Master Thesis Digital Banking & Financial Technology
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what kind of Macroprudential Regulation Framework? | Think Tank | European
Parliament . [online] www.europarl.europa.eu. Available at: https://www.europarl.europa.eu/thinktank/en/document/IPOL_STU(2021)662925. Salehi, M., & Alipour, M. (2010). E-banking in emerging economy: empirical evidence of Iran. International Journal of economics and finance , 2 (1), 201-209. Schulte, S. R. (2008). State technology to state of being: The making of the internet in global popular culture (1980 –2000) (Doctoral dissertation, The George Washington University). Scott, S. V., & Zachariadis, M. (2012). Origins and development of SWIFT, 1973 – 2009. Business History , 54 (3), 462-482. Shamdasani, P., Mukherjee, A., & Malhotra, N. (2008). Antecedents and consequences of service quality in consumer evaluation of self-service internet technologies. The Service Industries Journal , 28 (1), 117-138. 26 Chapter 2: Digital transformation of the banking system in Europe 2.1. Digital transformation (DT) Globally, organisations undergo periods of change for many reasons, such as growth, resolving internal issues, adapting to external pressures and adopting additional changes for the future (Kanter, 2003). Organizational change is a double- edged sword, as it is required for organizational viability but it is found to impact the workforce negatively and finds resistance (Demerouti et al., 2021: 374). Aravopoulou (2016: 19) pointed out that organizational change is a broad term that involves changes to a small or large extent. Organizational development affects both the internal and external environment of the organization. For this reason, they act as "drivers" of change and the two types of influences tend to complement each other. Internal environmental changes in an organisation include new equipment, new services and products, recruitment of new staff, new structure in the organisation's operations and change in strategy. That external environmental changes, according to Child (2015), involve new policies from central authority, social and cultural, technological, demographic, economic and changes in market forces (Alvesson & Sveningsson, 2015: 14). The nature of both the internal and external environment, which is subject to change due to the reason of DT, forces organisations to change many departments and areas within the organisation, including their strategy, structure, operations, technology and culture (Andrew & Mohankumar, 2015: 302). Limerick et al. (1995) defined organizational transformation as a holistic, ecological, humanistic approach to a radical, revolutionary change in the entire context of an organizational system. Transformational changes alter the basic structure, strategy and culture of the organization (including values and norms). It requires new learning, an innovative culture and effective leadership for successful implementation of DT. Many studies describe organizational transformation as a fundamental revolutionary change that occurs in the very structure of the organization. Furthermore, DT can be used as a tool for organizational development by encouraging operational structure and competitiveness while transforming the organization's strategy (Hanelt et al., 2021: 1170). 27 The rapid adoption of new digital technologies and their development over time has caused huge changes in almost all organisations and across the globe. These large-scale changes are widely known as DT, where it has been the focus of many academics and researchers with the development of business research. Vial (2019: 118) defined DT as a process that aims to improve an entity by inducing changes in its properties through the combination of information, technologies, computing, communications and connectivity of these parts. On the other hand, there are researchers who support the definition of DT as the enormous changes caused by digital technologies in organizations (Hess et al., 2016). Hess et al. (2016) highlighted DT for its complex nature and its role in transforming the business model of the entire industry. DT encompasses the concepts of "process alignment and culture transformation" (Gong & Ribiere, 2021: 2). According to these changes, improvements in productivity, performance and profitability of an organization can be achieved. Although Chatzopoulos and Weber (2021: 75) reported that DT improves organizations in areas such as customer experience and operations, which Westerman et al. (2014) agree with, however the latter added that success could only be achieved at the individual, organizational and financial levels if strong leadership skills are used to transform the organization and its culture in conjunction with strengthening the areas of business development. Parise et al. (2016: 2) focused on the consumer-focused definition of Digital Transformation, in which digital technologies are used to enhance the customer experience. While Horlacher & Hess (2016: 5133) pointed out that DT occurs when values and revenues are created due to digital technologies. On the other hand, Lundberg et al. (2020: 4347) described DT as "innovations" that provide changes in "structures, practices, values and beliefs". van Tonder et al. (2020: 116) defined the areas that were transformed during the transformation process that include business models, products, services, operations, processes, networks, skills, new talent development and culture production. While, Gurbaxani et al. (2019: 209) added that transformation can occur through vision development, strategy and change in the structure of the organization. It is necessary to distinguish between digitisation and DT. First, the former can be achieved through the application of technological methods, while the latter requires radical and holistic changes (Fischer at al., 2020: 2). Second, although each of the two terms has a different meaning, some authors use the two terms interchangeably (Legner at al. 2017: 3). Digital innovation is considered the cause of digital penetration (Rodríguez-Abitia & Bribiesca-Correa, 2021: 1). However, DT is considered the change process caused by both digital penetration and digital 28 innovation. At the same time, DT is also considered as a result of digital innovation (Skog et al., 2018: 432). According to Tilson et al. (2010: 2), digital