Saturday, February 06, 2016

Recessions uncover what auditors do not

On 14 December 2008, I was nervously looking around at the world and wrote a blog post Goodbye great moderation, hello financial fraud?  Almost on cue, we got the Satyam scandal: 21 December, 24 December, and then 7 January. We also got a few other problems in India which (I think) surfaced owing to the Great Recession : NSEL, a rash of ponzi schemes, Sahara, Saradha.

In China, unprecedented times are bringing forth revelations on an unprecedented scale [link, link]. Some of the rackets that are described in China appear quite familiar to us in India, but the magnitudes seen there are astonishingly large. We had such problems in developed markets also -- Madoff and MF Global.

Institutional reform: Consumer protection

One part of addressing this problem is the familiar machinery of the Indian Financial Code (IFC) version 1.1. As an example, see this analysis of ponzi schemes. As an IFC quality law is not found in either China or India, we have a rash of such problems in both countries.

Institutional reform: Criminal justice system

An important subset of financial crime is about plain criminal law. While the main track of financial policy has been along the Indian Financial Code, we need to develop a work program on improvements of the criminal justice system also. Put together, these will create an enforcement machinery that will generate deterrence against big financial scandals.

Procyclicality of trust?

Watching China unfold in recent weeks, I wonder if there's a general proposition of the following nature. Recessions will uncover what auditors could not, but under conditions of low institutional quality, this will happen on a bigger scale. Conversely, when institutional quality is low, business and finance will be hampered at all times by low trust. But in good times, when it's easier for the crooks to keep things under wraps, fewer scandals will burst into the public consciousness, and trust will go up. Procyclicality of trust may be heightened in places with low institutional quality.


  1. I am baffled at, how Biz ranking of India can be improved with a pathetic Criminal Justice system as ours?

  2. The Author has emphasized “Institutional Quality” as the bed rock of the high degree of trust which is sine qua non for flourishing Business and Commerce in a Country. A (deterrent) Criminal Justice System with (effective) enforcing machinery is suggested as a palliative to enhance the Institutional Quality.
    We wish to add another dimension to the Remedies urgently required to enhance Institutional Quality, that is, the woeful state of our Political and Legislative Institutions. Our hopelessly irresponsible “parliamentarians” do not allow the Houses to function, leaving the all important Bills (like the GST) to their fate. Needless to say, the Members derive this enormous energy for obstruction eating almost free food doubly savoured by free drinks)
    all supplied by the dumb Citizens of this Country. Baba Saheb Ambedkar must be turning in his grave at this woeful situation that was never envisaged by the architects of our ‘venerable’ Constitution. Right now, a Central University at Hyderabad is paralysed by the ‘sympathetic vultures’ of politicians shedding crocodile tears and making the most of political mileage of an unfortunate suicide of a student.
    The Criminal Justice System would be inadequate without strong Institutions free from totally selfish political interference.


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