Does Operational Risk Management Benefit from FinTech?

ABSTRACT

We discover the impacts of FinTech on operational risk in the context of Chinese commercial banks from 2008 to 2019. Based on the massive amount of data collected manually, we find that FinTech and its subtypes, except for mobile internet, significantly reduce operational risk. Specifically, the baseline results reveal that for one unit increase in the FinTech index, the decrease in operational risk is about 1.414 units. For different types of FinTech, artificial intelligence (AI) has the most significant impact on operational risk, and for an increase of one unit of the AI index, operational risk is reduced by 4.033 units. Moreover, we find that the impact of FinTech on operational risk mainly comes from the interest, leases, and dividend component and the services component; the influence of FinTech on operational risk is greater in state-owned banks compared to other commercial banks with other ownership structures. Our main results hold for an array of endogeneity and robustness tests.

KEYWORDS:

• FinTech
• operational risk
• commercial bank
• China

JEL:

• G21
• O30
• O33

Acknowledgements

We are grateful for the comments from the seminar participants at Xi’an Jiaotong University. Maoyong Cheng gratefully acknowledges the financial support from Chinese National Funding of Social Sciences (19CJY065 and 21FJYB016). All errors are our own.

Disclosure Statement

No potential conflict of interest was reported by the authors.

Supplementary Data

Supplemental data for this article can be accessed online at https://doi.org/10.1080/1540496X.2022.2164464.

Notes

1. ORX is the largest operational risk association in the financial services sector. Since 2002, ORX has been developing a global community of financial institutions committed to improving the management and measurement of operational risk. See https://managingrisktogether.orx.org/about.

2. We provide a detailed discussion of FinTech in Section 2, including the definition of FinTech, the application of FinTech in bank risk management, and related research.

3. Regarding the types of emerging technologies included in FinTech, the Financial Stability Board (FSB) considers that FinTech includes AI, blockchain, cloud computing, and big data, which are collectively referred to as ABCD. We take mobile internet into our account for two reasons: one is that the new generation of communication technology represented by 5G is changing various industries, and the other is that internet finance or mobile internet finance is also essentially a kind of FinTech (Xiang et al. 2017).

4. See https://www.db.com/media/.

5. Because of its outstanding features, this FinTech product was awarded the Top 10 Cases of FinTech Innovation (2018) in China (Beijing, 2018). See http://www.abchina.com/cn/.

6. See https://www.coe.int/en/web/portal.

7. The third step is subdivided into three substeps to match the paradigm of panel factor analysis. First and foremost, necessary pretests (the Kaiser-Meyer-Olkin tests and the Bartlett test) are carried out to determine whether there are shared elements among the original keywords in each dimension and whether these keywords are appropriate for factor analysis. Then, the common factors are extracted following the principle that the eigenvalue should be greater than 1. The results show that the variance contribution rate of the extracted common factors exceeds 60%, indicating that the extracted factors can reflect the information contained in the keywords. Finally, to ensure that the indices are positive, the maximum-minimum processing is applied to standardize data between 0 and 1, and AI_it, Blockchain_it, Cloud_it, Bigdata_it, and MI_it are obtained.

8. See http://www.fintechdb.cn/.

9. The descriptive statistics for the variables used in the regression analyses reports are in Table S2 in Part 2 of the supplemental online material.

10. Table S3 in Part 3 in the supplemental material reports the univariate regression results.

11. For example, in the case of blockchain technology, Chinese and European banks have very different attitudes toward it. In 2019, Spain’s Santander Central Hispano issued the world’s first blockchain bond, which it said in a public statement would be issued in an Ethereum-based token. In contrast, China is very cautious. Not only are cryptocurrencies officially illegal in China, but commercial banks pay more attention to the characteristics of data encryption and consensus when applying blockchain technology, such as Hyperledger of PSBC as stated in Section 2.2.

12. Because the FinTech index is a novel measure constructed by us, we also provide economic implications for the regression results after normalization. That is, for a one-standard-deviation increase in the FinTech index, the decrease in operational risk is about 3.180% (1.414 × 0.202/8.981 = 3.180%).

Additional information

Funding

The work was supported by the Chinese National Funding of Social Sciences [19CJY065 and 21FJYB016].