Corruption and bank efficiency: Expanding the ‘sand or grease the wheel hypothesis’ for the Gulf Cooperation Council

• Published date: 01 December 2022
• Author: Mohammad Kabir Hassan,Rashedul Hasan,Mohammad Dulal Miah,Muhammad Ashfaq
• Date: 01 December 2022
• DOI: http://doi.org/10.1002/pa.2737

RESEARCH ARTICLE

Corruption and bank efficiency: Expanding the ‘sand or grease

the wheel hypothesis’for the Gulf Cooperation Council

Mohammad Kabir Hassan

1

| Rashedul Hasan

2

| Mohammad Dulal Miah

3

|

Muhammad Ashfaq

4

1

Department of Economics and Finance,

University of New Orleans, New Orleans,

Louisiana, USA

2

School of Economics, Finance and

Accounting, Coventry University,

Coventry, UK

3

Department of Economics and Finance,

University of Nizwa, Nizwa, Sultanate

of Oman

4

IUBH University of Applied Sciences, Bad

Honnef, Germany

Correspondence

Rashedul Hasan, School of Economics, Finance

and Accounting, Coventry University,

Coventry, UK.

Email: ad6284@coventry.ac.uk

We draw upon the broader theoretical framework of rent-seeking to empirically ana-

lyze the impact of corruption on the efficiency of the banking industry in the Gulf

Cooperation Council. We have used various databases, including Bankscope, World

Bank, and Transparency International, to gather Bank-specific and macro-economic

data for 77 banks covering the period 2005–2014. We perform ordinary least square

(OLS) and generalised methods of moments regression (GMM) using a balanced panel

and find (1) Islamic banks as less efficient and stable as compared to conventional

banks in the GCC region, (2) corruption has a negative (positive) impact on Islamic

(conventional) banks' stability. Our findings provide support for the ‘sand the wheel’

hypothesis of corruption for Islamic banks. This finding supports the view that under

the current weak governance structures and complex policy framework, corruption

acts as an ‘escape hatch’for conventional banks. Our empirical findings could pave

the way for further policy reform for the banking sector in the GCC region.

KEYWORDS

corruption, efficiency, GCC countries, Islamic banks, rent-seeking

1|INTRODUCTION

In a corrupt society, firms find it profitable to avoid normal administra-

tive processes and resort to underground means. This tendency

wanes states the capacity to collect revenues required for providing

essential public goods, including efficient law and order (Aghion

et al., 2016). Weak law and order, coupled with insecure property

rights, amplifies corruption and discourages foreign capital inflows

(Lambsdorff, 2003). This welfare-reducing impact of corruption is

commonly referred to as the ‘sand or grease the wheel’hypothesis

(Méon & Weill, 2010; Méon & Sekkat, 2005; Sharma & Mitra, 2015).

On the contrary, Bhagwati (1982) shows that in an already dis-

torted market, corruption, or rent-seeking (Bhagwati terms it ‘directly

unproductive profit-seeking’), may lead to a welfare-enhancing effect.

Bardhan (1997) refers to such an environment as ‘the second-best

world’, characterised by policy-induced distortions such as pervasive

and cumbersome regulations. Huntington (1968) argues that a higher

level of corruption can improve growth bypassing bureaucratic

processes. Blessed by the gift of natural resources, economies in the

GCC countries have been relying heavily on hydrocarbon products,

which accounts for almost half of the total gross domestic product

(GDP). Corruption is one obstacle that may hinder the financial devel-

opment of the GCC region.

The effect of corruption on financial development is inconclusive.

Moreover, this issue remains largely unexplored in the context of

GCC countries. In particular, there is a limited number of studies

(Mohamed et al., 2021; Saif-Alyousfi & Saha, 2021; Saw et al., 2020)

that investigate the diverse impact of corruption on bank efficiency

with a theoretical perspective. The primary objective of this paper is

to provide empirical evidence on the impact of corruption on the effi-

ciency of the GCC banking sector. More specifically, we attempt to

test the ‘sands or grease the wheel’hypothesis for the GCC banking

sector. In the process, we collect secondary data from various data-

bases such as Bankscope for bank-specific data, World Bank database

for macroeconomic data, and Transparency International for the

country-level corruption data.

Received: 3 October 2020 Revised: 23 July 2021 Accepted: 26 July 2021

DOI: 10.1002/pa.2737

J Public Affairs. 2022;22(Suppl. 1):e2737. wileyonlinelibrary.com/journal/pa © 2021 John Wiley & Sons Ltd. 1of17

https://doi.org/10.1002/pa.2737

The timeliness of the research is crucial, given the backdrop of

the GCC countries ongoing political and economic maladies. The cur-

rent research expects to provide clues for the region to set its future

reforms agenda in the financial sector. Third, the Islamic finance

industry has grown rapidly in the GCC region, accumulating about

35% of the total assets of banking industries in 2007 (Srairi, 2010).

The comparative study between the two types of banking operations

(i.e., Islamic and conventional), which remains wholly ignored in con-

temporary literature, will provide an extra dimension for policy

options.

