19-02-2013, 09:27 AM
The Economic Effects of Technological Progress: Evidence from the Banking Industry
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Abstract
This paper examines technological progress and its effects in the banking industry. Banks are intensive users
of both IT and financial technologies, and have a wealth of data available that may be helpful for the general
understanding of the effects of technological change. The research suggests improvements in costs and lending
capacity due to improvements in “back-office” technologies, as well as consumer benefits from improved
“front-office” technologies. The research also suggests significant overall productivity increases in terms of
improved quality and variety of banking services. In addition, the research indicates that technological
progress likely helped facilitate consolidation of the industry.
Introduction
This paper examines the available evidence on technological progress and its effects in the banking
industry. Innovations in information processing, telecommunications, and related technologies – known
collectively as “information technology” or “IT” – are often credited with helping fuel strong growth in the
U.S. economy, although questions remain about the relative importance of IT versus other factors. The
extensive research on the banking industry may help in the general understanding about the effects of
technological change. The category of Depository and Nondepository Financial Institutions – of which
banking is an integral part – is the most IT-intensive industry in the U.S. as measured by the ratio of computer
equipment and software to value added (Triplett and Bosworth 2002, Table 2).
Banks are also significant users of financial technologies that employ economic and statistical models
to create and value new securities, estimate return distributions, and make portfolio decisions based on
financial data. Examples include financial engineering used to create new financial derivatives, credit risk and
market risk models employed to improve portfolio management, and modern credit scoring and discriminant
analysis used to evaluate credit applications. These financial technologies often depend heavily on the use of
IT to collect, process, and disseminate the data, as well as on economic and statistical models to evaluate the
data. Technological progress in the banking industry is also important because of the key roles of banks in
providing financing, deposit, and payments services to other sectors of the economy.
Changes in the banking industry over time
We present statistics that illustrate some of the changes in technology, performance, and structure of
the banking industry. Table 1 gives data on changes in the structure of the commercial banking industry
annually over the period 1984-2001, which illustrate the consolidation of the industry. The total number of
banking organizations (top-tier holding companies plus independent banks) and the number of banks
substantially declined over the 17-year period at average annual rates of 3.3% and 3.4%, respectively, even
while gross total assets (GTA) grew by 3.0% per year. The consolidation has primarily occurred through
mergers and acquisitions (M&As) that combine institutions in different local markets – the average local
market Herfindahl index has increased by only 1.1% annually.
Information exchanges
Information exchanges, as we use the term here, are intermediaries through which banks and other
creditors share data relevant to the creditworthiness of loan applicants. These exchanges collect data from
financial institutions, trade creditors, public records, and other sources, aggregate and summarize the data, and
then provide credit reports or credit scores to lending institutions. The exchanges may be private third-party
credit bureaus, associations organized by banks, or public credit registers organized by central banks.15
The technology of information exchanges has been shown to add value. A cross-country analysis
found that bank lending is higher and default rates are lower in nations in which lenders use either private or
public information exchanges (Jappelli and Pagano 1999).
Some potential inferences from the microeconomic research on banking technologies
This research points to some potential general inferences about new technologies. First, there is a
multiplicity of different actual and measured effects of new technologies on productivity growth and industry
structure. Some new technologies – such as ATMs in the early 1980s and possibly Internet banking currently
or in the near future – may increase productivity significantly in terms of the quality of the service to the
consumer, but these benefits may not be easily measured. Firms may provide the higher quality without
charging the full costs due to competitive pressures. In contrast, some new technologies – such as the
innovations in processing electronic payments – may have very significant and easily observable effects in
terms of productivity gains and increased scale economies. Some new technologies – such as innovations in
information exchanges – may alternatively have significant benefits that can only be measured with
nontraditional methods, such as examining the composition of the loan portfolio.
Second, the research on banking technologies suggests that most of the important new technologies
were generally adopted earlier by large firms than small firms. Large banks have generally been first to 1)
adopt transactional Internet websites, 2) use electronic payments technologies, and 3) employ the SBCS
technology, although there are exceptions, such as some of the new Internet-only banks.
Conclusions
Research on the banking industry provides a wealth of information about technological progress.
Banks intensively use modern technologies and the detailed data on this industry allow for investigations of the
effects of advances in both IT and financial technologies and in both “front-office” and “back-office”
technologies. Banking industry data give opportunities to investigate examples in which individual
technological changes can be observed and some of their effects can be measured. The detailed data also
allows researchers to link technological progress to productivity and other indicators of performance using multiproduct cost and profit functions and other methods. These methods help account for improvements in
service quality and variety and address other difficulties inherent in the use of labor productivity indexes. The
banking data also allow for analysis of the effects of technological progress on banking industry structure – or
the extent to which technological progress facilitates consolidation – using statistics on bank scale, distances,
and mergers and acquisitions (M&As).