Using responsible investment to tackle systemic corruption

According to the 2023 Investment Report by the United Nations Conference on Trade and Development, developing countries need around USD$4 trillion per year to reach their Sustainable Development Goals. By 2050, Least Developed Countries with capital (LDC) will account for almost 40% of global population growth. However, they received less than 2% of global foreign direct investment (FDI) flows in 2022.

High levels of corruption and weak institutions are big barriers for investors. A February 2024 study I did with colleagues at Nottingham University Business School Malaysia, Corruption in least developed countries and ESG (responsible) investment: Standard Chartered Bank in Nepal, which was published in Journal of Financial Regulation and Compliance (JFRC), shows how responsible investment in an LDC can improve ethics and reduce market-wide systemic corruption through competition and knowledge-sharing while strengthening regulatory institutions.

In other words, the study offers a new, market-driven tool to fight corruption.

Nepal’s banking reform: A path to transparency and competition

In 1984 Nepal started the transformation of its banking sector by allowing private sector banks and foreign ownership. Before this, three government-owned banks dominated and were known for extracting rent from customers. Foreign investors, such as Dubai Bank, Crédit Agricole and Standard Chartered Bank (SCB), entered the market, improving governance standards. Former Finance Minister Dr. Yuba Raj Khatiwada highlighted the positive impact of foreign investment on governance and competition: “New banks with foreign investors practised a higher standard of governance and loan provisioning compared with incumbent banks. Soon, the incumbents were forced to compete, improving customer service and governance, while the central bank enforced better governance, improving practices across all banks.”

By 1988 financial reforms, supported by the World Bank, addressed vulnerabilities in incumbent banks.

Today Nepal’s banking sector has 20 top-tier commercial banks, regulated by the independent central bank. Mandatory listing on Nepal’s stock exchange has improved transparency and governance. As a former regulator who participated in our study said, “[The] presence of SCB in Nepal promoted competition in [the] banking system whereby rent seeking was almost abolished.”

In search of a market-driven anti-corruption tool

The case intrigued me. Nepal, classified as an LDC, faces serious challenges, including high levels of corruption. Despite decades of aid-funded efforts to combat corruption, Transparency International’s (TI) 2023 Corruption Perceptions Index (CPI) for LDCs has barely moved, averaging 29 out of 100. In contrast, the EU average was 64. A score below 50 indicates “serious corruption”. Nonetheless, Nepal has seen slight improvements in the same period.

There are many anti-corruption toolkits. Robert Hunja at the World Bank suggests “10 ways to fight corruption”; while TI offers “5 Key Ingredients”:

• End impunity;
• Reform public administration and finance management;
• Promote transparency and access to information;
• Empower citizens; and
• Close international loopholes.

Why aren’t aid programmes noticeably reducing corruption in LDCs?

Of course, this question is too simplistic. There is no silver bullet. Just look at recent relatively successful anti-smoking campaigns. It wasn’t only education, high prices or images on packaging that reduced smoking rates: it was the combined effect of all efforts that ultimately changed social norms against smoking.

To achieve the same effect and fight systemic corruption in LDCs, social norms must change. Top-down measures such as harsher penalties, legislative and regulatory reform, and anti-corruption commissions will not succeed alone (and smoking was never criminalised).

So, I set out to discover whether Nepal’s banking sector, and similar examples I’d witnessed, could teach us how norms changed, building on Robert Hunja’s suggestion to “Align anti-corruption measures with market, behavioral, and social forces.” Could investment in LDCs (also known as frontier markets) by responsible investors with a global reputation at stake already be eroding corruption without their (and our) knowing it? Could it change market and social norms to make corruption unacceptable and self-regulating?

In 2017 I published an article entitled “Can investing in frontier markets tackle corruption?” at London Business School, where I lecture on sustainable business and investment in frontier markets. The article posits that, “Investment that enforces strict anti-corruption, corporate and ESG codes helps build new industry champions in Frontier Markets. Once a well-funded innovator takes the lead, industry competitors are compelled to emulate these better practices to survive.”

This theory was featured in the 2022 “Investing with Integrity” report by TI, supported by British International Investment (BII) (p20).

Study methodology and findings

Corruption and ethics are notoriously difficult to study quantitatively. In our JFRC paper, we used a qualitative methodology using focus groups and semi-structured interviews to explore the effects of responsible international investment, using Standard Chartered Bank as a case study in Nepal’s banking sector. Study participants included the banking regulator (central bank), Nepalese domestic banks, former and current management of SCB Nepal, and senior staff from SCB global divisions on financial crime, ESG and sustainability. Our key findings were:

The mechanisms through which these industry changes were driven are illustrated here:

Policy implications

The study has practical and policy implications for multiple stakeholders. Many suggestions centre around enhanced design and capacity of blended finance funds (see table below) to attract reputable private sector investors to LDCs, who may stimulate effects similar to SCB in local markets.

At the G20 Finance Ministers and Central Bank Governors Summit in GIFT City, Gujarat 2023, where I spoke on creating a step change in climate finance to LDCs, this was a dominant discussion. Particularly memorable was the new World Bank President, Ajay Banga, who advocated scaling and replicating blended finance solutions through his One World Bank vision.

This was underlined at the main G20 Summit in New Delhi, which stressed “systematic rather than episodic” coordination between private and public sector arms of multilateral development banks (MDBs), (G20 Independent Experts Group, 2023). I hope that our study provides further evidence to make blended finance pools more accessible for LDC economies.

Limitations and next steps

The findings of one study of one sector in one LDC will not necessarily apply globally. Factors unique to Nepal or banking may mean they only apply to a narrow field. More research is required. Most obviously, SCB operates in many least developed and lower middle-income countries, including 11 of 45 LDCs. A similar study could be applied to multiple SCB LDC markets, and studies of other competitive industries in LDCs would help understand whether the effect is limited to banking (or regulated industries).

Tim is Honorable Professor of Sustainable Business at The University of Nottingham (Malaysia). He is founder and CEO of Dolma Fund Management, an impact fund manager investing in renewable energy, AI/tech and healthcare in Nepal. He is a Guest Lecturer at London Business School and sits on the Executive Advisory Committee of FAST-Infra Label, to increase investment into global sustainable infrastructure. He previously worked at Deloitte, J.P. Morgan and E.On and gained his MBA from London Business School in 2002.

You can read the full study in JFRC here: https://www.emerald.com/insight/content/doi/10.1108/JFRC-07-2023-0112/full/html