technologies have paved the way for digitisation, digital innovation, penetration and digital media. Due to the use of digital technologies, organizations must simultaneously make changes at multiple levels, including its strategy and culture (Ismail et al., 2017). The implementation of digital transformation is linked to strategies where organisations seek to set and redefine key objectives that are in line with increased customer expectations. Essentially, companies implementing digital transformation can innovate and optimise their operations by upgrading their business model. In addition, the culture of the organisation is directly linked to digital transformation, as it can accelerate its implementation or, conversely, be a problem and a cause of delay. The consumers themselves also play a key role in the implementation of digital transformation, as digital transformation comes to be linked to their real needs, as well as to the requirements they express. Finally, it should be mentioned that through the applications of digital transformation, the levels of interaction between the human resources and the organization are enhanced, as well as between the customers and the organization itself (Ministry of Digital Governance, n.d.). 2.2. The cost-benefit regulation on the traditional banking operations Regulation ideas have been founded on two basic paradigms: public interest and private interest theories. The assumption behind public interest regulatory theories is that regulators have sufficient knowledge and enforcement powers to successfully promote the public interest. Thus, regulation is provided in response to public demand for the correction of inequitable or inefficient market processes (Baumol, 2004). The implication is that regulations are designed to serve society as a whole rather than popular vested interests. According to the public interest viewpoint, regulation supports the efficient operation of banks by simply avoiding market failures for the benefit of larger civil society (Whynes and Bowles, 1981). Because regulators are regarded as neutral arbiters, they would not be hampered by information market failures, and they could more easily package information to establish the point at which the marginal cost of 29 intervention equals the marginal social benefits (Asch, 1988). As a result, the public interest would be served if the banking system allocated resources in a socially optimal manner that maximizes production while minimizing variations, i.e. maximizes social welfare. In contrast, the private interest theory of regulation is more skeptical of regulators' motivations and behavior, viewing regulation as socially ineffective. The regulators are supposed to be under-informed about cost, demand, quality, and other aspects of corporate behavior. They are also vulnerable to regulatory capture by advocacy or special interest groups. As a result, when it comes to controlling enterprises or societal activities, they can only do it imperfectly, if at all (Den Hertog, 2010: 20). 2.2.1. Capital Requirements and Cost Efficiency Bank capital adequacy is critical in mitigating financial insolvency. Several studies have found that tight capital requirements improve bank cost-efficiency (Haque and Brown, 2017: 7; Chortareas et al. 2012: 297). Other studies, on the other hand, have claimed that strict financial market regulation has the potential to harm banks' performance by prohibiting them from enjoying economies of scale and scope through a more diverse variety of banking products or a bigger scale of operations (Barth et al., 2013: 26-27). In this situation, regulations may result in inefficient resource allocation; thus, deregulation allows and pushes banks to use more efficient manufacturing practices (Claessens & Laeven, 2004: 5). According to Anginer, Demirguc-Kunt, and Zhu (2014: 21), prudential capital requirements appear to have a favorable influence on bank stability in banking sectors with (1) relatively weak supervision and monitoring and (2) underdeveloped institutions. Furthermore, he established that banks in transition nations saw a surge in demand for bank loans during the research period because the majority of those countries had seen sustained growth and low inflation rates for over two decades. However, the presence of regulatory capital requirements has constrained banks' ability to develop. When controlling for other supervisory and regulatory policies, Barth et al. (2004) discover that, while stringent capital requirements are associated with fewer nonperforming loans, capital stringency is not robustly linked with banking sector stability, development, or bank performance (measured with overhead and margin ratios). Furthermore, in determining whether greater capital requirements are worthwhile, D’Erasmo (2018: 5) discovered that higher capital requirements cause 30 major banks to grow larger, placing pressure on small banks to combine or collapse. As huge banks' market clout develops, they extract higher profits by hiking lending rates, which tightens credit and depresses the economy's productivity. Furthermore, fewer fail while taking more risks because their charter value is higher under the tighter capital requirements. 2.2.2. Liquidity Requirement and Cost Efficiency Liquidity is crucial to the stability of the banking system, given that it represents the ability to fund assets and satisfy obligations when they fall due. According to Ryan et al. (2014: 28), tougher liquidity laws would compel banks to change both their asset and liability organizations in order to meet these new criteria. This suggests that their policies tend towards improving their share of high-quality liquid assets and funding from more stable non-financial deposits while at the same time, strive to lower the short-term intra-financial loans share and short-term wholesale funding. Corporate lending rates and interbank funding costs are also influenced by the liquidity ratio. Bonner and Eijffinger (2012) discovered that Dutch banks who fell short of their liquidity targets did not impose a higher interest rate on business loans. Furthermore, the banks paid higher interest rates on unsecured interbank loans, despite the fact that this regulatory information was not made public. 