Does IT investment improve bank performance? Evidence from Europe

This paper investigates whether investment in information technology (IT) – hardware, software and other IT services – influences the performance of banks. Using a sample of 737 European banks over the period 1995–2000 we analyse whether IT investment is reflected in improved performance (measured using both standard accounting ratios and cost and alternative profit efficiency measures). Despite banks being major investors in IT we find little relationship between total IT investment and improved bank profitability or efficiency indicating the existence of a profitability paradox. However, the impact of different types of IT investment (hardware, software and services) on banks’ performance is heterogeneous. Investment in IT services from external providers (consulting services, implementation services, training and education, support services) appears to have a positive influence on accounting profits and profit efficiency, while the acquisition of hardware and software seems to reduce banks’ performance.     

Information technology investment governance: What is it and does it matter?

While the growth in the number of IT investments remains strong, research in the IT investment field is limited, resulting in suboptimal practical guidance on effectively governing IT investments. Based on resource-based theory, this paper reports the initial work involved in developing a construct named IT investment governance (ITIG), because it can be used to measure organizations' capability to govern their IT investments. This paper then empirically examines the association of ITIG and corporate performance. The preliminary result is a four-factor, 16-item instrument for assessing the ITIG construct. This method's factors are IT investment value governance, IT investment value monitoring, IT investment appraisals and IT investment project management. The impact of ITIG on corporate performance was demonstrated with a significant and positive relationship found to exist between the ITIG construct and corporate performance, thus supporting the effectiveness of the ITIG construct. Corporations with higher levels of ITIG capability are more likely to maximize the contribution of their IT investments to firm value.     

R&D productivity following first-time CIO appointments

Prior studies find that firms announcing the appointment of a new chief information officer (CIO) are rewarded by stock price increases, suggesting that the market expects new CIOs to add longterm value to the firm. In this paper, we examine whether first-time CIO appointments result in improved R&D productivity. We focus on R&D investments because one role of IT management is to aid in discovery and management of growth opportunities. Successful R&D activities are designed to create the type of knowledge-based, growth-critical assets (new or improved products, better distribution methods, etc.) that effective IT management would be expected to assist. After controlling for industry performance, we find that the productivity of R&D improves significantly after the appointment of a new CIO for appointments before 1999 (1997–1998) but not for appointments in later years (1999–2007), and that productivity improvements over the entire sample period occur for CIO appointments by firms with superior IT capabilities. Our results for R&D investments suggest that new CIOs improve the way IT is managed and improve their firms' approach to knowledge management.     

Diversification and Performance in Banking: The Israeli Case

This paper analyzes performance and portfolio choice of banks investments across business units using methodologies developed mainly for equity investments. The backgrounds to the paper are major recent developments in the financial services industry, mainly consolidation in the banking industry that raised the issue of efficiency gains due to diversification. The paper focuses on banks in Israel as an extended case study, using the fact that Israeli banks have operated as (limited) universal banks for a long time. The results suggest that there are gains to diversification and that risk adjusted performance is mostly consistent with optimal portfolio choice. Most of the previous research in this area has been done in the US. These studies necessarily focused on hypothetical combinations of different business activities because of the legal limits on US banks. Thus this paper adds to the literature both by examining actual combinations and looking at another country.     

How Continental Bank outsourced its "crown jewels."

No industry relies more on information than banking does, yet Continental, one of America's largest banks, outsources its information technology. Why? Because that's the best way to service the customers that form the core of the bank's business, says vice chairman Dick Huber. In the late 1970s and early 1980s, Continental participated heavily with Penn Square Bank in energy investments. When falling energy prices burst Penn Square's bubble in 1982, Continental was stuck with more than $1 billion in bad loans. Eight years later when Dick Huber came on board, Continental was working hard to restore its once solid reputation. Executives had made many tough decisions already, altering the bank's focus from retail to business banking and laying off thousands of employees. Yet management still needed to cut costs and improve services to stay afloat. Regulators, investors, and analysts were watching every step. Continental executives, eager to focus on the bank's core mission of serving business customers, decided to outsource one after another in-house service--from cafeteria services to information technology. While conventional wisdom holds that banks must retain complete internal control of IT, Continental bucked this argument when it entered into a ten-year, multimillion-dollar contract with Integrated Systems Solutions Corporation. Continental is already reaping benefits from outsourcing IT. Most important, Continental staffers today focus on their true core competencies: intimate knowledge of customers' needs and relationships with customers.     

