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Corruption

Updated on April 11, 2024
Article byAnkush Jain
Edited byAnkush Jain
Reviewed byDheeraj Vaidya, CFA, FRM

Corruption Meaning 

Corruption is the abuse of power entrusted upon an individual or an entity for private gain. It includes a wide range of dishonest or unethical behaviors. It can manifest in various forms, such as bribery, embezzlement, nepotism, and favoritism, undermining the integrity of institutions, eroding public trust, and derailing economic and social development. Corruption reduces transparency, fairness, and accountability. 

Corruption

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Corruption cases in the financial system pave the way for significant risks to economic stability, market integrity, and investor trust. Efforts to fight financial corruption require strict regulatory frameworks, effective enforcement mechanisms, and increased transparency and accountability across the financial sector. This shall not only retain investor confidence but also contribute towards the economic development of the economy.

Key Takeaways

  • Corruption is the illegal act of using unethical means to gain financial or other gains through bribery, fraud, embezzlement, and kickbacks. 
  • These unethical practices ultimately reduce the trust the standard population has in regulatory, government, and judicial bodies. 
  • Less fairness in the market demotivates investors and other players, as a few unethical players receive preferential treatment, leading to the demotivation of others.
  • Ultimately, it results in substantial financial losses for individuals, companies, or even governments. This has a direct impact on the economic growth and development of an economy.

Corruption In Financial System Explained

Corruption in the financial system refers to dishonest or unethical conduct within the financial sector involving individuals, institutions, or government entities. This corruption can manifest in various forms, including bribery, embezzlement, money laundering, insider trading, and fraudulent accounting practices.

People, organizations, or governments engage in corrupt activities driven by the greed for more power or money than they currently possess, intertwining these factors. Those in power seek more wealth to expand their influence, while wealthy individuals strive for increased riches to enhance their societal status. 

Nevertheless, choosing illicit means or unethical means to reach a goal of personal gain despite undermining others’ fair chance is unjust and wrong. This affects not only the people directly involved but also the investors’ morale towards the market and the trust in government and regulatory bodies.

It is often assumed that the corruption scale is high only in politics or major decision-making bodies or conglomerates of a country, region, or the world. However, it starts at the smallest of places and builds up throughout the system. For instance, a $10 bribe to a policeman to avoid getting a ticket is a classic case of corruption we often overlook. 

To eradicate this disease within the financial system from its root, we must implement stricter regulatory oversight. Additionally, we should establish independent bodies with the authority to investigate and impose sanctions upon discovering any wrongdoing. 

All in all, even if the support from the system is enhanced, the decision-makers need to assert that it is a two-way street. Hence, reporting corruption to the respective authorities is essential, of course, with proper whistleblower protection from the authorities, as mentioned above. 

Causes

Regardless of the scale of the violation, whether it is petty corruption or multimillion-dollar scams, the motives behind committing such acts can often be attributed to a handful of factors. They are as discussed below. 

  • Lack of Transparency: When financial transactions and decision-making processes are opaque, it creates opportunities for corrupt practices to flourish.
  • Weak Regulatory Frameworks: Inadequate regulations or enforcement mechanisms can allow individuals and institutions to engage in corrupt activities with impunity.
  • Conflict of Interest: Conflicts of interest among financial professionals, regulators, and policymakers may lead to decisions that prioritize personal gain over the public interest.
  • Greed: A culture that values profit maximization at any cost, by hook or crook, can breed unethical behavior and corruption within financial institutions.
  • Complex Financial Instruments: The complex nature of modern financial instruments can hide fraudulent activities under the mountain of digital data. This makes it easier for individuals to engage in corrupt practices.
  • Globalization: Cross-border financial transactions and regulatory differences in different jurisdictions create loopholes that can be exploited for corrupt purposes.
  • Inadequate Oversight: Insufficient oversight and monitoring of financial activities provide ample opportunities for corruption to go undetected and unchecked.

Types

Like all things good and evil, corruption cases come in different forms. Let us discuss their different types so we can recognize them if and when we experience them. Let us do so through the points below. 

  • Bribery: It is the act of offering or accepting money, gifts, or other benefits in exchange for favorable treatment in financial transactions or regulatory decisions.
  • Embezzlement: It is the misappropriation of funds or assets by individuals entrusted with their management, such as executives, employees, or financial advisors.
  • Insider Trading: Illegally trading securities based on non-public, material information that could affect the market value of those securities.
  • Money Laundering: Concealing the origins of illegally gained money by transferring it through legitimate financial channels to make it appear legitimate.
  • Fraud: Deceptive practices intended to gain an unfair advantage or deceive investors, including accounting fraud, securities fraud, and mortgage fraud.
  • Kickbacks: These refer to payments made to individuals or entities in exchange for referring business or steering contracts to specific parties.
  • Tax Evasion: Illegally avoiding or underreporting taxes owed to government authorities by manipulating financial records or concealing income.

Examples

Now that the causes, types, and related factors of corruption cases are clear, it is essential we also touch upon its practicality through the examples below to understand the concept and its consequences thoroughly. 

Example #1

Let’s say, Joe was the CFO of a multi-national corporation. In a board meeting, one of the members pointed out inconsistencies in the financial numbers and proposed an external audit to ensure the financial statements were credible. 

Upon completing the external audit, the team of independent auditors concluded that Joe was embezzling money from the company. The funds were being used for his gains. He wrote overvalued cheques to suppliers he knew. By doing that, he got the excess money transferred to his bank account and provided kickbacks to the supplier as well. 

In total, it was found that he has embezzled over $950,000 in 5 years as CFO. He was sued and presented before the court.