2.2.3. Interest Rate and Cost Efficiency According to Eregha (2010: 41), interest rates have a favorable impact on domestic loan demand in the short term but a detrimental impact in the long run. Increases in actual lending rates may not have an immediate impact on credit demand; nevertheless, in the long run, they may lead to a decrease in credit demand and vice versa. As a result, the possibility that interest rate regulation is an unproductive policy choice emerges. According to Maimbo and Gallegos (2014: 23), interest rate caps are ineffective at addressing the underlying causes of high rates, such as a lack of market competition, market inefficiency, large fiscal deficits, and legal bottlenecks that prevent customers from switching banks, and they introduce additional distortions into the system as banks attempt to circumvent caps. 31 2.2.4. Quality of Funding and Cost Efficiency According to Arnould et al. (2021: 2), excessive funding costs caused by bank-specific vulnerabilities can erode banks' revenues and deplete banks' capital buffers in bad times or slow their build-up in good times. This means that excessive funding costs caused by bank vulnerabilities might harm banks' ability to absorb macroeconomic shocks and jeopardize the banking sector's overall stability. Furthermore, Arnould et al. (2021: 11) believe that if increased funding costs are carried through to higher lending rates, the real economy will suffer by decreasing demand for new lending, causing deleveraging, and resulting in weaker economic activity. Ellis and Flannery (1992: 485) demonstrated the relationship between capital levels and interest rates. They give empirical evidence that lower capital levels are connected with higher interest rates on uninsured deposits. 2.2.5. Security Market Regulation and Cost Efficiency The creation of an informationally and financially efficient market is aided by the security market. According to Avgouleas and Cullen (2014: 8), countries with underdeveloped capital markets and inefficient legal frameworks make market discipline an inadequate instrument for improving banking sector efficiency. Furthermore, a lack of openness in financial transactions and poor information quality cause principal/agency relationships to fail, resulting in severe restrictions in comprehending and assessing risks, rendering traditional models of corporate governance useless. In opposite, Barth et al. (2013) believe that regulatory scrutiny has been severely influencing the efficiency of the banks by imposing expenses, including higher origination standards, slower loan growth, compliance costs and inefficiencies. 2.2.6. Bank size and Cost Efficiency Bank size, which is frequently assessed by total assets, determines both the scope of activity and the type of clients it serves. Huge banks, for example, have a customer that is more stable, such as governments, large enterprises, and international corporations. Small banks, on the other hand, primarily serve disadvantaged and low-income households and their microenterprises. Larger banks 32 are more efficient, according to Tecles and Tabak (2010: 1592). On the contrary, Isik and Hassan (2002: 731). 2.2.7. Macroeconomic Environment and Cost Efficiency Economic growth increases cost-efficiency, whereas inflation increases cost- inefficiency. The negative relationship between GDP growth and cost inefficiencies is that increased disposable income leads to increased demand for goods and services produced by enterprises. Increased sales would, in turn, enhance enterprises' and consumers' debt service capabilities, resulting in a decrease in non-performing loans. Rinaldi and Sanchis-Arellano (2006: 6) discovered that rising inflation impairs the performance of the bank loan portfolio, implying a positive (negative) link between inflation and cost inefficiencies. In studies to capture the effect of the macroeconomic environment, inflation and GDP growth rate have been utilized (Osoro & Kiplangat, 2020: 10). Mulidy (2021) estimated the Bank regulation - Cost inefficiency nexus at Industry-level. According to the findings, rigorous capital requirements have a favorable and statistically significant influence on bank cost efficiency. This finding indicates that banks' cost-cutting behavior is positively related to capital-requirement tightening. The findings are consistent with those of Barth et al. (2013), Haque and Brown (2017) and Chortareas et al. (2012), who found that rigorous capital requirements improve bank cost efficiency. Coefficient T-ratio Constant 16.387 5.00 Capital adequacy -3.9519 -4.21 Liquidity Ratio 5.4464 9.60 Interest Rate -0.00005 -1.36 Quality of Funding -0.31717 -1.31 Size -0.93942 -2.89 Security Market Dummy 0.67314 1.11 GDP Growth Rate -18.9698 -1.90 Inflation rate -4.0909 -1.46 Table 1 Bank Regulation - Cost Inefficiency Nexus at Industry-Level (Mulindi, 2021) According to Cambis (2012), since the 1960s and 1970s, with the seminal work of Phelps, Friedman, and Lucas, inflation expectations have been a central 33 factor in models of inflationary dynamics, and they play a crucial role in New Keynesian dynamic stochastic general equilibrium (DSGE) models used to inform and evaluate monetary policy. In many inflation models utilized by central banks, inflation is driven by three primary factors: some measure of a resource utilization gap (such as the output gap or unemployment rate gap) or marginal cost of production; lagged inflation, which captures the inertia in the inflation process; and inflation expectations. According to Coibion, Gorodnichenko, and Ropele (2019), enterprises do base pricing decisions on their inflation forecasts, and their research demonstrates that firms boost prices in response to rising inflation expectations. Additionally, the OECD Composite Leading Indicators (CLIs), which are designed to predict economic activity reversals over the next six to nine months, continue to indicate a deteriorating picture in the majority of the world's largest nations. The CLIs continue to foresee a loss of growth momentum in the majority of significant OECD nations, as they are weighed down by historically high inflation, poor consumer confidence, and falling share market indexes. The OECD composite leading indicators are cyclical indicators based on a variety of forward-looking measures, including order books, building permits, confidence indicators, long-term interest rates, and new vehicle registrations, among others (Cambis, 2022). |