Information technology,contextual factors and the volatility of firm performance

This study uses previous theory developed in the IT implementation literature and the information processing view of the firm to empirically investigate the impact of IT investments and several contextual variables on the volatility of future earnings. We use InformationWeek 500 data on IT spending from 1992–1997 to find evidence that IT investments increase the volatility of future earnings but that this impact is highly contingent upon three firm level contextual factors — sales growth, unrelated diversification, and size. These factors can lead to conditions in which IT increases or reduces earnings volatility. Taken together, these results may help explain what has recently been termed the “new productivity paradox,” i.e., the apparent under-investment in information technology despite evidence of highly positive returns for doing so, and suggests settings where managers may be under- or over-discounting returns on IT investments.     

TARP funds distribution and bank loan supply

This paper investigates the determinants of the Troubled Asset Relief Program (TARP) funds distribution to banks and the stimulus effect of TARP investments on credit supply in the economy. Using banks’ political and regulatory connections as instruments, this paper finds that TARP investments increased bank loan supply by an annualized rate of 6.36% for banks with below median Tier 1 capital ratios. This increase is found in all major types of loans and can be translated into $404 billion of additional loans for all TARP banks. On average, TARP banks employed about one-third of their TARP capital to support new loans and kept the rest to strengthen their balance sheets. Furthermore, there is little evidence that loans made by TARP banks had lower quality than those by non-TARP banks. In sum, this paper shows a positive stimulus effect of TARP on credit supply during the 2008–2009 financial crisis.     

Productivity and efficiency at large and community banks in the US: A Bayesian true random effects stochastic distance frontier analysis

This paper compares the productivity and efficiency of large banks and community banks in the United States over the period 1997–2006. This comparison is performed by estimating a true random effects stochastic distance frontier model—a model that is capable of disentangling unobserved heterogeneity from inefficiency—within a Bayesian framework. We find that failure to consider unobserved heterogeneity results in a misleading ranking of banks and mismeasured technical efficiency, productivity growth, and returns to scale. Our results show that, compared with community banks, large banks have experienced much higher productivity growth and higher levels of returns to scale. Our estimates of total factor productivity growth show a clear downward trend for both large and community banks, and our decomposition of the output-distance-function-based Divisia productivity index indicates that technical change is the driving force behind this trend.     

The impact of different media channels on consumers and the wastage of potential advertising opportunities through existing customer communications

The first section of this paper investigates the impact of different media channels on the consumer, including television advertising, direct mail, direct Email and SMS advertising. It reveals that existing customer communications such as bills, statements and customer service letters top the survey commanding an average 38 seconds of consumer attention time. The second half of this report looks into the wastage of existing customer communications as an advertising tool. The research indicates that £365m of potential advertising opportunity is wasted by the financial services sector each year, which is the largest wastage of the industries surveyed. The retail banking sector wastes the highest proportion, with credit card issuers coming second. Direct insurance providers fare much better, although the number of customer interactions is far fewer than with credit card issuers or banks.     

Exploring the causal relationships and allocation puzzle between portfolio investments and real sector growth in Sub-Saharan Africa

This study explores the causal dynamics and allocation puzzles between real sector growth and portfolio investments (equity and private debt) in Sub Saharan (SSA). We use growth in manufacturing, industry, agriculture, and services to capture the real sector and employ the two-step dynamic systems GMM model to establish our empirical relationships over the period 1980–2017. We found no evidence in support of the puzzle at the overall level of the real sector and portfolio investments. However, at a decomposed level, we established a bi-directional relationship of a positive association between debt flows and growth in agriculture and services, with no evidence of an allocation puzzle. Though we found a bi-directional association between debt and industrial growth, the association was detrimental in both directions. Finally, the study established a two-way inverse causality between equity flows and manufacturing growth. The paper provides a strong foundation for an additional source of financing, especially for the growth of the service and agriculture sectors. The findings also indicate complementary reactions between real sector growth and portfolio investments in SSA.     

Inflation targeting: Is IT to blame for banking system instability?

