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Public Sector Corruption and the Valuation of Systemically Important Banks

We relate the valuation dynamics of global systemically important banks (G-SIB) to levels of public sector corruption in their country of domicile. We show that G-SIB valuations benefitted from higher perceived public sector corruption before the global financial crisis (1998:Q1-2007:Q2), but not during or after the crisis (2007:Q3-2018:Q1). We interpret this as evidence of a corruption-related hidden subsidy in the valuation of G-SIBs before the crisis, which is reversed after the crisis. Corruption affects the transmission channels of bank characteristics to Price-to-Book (PB) valuation ratios both through negative and positive indirect effects. We provide evidence that the corruption-related distortions of level playing field before the crisis were primarily attained through the leverage channel. The sensitivity of PB to earnings risk increases with corruption and this is particularly evident post-crisis. Higher corruption leads to a dwindling pass-through to PB of dividend payout ratios, growth rates in GDP, and expected net-income.