We make three unique contributions. First, our results contribute

to reducing the gaps in the literature on corruption and financial

development. Since the existing literature is inconclusive, we expect

to provide additional evidence and the factors through which corrup-

tion affects financial development. Second, we examine the impact of

corruption on banks' efficiency in the GCC countries, which is limited

in supply. Unlike previous studies, which mainly attribute the bank's

inefficiency to internal factors, including management myopia and

technical inefficiency, this study considers both internal and external

factors in examining the bank's inefficiency.

We structure the rest of the paper as follows: Section 2discusses

the rent-seeking theory that encompasses the broader concept of cor-

ruption. Section 3presents the methodological aspects of the study,

which covers sample selection, variable definition leading to the

econometric model development for empirical analysis. In Section 4,

we discuss the efficiency of the banking section before moving

toward the theoretical discussion that leads toward hypothesis devel-

opment. We explain empirical results in Section 5, discuss the results

in Section 6, while the final section summarises and concludes the

study findings.

2|LITERATURE REVIEW

GCC countries have been able to establish and sustain monarchies in

all member states. Soon after ending the prolonged period, the Arab

states established a kingdom or sultanate. The restoration of social

stability in the GCC region proves the concentration of power at the

centre. State society relation is hierarchical, where an administrator at

the top governs the society through a mutual social contract. GCC

states possess a durable power to penetrate society. Hence, rent-

seeking competition is not pervasive, which keeps the rent-seeking

cost low.

Especially after the event of the Arab Spring, the region has faced

tremendous pressure from different societal groups internally and

externally. Internal forces have taken various forms, including popular

mobilisation and social discontent, resulting in economic handouts,

patronage, limited political and economic reforms (Colombo, 2012).

Although GCC states have tactically managed such challenges without

much social chaos, which shows their resilience to tackle adverse

internal political circumstances, the social contract has been loosened

since then. Rougier (2016) offers by analysing various data that after

the Arab Spring, authoritarianism that characterises the Middle East

and North Africa (MENA) has been vanished for very high levels due

to social transformation. Such a level of authoritarianism may entail a

negative rent-seeking outcome.

Ramanathan (2007) reports improvement in MPI among banks in

Bahrain and records the highest reduction in productivity among

selected banks in Qatar. Saw et al. (2020) report a higher level of effi-

ciency for both Islamic and conventional banks in Qatar. Such results

complement the findings of Grigorian and Manole (2005), as their

study found banks in Bahrain with a higher level of technical effi-

ciency as compared to other GCC countries. Aghimien et al. (2016)

investigated the efficiency level of banks operating in the Gulf region

and highlighted the impact of corruption on the efficiency of baking

operations in the region.

Kamarudin et al. (2017) makes a unique contribution by compar-

ing the efficiency of foreign and domestic banks in Southeast Asian

countries and conclude that foreign-owned banks demonstrate a

higher level of efficiency as compared to domestic banks. Alqahtani

et al. (2017) find domestic banks in the GCC region are more cost-

efficient than foreign banks. Kamarudin et al. (2016,2018) provide

empirical evidence that control of corruption enhances the revenue

efficiency of both Islamic and conventional banks in the GCC region.

Furthermore, Islamic banks in the GCC region suffers from financial

turmoil caused by the subprime crisis (Al-Gasaymeh, 2016; Belanès

et al., 2015; Mohanty et al., 2016).

3|THEORETICAL UNDERPINNINGS AND

HYPOTHESIS DEVELOPMENT

Corruption was a widely discussed phenomenon in the literature of

development economics in the 1990s (see, e.g., Bardhan, 1997; East-

erly & Levine, 1997; Gray & Kaufmann, 1998; Khan, 1998;

Mauro, 1998; Rose-Ackerman, 1998; Shleifer & Vishny, 1993). Most

studies, however, found evidence that corruption deteriorates eco-

nomic development. Mauro (1995), analysing international data,

shows that corruption hinders investment and lowers economic

growth. Corruption increases uncertainty in an economy, leading to

higher transaction costs (Anokhin & Schulze, 2009). Also, corruption

leads to inefficient economic outcomes because it influences the mis-

allocation of scarce resources, encourages rent-seeking, and distorts

sectoral priorities and technology choices (Zhang & Barnett, 2014).

Lui (1985) provides empirical evidence on the positive impact of

corruption on efficiency through the optimal allocation of available

resources. Subsequently, the mainstream literature on corruption has

extended to various branches. For instance, literature examining the

impact of corruption on financial development is comparatively new.

Bougatef (2017) finds that corruption reduces bank profitability by

diverting funds to undeserving projects. Tran et al. (2020) confirm

such findings in the context of Vietnam.

On the other hand, Treisman (2000) demonstrates that corruption

eventually finds a way out to disrupt efficiency in jurisdictions with

higher levels of corruption. In developing countries, Song et al. (2020)

confirm the findings of Treisman (2000). However, Cherif and

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