In light of the financial crisis, the practice of inflation targeting (IT) has been blamed for authorities’ failure to respond to the increase in financial systemic risk and to the development of asset bubbles. However, utilizing a rich database containing nearly 5500 commercial banks from 70 countries (among which, 22 are IT) for the period 1998–2012, this paper argues that on average, inflation targeting national banking systems (i) are more stable; (ii) possess sounder systemically important banks; and (iii) are less distressed than (or at least as distressed as) other banks during periods of global liquidity shortages. Our results are robust to a series of tests, such as when we compare countries with the same legal origins or control for the delegation of bank supervision responsibility to bodies other than the central bank. Overall, we conclude that IT cannot be blamed for contributing to financial fragility.     

Do ATMs Increase Technical Efficiency of Banks in a Developing Country? Evidence from Indian Banks

Prior studies have confirmed that the greater the investment in information technology (IT), the better the performance of the firm. In the present study, we use bootstrap data envelopment analysis (DEA), which has previously been used in the accounting literature, and which has an edge over traditional accounting‐based measures, to compute the performance efficiency of Indian banks. Specifically, we measure the impact of automated teller machine (ATM) investment intensity on the production efficiency of Indian banks. We also study the impact of bank ownership, soundness, size and risk on efficiency. The study contributes to the literature on the productivity paradox and also draws on structure–conduct–performance theory. We find that ATM intensity has a significant negative association with bootstrap DEA technical efficiency. These results differ from prior research in developed countries. The results could be ascribed to heavy investment in IT such as ATMs by banks, and their inability to reduce labour costs given that many processes still continue to be manual. Accordingly, the study suggests that investment decisions with regard to IT need to be taken with great caution. If the related processes are not simultaneously automated, such investments are unlikely to yield the results that management may have envisaged.     

Turkish bank efficiency: Bayesian estimation with undesirable outputs

This paper analyzes the productivity and efficiency of Turkish banks from 2002 to 2010. We obtained estimates of efficiency, productivity growth and efficiency growth using a Bayesian stochastic frontier approach and focused on accounting for Non-Performing Loans (NPLs) for use in our model. Specifically, we introduce NPLs as a bad output in an input distance function, and estimate a system of non-linear equations subject to endogeneity. We confirm that the productivity growth of Turkish banks was positive over the period of this study, which was mainly due to the improvement in technology, while efficiency growth continued to be negative over the same period. Methodologically, we also prove that not accounting for NPLs in estimating the frontier model might seriously distort the efficiency and productivity results. The study also provides measures of shadow prices for NPL and discusses the results in terms of several interesting trends in Turkish banking. Finally, the paper provides efficiency and productivity comparisons between domestic and foreign banks.     

Riding the waves of technology through the decades: The relation between industry-level information technology intensity and the cost of equity capital

This paper examines the effect that information technology (IT) investments have on the industry cost of equity capital. We find that industry IT intensity, defined as the relative amount of IT investment to total fixed asset expenditures, is negatively related to the industry cost of equity capital. These results indicate that industries with higher levels of IT investment have lower cost of equity capital. We also find that the relation between IT intensity and cost of equity capital changes over time. Initially, investors viewed IT investments as risky ventures and demanded higher levels of cost of equity (or higher return on their investment) for those industries investing in IT. However, beginning in the 1980s, as IT became more reliable, more cost effective, and had the ability to transform businesses, investors viewed IT Intensity as a positive business strategy with less associated risks and reduced their required cost of equity capital (or lower return on their investment). Extrapolating from our industry results, IT investments allow firms to potentially raise capital at a lower price so they have more assets to employ, indicating that IT investments can be a key factor for business success.     

Advertising investments,information asymmetry,and insider gains

Extant research has documented various sources of informational advantages enjoyed by company insiders including firm size, analyst following, dividend payout policy, book-to-market ratio, and the presence or absence of R&D investments. Surprisingly, despite this large body of work, virtually no research has investigated the contribution of advertising investments to information asymmetry. This omission is particularly glaring since: (a) advertising investments constitute a significant fraction of many firms' ongoing expenditures, and (b) the received literature provides strong theoretical arguments relating advertising investments and information asymmetry. Accordingly, the primary objective in this study is to empirically address this gap. Using advertising and insider transaction data at over 12,000 firms from 1986 to 2011, we find that insider gains are significantly greater at firms characterized by advertising investments. Specifically, a zero cost portfolio that is long on firms with net insider purchases and advertising investments, and short on firms with net insider purchases and devoid of advertising investments, garners annual abnormal returns of 5.5%. In addition, we find that investors' reaction to news of insider purchasing is significantly more pronounced at firms characterized by advertising investments — investors rationally recognize the greater information content associated with insider purchases at these firms.     

