October 9, 2019

How Corruption in Financial Markets Hurts Everyone

October 9, 2019

Corruption in the financial markets is not a new concept. It occurs in not only financial capitals around the world – London, New York, Hong Kong, but also small developing capital market such as Vietnam or Bangladesh and it can have an even larger impact. From adjusting an interest rate, providing a loan, or short-selling a stock, billions of dollars can be stolen without anyone realizing for the better. A pressing question is How does it impact average person’s life?

Financial or capital markets corruption can seriously threaten an economic system’s well-being – and it’s something Vietnam should watch out for. Take the case of borrowing money in Bangladesh. In the early 2000s, nearly 60% of people seeking loans in Bangladesh admitted to giving a bribe to receive a loan.

This additional cost – the bribe – meant that fewer people with sound business ideas were able to access capital. It also meant that those who were willing to pay this bribe were able to receive loans without having the credit history or collateral to back it up. The result is that bad projects got loans – in a sample group of 125 defaulters in the early 2000s, over 78% had used connections to get the loan.  

When financial markets are corrupt, information becomes opaque. This means that insiders gain, and the average investor loses. One example of this came most recently in the blockchain craze. Without proper regulation, like in the stock market,  groups of bad actors would create “pump and dump” schemes. In these fraudulent ploys, a group of investors would create fake positive news surrounding a stock or cryptocurrency coin. They would then invest large amounts, artificially increasing the price. When other investors followed, they would then sell the stock or coin at the high price, “dumping” the value on others. The unwitting investors not involved in the scheme would often lose significant amounts that they invested.

A significant debate in finance and corruption has also been around algorithms’ role in capital markets. In 2013, Michael Lewis came out with a book called Flash Boys which depicted the current state of high-speed trading. For reference, high-speed training is the use of algorithms to buy and sell stocks faster than any human could react. As Lewis argued in his book, this use of high-speed trading is a form of scalping, manipulating the market to benefit high-speed traders at the cost of average investors and shareholders.

In financial circles, the morality of this type of high-speed trading is hotly contested. Many argue that high-speed trading provides a useful “liquidity” to the market. This liquidity makes it easier for people to buy and sell assets. As well, the use of high-speed trading reduces the “spread” or the cost to buy or sell stocks. Others argue that it unfairly advantages certain firms against others.

In each of these examples, the cost of corruption can still feel distant. Why should the average person care about financial corruption and corruption in capital markets?

When the capital market is corrupt, everything else in business slows down. In a 2006 paper on corruption, David Ng of Cornell found that when a market is corrupt, then firms have higher borrowing costs, lower stock valuation, and worse corporate governance. Put simply, everyone – from the stockholder to the consumer – loses when the capital market is corrupt. It becomes harder to do business, so less business happens.

As Vietnam’s stock markets mature, questions around capital market corruption will become front and center. For Vietnam to create a thriving market system, it will need to have a market that is attractive and stable for its top companies. If it does not, then Vietnam’s largest companies will choose to list elsewhere, diverting capital outside of Vietnam.

Sandy Frucher, the Vice-chairman of Nasdaq, has been front and center in the creation and revitalization of ethical capital markets. In 1998, he became the CEO and Chairman of the Philadelphia Stock Exchange. The exchange had previously been going through financial troubles and he revitalized the exchange – increasing revenue growth by 64% and options value growth of 155%. In 2007, the exchange was acquired by Nasdaq for over $690 million USD where he then became the Vice Chairman.

Over the past few decades, Frucher has also been an advisor here in Vietnam. In particular, he helped provide consulting advice for the Ho Chi Minh City Stock Exchange in its earliest days.

On Tuesday, October 15, at 5:30 PM, Sandy Frucher will give a moral series talk on “Corruption in Financial Markets” at Fulbright University Vietnam in District 7. To learn more about what Vietnam should – and shouldn’t – do to tackle corruption in financial markets, please join Fulbright on October 15.

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