How can regulators identify corruption?

21 September 2015

On 17 September, Sumit Agarwal, Professor of Economics, Finance and Real Estate at the National University of Singapore, gave a CFS Lecture. Agarwal showed different examples of how regulators can detect corruption and insider trading behavior. Corruption is a critical issue especially in developing economies, he said. Overall, corruption would cost the world over one trillion dollars annually. It has an adverse impact on economic growth and other outcomes, such as health or education, and accentuates inequality. In his lecture, Agarwal presented three different research papers that deal with corruption in China and Mexico as well as with insider trading in Singapore.

In his first example, analyzing corruption in consumer lending in China, Agarwal used credit card data to show that banks extend over-generous consumer credit to bureaucrats and that delinquent credit cards of bureaucrats are more likely to be reinstated after writing-off their debts. In this study, he also found that branches within a bank that grant more credit lines to bureaucrats are in return associated with higher government deposits. Besides, Agarwal analyzed possible implications for social welfare of this corrupt behavior. He came to the conclusion that non-bureaucrat consumers suffered from credit under-provision because people who live in areas with a high bureaucrat credit line premium were associated with significantly lower credit lines.

Agarwal presented a second paper where he empirically investigated political rents in private bank lending in Mexico. He found that banks actually gave higher loans to firms in the districts of politicians who held influential portfolios. The loans offered to politically connected firms had substantially more favorable terms but performed worse ex post (default more often). As an example, Agarwal stated that the credit supply to the agriculture sector in the Mexican state of Colima more than quadrupled after the senator from this state was appointed chairman of the Agriculture Commission in 2006. These kind of political rents were excursively offered by large banks. In return, these banks were able to lend out significantly more public loans.

In another example from Singapore, Agarwal showed how bureaucrats used insider information to benefit from housing transactions at the cost of the general public in Singapore. In his paper, Agarwal focused on the announcements of two new railway constructions in Singapore. Properties located close to the new railway station were expected to increase significantly in price after the announcement, he pointed out. Therefore, bureaucrats who knew about the railway construction in advance could make profits by purchasing these properties before the official announcement. Using housing market data from Singapore, Agarwal found significant evidence that bureaucrats made actually use of their insider information. Especially bureaucrats who worked in a critical area, such as the transportation department, had an information advantage and purchased significantly more of the properties that were expected to increase in price.