Financial contagion and depositor monitoring

This paper analyzes market discipline in a many-bank economy where contagion and bank runs interact. We present a model with differently-informed depositors, where those depositors that are more informed have incentives to monitor banks’ investments. It is shown that when banks are undercapitalized, and the probability of success of the risky asset is low, depositors might prefer a contract that is subject to bank runs in the interim period to a contract that allows banks to gamble with their funds and maintain their investment.The results of the paper emphasize the benefits of private monitoring of banks in order to promote market discipline.     

Capital regulation and credit fluctuations

Credit cycle stabilization can be a rationale for imposing counter-cyclical capital requirements on banks. The model comprises two productive sectors: in one sector, firms can finance investments through a bond market. In the other, firms rely on bank credit. Financial frictions limit banks’ borrowing capacity. Aggregate shocks impact firms’ productivity. From a welfare perspective, banks lend too much in high productivity states and too little in bad states, although financial markets are complete. Imposing a (stricter) capital requirement in good states corrects capital misallocation, increases expected output and social welfare. Even with risk-neutral agents, stabilization of credit cycles is socially beneficial.     

Six IT decisions your IT people shouldn't make

Senior managers often feel frustration--even exasperation--toward information technology and their IT departments. The managers complain that they don't see much business value from the high-priced systems they install, but they don't understand the technology well enough to manage it in detail. So they often leave IT people to make, by default, choices that affect the company's business strategy. The frequent result? Too many projects, a demoralized IT unit, and disappointing returns on IT investments. What distinguishes companies that generate substantial value from their IT investments from those that don't? The leadership of senior managers in making six key IT decisions. The first three relate to strategy: How much should we spend on IT? Which business processes should receive our IT dollars? Which IT capabilities need to be companywide? The second three relate to execution: How good do our IT services really need to be? Which security and privacy risks will we accept? Whom do we blame if an IT initiative fails? When senior managers aren't involved in these decisions, the results can be profound. For example, if they don't take the lead in deciding which IT initiatives to fund, they end up overloading the IT department with projects that may not further the company's strategy. And if they aren't assessing security and privacy risks, they are ignoring crucial business trade-offs. Smart companies are establishing IT governance structures that identify who should be responsible for critical IT decisions and ensure that such decisions further IT's strategic role in the organization.     

In search of a rational foundation for the massive IT boom in the Australian banking industry: Can the IT boom really drive relationship banking?

Information technology (IT) is meant to improve bank performance by lowering operational costs and improving the process of financial intermediation of banks. However, the empirical evidence has failed to reach a consensus on the precise effects of IT on bank performance as some find evidence to concur with the Solow Paradox, while others contradict this paradox. The heterogeneity in the quality of banking services is partly responsible for the inconsistency in the findings. To sidestep the issue of heterogeneity, we consider the top-tier Australian banks for which the quality of banking services is homogeneous. Applying the dynamic panel data methodology, i.e., panel autoregressive distributed lag (panel ARDL) and cross-sectionally augmented panel ARDL (CS-ARDL) models, we investigate the effect of IT on the cost and profit efficiency frontiers of the top-tier Australian banks during 2000–2019. We unequivocally establish that the frontiers of bank profits rise due to the adoption and diffusion of IT investment, contradicting the assumed failure of IT to adequately collect soft information in the banking industry. Furthermore, we find that the cost frontiers have risen, driven by the IT boom. Hence, there is evidence that despite increases in operational inefficiency, IT has shifted the profit frontiers up by enhancing relationship banking in Australia.     

Efficiency,technical change,and returns to scale in large US banks: Panel data evidence from an output distance function satisfying theoretical regularity

This paper provides parametric estimates of technical change, efficiency change, economies of scale, and total factor productivity growth for large banks (those with assets in excess of $1 billion) in the United States, over the period from 2000 to 2005. This is done by estimating an output distance function subject to theoretical regularity within a Bayesian framework. We find that failure to incorporate theoretical regularity conditions results in mismeasured shadow revenue and/or cost shares, which in turn leads to perverse conclusions regarding productivity growth. Our results from the regularity-constrained model show that total factor productivity of the large US banks grew at an average rate of 1.98% over the sample period. However, our estimates also show a clear downward trend in the growth rate of total factor productivity and our decomposition of the primal Divisia total factor productivity growth index into its three components – technical change, efficiency change, and economies of scale – indicates that technical change is the driving force behind this decline.