Do financial technology firms influence bank performance?
Introduction
The last decade or so has seen strong growth in digital innovation, especially in financial technology (FinTech). However, the traditional players (financial institutions) in the financial sector have only slowly begun to participate in new technological innovations (Brandl and Hornuf, 2017). Although there have been acquisitions of FinTech firms by banks recently, most FinTech start-ups are independent of banks and are open to investment interests. Because many banks, apart from the well-known big banks, still offer old-fashioned, costly, and cumbersome financial services (Brandl and Hornuf, 2017), FinTech firms have the opportunity to take over several key functions of traditional banks (Li et al., 2017). Put differently, FinTech firms are likely to trigger a substitution effect, whereby banks are likely to cede some business activity. To what extent banks will be affected and how much FinTech firms will replace the activities currently controlled by banks is an empirical issue.
The effect of FinTech firms on banks can be explained by the consumer theory (Aaker and Keller, 1990) and disruptive innovation theory (Christensen, 1997). The consumer theory suggests that new services (such as those provided by FinTech firms) by meeting the same consumer demand can replace the old services (such as those provided by traditional banks). Based on the disruptive innovation theory, new entrants who apply innovative technology to provide more accessible and cost-effective goods and services can create competition in the market. The remits of these theories are relevant to our story where new entrants are FinTech firms and established incumbents are traditional banks. Complementing this line of thought is the work of Jun and Yeo (2016), who provide a model of a two-sided market with vertical constraints, emphasising on firm entry. Their model focusses on end-to-end and front-end service providers—a distinction that we do not make. Competition in our story is generated by new entrants regardless of who they are. A key feature of FinTech firms is that they apply innovative technology to perform tasks previously reserved for banks, such as lending, payments, or investments (Chishti and Barberis, 2016; Brandl and Hornuf, 2017; Puschmann, 2017). Recently, FinTech firms have been developing practical applications to improve efficiency in financial services across a range of services, including (but not limited to): contactless and instant payments; asset management services; investment and financial service advice; and information and data management/storage (Villeroy de Galhau, 2016). In this vein, Jagtiani and Lemieux (2018) argue that non-bank lenders can secure soft information relating to creditworthiness. This service is considered valuable for consumers and small business alike, particularly those that are characterized by weak credit history. On the contrary, banks operate on old information technology system and are perceived to be slow in adopting new technology (Hannan and McDowell, 1984; Laven and Bruggink, 2016; Brandl and Hornuf, 2017). The main conclusion, therefore, is that eventually FinTech firms can substitute the traditional banks by providing less expensive and more efficient services. Our hypothesis, therefore, is that FinTech growth will negatively influence bank performance.
Despite the emergence of digital innovation and its perceived effect on the financial industry, the effect of digital innovation and FinTech growth on the financial system are less understood. Exceptions include: (a) Cumming and Schwienbacher (2016), who investigate the pattern of venture capital investment in FinTech using a global sample of firms; (b) Haddad and Hornuf (2018), who test the determinants of the global FinTech market; (c) Brandl and Hornuf (2017), who trace the transformation of the financial industry after digitalization; and (d) Li et al. (2017), who focus on how retail banks' share prices react to FinTech start-ups.
We test our hypothesis using bank-level data from Indonesia. We consider Indonesia because, among emerging markets, its FinTech growth has been phenomenal, as shown in Fig. 1. This trend in the growth of FinTech firms makes Indonesia an interesting case study to analyse how FinTech influences bank performance in an emerging market context. In general, we understand little about how FinTech impacts the banking sector. Using data from 41 banks, our panel models of the determinants of banking sector performance suggest that FinTech firms have a negative effect on Indonesian bank performance. FinTech, we show, also negatively predicts bank performance.
Specifically, we summarize our key findings as follows. First, we find that FinTech reduces net interest income to total assets (NIM), net income to total equities (ROE), net income to total assets (ROA), and yield on earning assets (YEA) by 0.38%, 7.30%, 1.73%, and 0.38% of their sample mean values (reported in Table 1), respectively.