Example #2

In November 2023, Binance, the world’s largest cryptocurrency exchange, and its CEO, Changpeng Zhao, admitted to multiple financial crimes, resulting in a settlement of approximately $4.3 billion, as announced by the Justice Department. 

The company and its CEO confessed to violating laws by neglecting to uphold an effective anti-money laundering program. Additionally, Binance pleaded guilty to the charges of not registering as a money-transmitting business and contravening the International Emergency Economic Powers Act. Following these admissions, Zhao resigned as CEO. 

These events unfolded shortly after the Justice Department’s successful prosecution of Sam Bankman-Fried, the founder of the FTX cryptocurrency exchange, for orchestrating a fraudulent scheme that cheated customers and investors of over $10 billion.

Consequences 

Let us understand the consequences of the corruption scale being high through the points below. It shall shed light on how much damage it can cause to not just the people directly involved but also others.

  • Corruption undermines investor confidence and economic stability, leading to reduced investment, slower economic growth, and financial market volatility.
  • Corruption distorts resource allocation by favoring connected individuals or entities over more deserving or efficient projects, resulting in inefficiency and misallocation of resources.
  • It hampers fair competition and creates barriers to entry for new businesses. This reduces market competitiveness and hinders innovation and economic development.
  • Its presence dissolves the rule of law and undermines the credibility and integrity of legal and regulatory institutions. The undermining of the law leads to a lack of accountability, and exemption from punishment for wrongdoers. It moreover leads to diminished public trust in government, judicial, and financial institutions.
  • Corruption worsens social inequality by diverting resources away from essential public services and infrastructure projects. This disproportionately affects marginalized communities and further widens the gap between the rich and poor.
  • Widespread corruption discourages domestic and foreign investors, as they perceive increased risks and uncertainty associated with investing in corrupt environments. This leads to capital flight and reduced economic growth prospects.

How To Stop?

While there is no end to proving how wrong even petty corruption is on multiple fronts, it is always wise to look for solutions rather than cribbing about the apparent problem. Let us attempt to do this through the explanation below that discusses how to stop such cases.

  • Robust Legal Frameworks: Implementing and enforcing stricter anti-corruption laws and regulations to shun corrupt practices and hold violators accountable.
  • Boost Transparency: Promoting transparency and accountability in financial transactions and government operations can do a world of good. Transparency can be boosted through measures such as open data initiatives, disclosure requirements, and public access to information.
  • Oversight Mechanisms: Establishing independent oversight bodies, such as anti-corruption commissions or audit institutions, to monitor financial activities can add a layer of oversight. They should be bestowed with the power to investigate corruption allegations and impose sanctions on wrongdoers.
  • Whistleblower Protection: Providing legal protections and incentives for whistleblowers to report corruption, including safeguards against retaliation and rewards for disclosing information, can lead to successful prosecutions.
  • Promoting Ethical Leadership: Creating a culture of integrity and ethical behavior among financial professionals, government officials, and corporate leaders through training, awareness campaigns, and strict codes of conduct.
  • International Collaboration: Collaborating with international organizations, governments, and law enforcement agencies can benefit all parties involved. They can fight cross-border corruption, share best practices, and recover assets stolen through corrupt practices.

Corruption vs Lobbying vs Bribery

Let us understand the differences between all three concepts through the points below. This shall help us understand not only the corruption scale but also its related concepts.

Corruption

  • Corruption involves the misuse of power or authority for personal gain.
  • It often includes actions such as embezzlement, nepotism, and favoritism.
  • It can occur at various levels, including government, business, and societal institutions.
  • Undermines the fairness and integrity of systems, leading to inequality and inefficiency.
  • Examples include bribery, extortion, and kickbacks.

Lobbying

  • Unethical lobbying involves using dishonest or corrupt tactics to influence government policies or decisions.
  • It may include offering bribes, making false promises, or exerting undue pressure on policymakers.
  • Often, it aims to advance narrow interests at the expense of the public good.
  • It affects the integrity of the democratic process and trust in government institutions.
  • This can lead to policies that favor special interests over the actual welfare of society as a whole.

Bribery

  • It involves offering, giving, receiving, or soliciting something of value to influence the actions of someone in a position of power or authority.
  • They are usually aimed at gaining an unfair advantage or favorable treatment.
  • It is often illegal and unethical, as it disorients decision-making processes and compromises integrity.
  • It can be found in various contexts, including business transactions, politics, and government affairs.
  • Examples include offering bribes to public officials for favorable contracts or licenses or bribing foreign officials for business advantages.

Frequently Asked Questions (FAQs)

How does corruption affect a country?

Corruption undermines economic growth by diverting resources away from productive activities, distorts market competition, and discourages investment. It erodes public trust in government institutions, undermines the rule of law, and widens social inequalities. Corruption also hampers development efforts, weakens democratic governance, and increases the risk of political instability and conflict within a country.

Is corruption a social issue?

Yes, corruption is a significant social issue that affects various aspects of society. It diminishes public trust in institutions, breeds inequality by favoring privileged individuals or groups, and undermines the rule of law. Corruption also increases poverty by diverting resources away from essential services and contributes to social unrest and political instability.

How corruption leads to poverty?

Corruption leads to poverty by diverting resources away from essential services and infrastructure projects that could benefit the disadvantaged. Funds meant for public welfare are often siphoned off through corrupt practices. This limits access to education, healthcare, and other primary and essential needs. Additionally, corruption widens the gap between the rich and poor by creating barriers to economic opportunity. Therefore, there is further marginalizing of vulnerable populations and orchestrating cycles of poverty.

This article has been a guide to Corruption & its meaning. We explain its causes, types, consequences, examples, how to stop it & compare it with bribery & lobbying. You may also find some useful articles here –

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