms in cer-
tain dimensions of the nancial system actually lower the probability of systematic banking
© 2018 International Review of Finance Ltd. 2018
International Review of Finance, 20:2, 2020: pp. 515527
DOI: 10.1111/ir.12210

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