Second, FinTech predicts bank performance. With every new FinTech firm introduced into the market, we find that FinTech negatively predicts NIM, ROE, ROA, and YEA by 0.53%, 9.32%, 2.07%, and 0.48% of their sample means, respectively. Third, we test whether bank characteristics, such as market value (MV) and firm age (FA) influence the way FinTech influences bank performance. We find that they do. Specifically, the effect of FinTech is stronger on (a) large banks compared to small banks, and (b) mature banks compared to younger (new) banks. We conclude our analysis by testing whether FinTech affects bank performance differently for state-owned versus private banks. We show that FinTech has a bigger effect on state-owned banks.
We confirm our results through multiple robustness tests. Using four measures of bank performance, we test the sensitivity of the relation between FinTech and bank performance to measures of performance. We find no evidence that measures of bank performance matter to the relation between FinTech and performance. We explore the effects of FinTech on bank performance by asking whether the way FinTech affects performance is dependent on specific bank characteristics. By and large, we find that FinTech negatively influences performance regardless of bank size and age, and while we do uncover some positive effect of FinTech for younger banks, there is no evidence that FinTech predicts performance of these younger banks. We explain this positive effect by drawing on Giunta and Trivieri (2007) and Haller and Siedschlag (2011). These authors find that younger firms adopt and use technological innovations much more successfully. In addition, in testing the effects of FinTech, we utilize a wide range of control variables consistent with the banking performance determinants literature. The role of FinTech in influencing performance survives these tests. We also check for the sensitivity of our results by (a) controlling for 2017 Global Financial Crisis (GFC) effects and (b) using a different panel data estimator. We conclude that the negative effect of FinTech on bank performance holds across all these additional tests.
Our paper's main contribution is to show how FinTech influences bank performance. There are no studies on this subject at present. Our paper, therefore, represents the first empirical study exploring the hypothesis that FinTech negatively influences bank performance. Using bank-level data from Indonesia,1 we show that FinTech negatively influences bank performance and that this relation is robust.
This paper is organized into three additional sections. We discuss the data and the empirical framework in Section II. A discussion of the results appears in Section III. Finally, Section IV sets forth our concluding remarks.
Section snippets
Data and empirical framework
This section has two objectives. First, we discuss the data. Then, we present the empirical framework for testing our hypothesis that FinTech has a negative effect on bank performance.
Benchmark model
We begin the discussion of our results with Table 3, where we estimate the traditional determinants of banking sector performance. The panel data regression is estimated using the two-step GMM system dynamic panel estimator. The results are provided column-wise representing each of the four dependent variables, which are measures of banking sector performance. This regression sets the benchmark for the rest of the analysis because it is estimated without the FinTech variable. Several
Concluding remarks
This paper is inspired by the phenomenal growth of FinTech firms in Indonesia and, indeed, globally. Exceedingly little is known about whether such firms impact the banking sector. We develop our hypothesis—that FinTech growth hinders bank performance—out of this gap in the literature. We collect a unique sample of data on banks and FinTech firms in Indonesia. With a dataset comprising a panel of 41 banks (spanning the period 1997 to 2017), we estimate both a banking performance determinant and
References (92)
- et al.
Accounting and capital market measures of risk: evidence from Asian banks during 1998–2003
J. Bank. Financ.
(2008) - et al.
Government intervention, bank ownership and risk-taking during the Indonesian financial crisis
Pac. Basin Financ. J.
(2014) - et al.
Bank profitability and the business cycle
J. Financ. Stab.
(2009) - et al.
Bank-specific, industry-specific and macroeconomic determinants of bank profitability
J. Int. Financ. Mark. Inst. Money
(2008) - et al.
How does capital affect bank performance during financial crises?
J. Bank. Financ.
(2013) - et al.
Competitive viability in banking: scale, scope, and product mix economies
J. Monet. Econ.
(1987) - et al.
Privatization matters: Bank efficiency in transition countries
J. Bank. Financ.
(2005) - et al.
Bank performance, efficiency and ownership in transition countries
J. Bank. Financ.
(2005) Concentration and other determinants of bank profitability in Europe, North America and Australia
J. Bank. Financ.
(1989)- et al.
