DOES CORRUPTION SAND THE WHEELS OF FINANCIAL SECTOR DEVELOPMENT? EVIDENCE FROM GLOBAL PANEL DATA

Abstract

This study examines the effects of corruption and political instability and violence on the financial sector development. We estimate the impact for a panel of countries classified by income groups and regulatory quality. The study considers the period from 1996 to 2015 for analysis. The empirical models of this study test the linear as well as nonlinear relationships between corruption and financial sector development. Our analysis utilizes a dynamic panel data model and takes care of the potential endogeneity problem in estimation. The results show that corruption has a negative effect on financial sector development for all as well as different income-group countries. Our results further show that the effects of corruption are nonlinear in nature and indicate that corruption is more financial development-reducing when its level is very high. We also test the joint effect of corruption and political instability and violence on financial development. It largely shows that their combined effect is positive, implying that widespread corruption can positively affect financial development if a country is suffering from an unstable political institution.