The effect of the political connections of government bank CEOs on bank performance during the financial crisis
J. Financ. Stab.
(2018)
Determinants of bank interest margins in central and Eastern Europe: a comparison with the west
Econ. Syst.
The impact of state ownership on performance differences in privately-owned versus state-owned banks: an international comparison
J. Financ. Intermed.
Determinants of bank profitability before and during the crisis: evidence from Switzerland, Journal of International Financial Markets
Inst. Money
The determinants of commercial banking profitability in low-,middle-, and high-income countries
Q. Rev. Econ. Financ.
Determinants of bank profitability in transition countries: what matters most?
Res. Int. Bus. Financ.
What explains the low profitability of Chinese banks?
J. Bank. Financ.
Benefits of public reporting: evidence from IPOs backed by listed private equity firms
J. Corp. Finan.
Ownership structure, risk and performance in the European banking industry
J. Bank. Financ.
Ownership structure, risk and performance in the European banking industry
J. Bank. Financ.
Risk-based capital, portfolio risk and bank capital: a simultaneous equations approach
J. Econ. Bus.
Do fintech lenders penetrate areas that are underserved by traditional banks?
J. Econ. Bus.
Consolidation and commercial bank net interest margins: evidence from the old and new European Union members and candidate countries
Econ. Model.
Financial penalties and bank performance
J. Bank. Financ.
The impact of bank capital on profitability and risk in Asian banking
J. Int. Money Financ.
Bank performance and convergence during the financial crisis: evidence from the ‘old’ European Union and Eurozone
J. Bank. Financ.
Bank ownership and performance. Does politics matter?
J. Bank. Financ.
Determinants of European bank profitability: a note
J. Bank. Financ.
The effects of bank regulations, competition, and financial reforms on bank performance
Emerg. Mark. Rev.
Convergence in bank performance for commercial and Islamic banks during and after the global financial crisis
Q. Rev. Econ. Financ.
Factors influencing the profitability of domestic and foreign commercial banks in the European Union
Res. Int. Bus. Financ.
Development, Social Change, and Islamic finance in contemporary Indonesia
World Dev.
Capital requirements and bank behavior: empirical evidence for Switzerland
J. Bank. Financ.
The long-term effect of digital innovation on bank performance: an empirical study of SWIFT adoption in financial services
Res. Policy
The effects of ownership change on bank performance and risk exposure: evidence from Indonesia
J. Bank. Financ.
The effects of ownership change on bank performance and risk exposure: evidence from Indonesia
J. Bank. Financ.
The relation between commercial bank profit rates and banking concentration in Canada, Western Europe, and Japan
J. Bank. Financ.
The dark side of diversification: the case of US financial holding companies
J. Bank. Financ.
Age diversity, directors’ personal values, and bank performance
Int. Rev. Financ. Anal.
Bank funding structures and risk: evidence from the global financial crisis
J. Bank. Financ.
Financial liberalization, crisis, and restructuring: a comparative study of bank performance and bank governance in South East Asia
J. Bank. Financ.
The impact of earnings management on the performance of ASEAN banks
Econ. Model.
Consumer evaluations of brand extensions
J. Mark.
Examining the relationships between capital, risk and efficiency in European banking
Eur. Financ. Manag.
The efficiency of banks in Indonesia: sharia vs. conventional banks
Bull. Monet. Econ. Bank.
ANNs-based early warning system for Indonesian Islamic banks
Bull. Monet. Econ. Bank.
The impact of macroeconomic condition on the banks performance in Indonesia
Bull. Monet. Econ. Bank.
Cited by (161)
Can FinTech transform corporate liquidity? Evidence from China
2024, Innovation and Green DevelopmentBeyond innovation: Fintech credit and its ripple effects on traditional banking profitability
2024, Finance Research LettersThreshold and spillovers effects of fintech on China's energy dependence on fossil fuel
2024, Resources PolicyRole of financial inclusion and digital transformation on bank credit risk
2024, Journal of International Financial Markets, Institutions and MoneyFinancial technology, inclusive finance and bank performance
2024, Finance Research LettersFinTech adoption in banks and their liquidity creation
2024, British Accounting Review