The digital age has revolutionised the banking industry, as banks shift customers from traditional branches to digital platforms that offer banking services instantaneously around the clock. Though this brings convenience, affordability, and a wider range of financial tools at our fingertips. However, this shift also brings unforeseen challenges.

Gloria Yang Yu, Assistant Professor of Finance, delves into the nuances of this transformation, exploring its impact on banking operations, competition, and varied customer groups. While many deem digital banking a solution for financial inclusion, she explains why there could be a downside to the digitalisation of banking services.

Q: How has the emergence of digital banking impacted the way banks operate and compete?

Asst Prof Yu: We find that, in the United States high-speed mobile network expansion affects banks’ branch closures, entry and pricing decisions. Before the digital disruption, physical branches were valuable because digital service quality was not satisfying. However, third-generation wireless mobile telecommunications technology (3G) improves digital services and digital banking becomes a viable alternative to physical branches. Banks that rely less on branches will close costly branches to optimise their operations. The improved digital service will increase their profit margins, which then attract new entries. As competition intensifies, these banks offer digital services at lower prices to stay competitive. Banks with higher reliance on physical branches maintain more branches and charge higher prices on non-tech-savvy consumers who are captive to branch services.

Q: Why do these developments lead to fewer bank branches in countries with a larger population of young tech-savvy people?

Asst Prof Yu: The reason is that 3G improves digital services which attracts tech-savvy consumers as they prefer digital services via a website or mobile app. Branches become less valuable to them and some banks close costly branches, especially in these regions populated by more tech-savvy investors.

We have not examined countries outside the U.S. in our study. But speaking anecdotally, countries with relatively underdeveloped banking sectors, such as Vietnam, Laos, Cambodia and Myanmar, would likely see an uptick in the number of physical branches in the near future. More developed regions such as Singapore have seen branch closures and this trend is likely to continue, as is the case for mature economies. 

Q: What are the implications of digital disruption on different customer groups? 

Asst Prof Yu: We find that digital disruption allows tech-savvy consumers, usually the younger, richer and more educated consumers to enjoy cheaper and better financial services; they are also more financially included. On the contrary, non-tech-savvy, typically the older, poorer and less-educated consumers bear higher costs to access banking services and face a higher risk of losing access to banking services. 

Q: Is digital banking a solution for financial inclusion for the unbanked and underbanked population?

Asst Prof Yu: Digital banking allows banks to expand geographically and reach a wider audience and its remote services certainly provide users with efficiency, convenience and flexibility. It is often believed that such technology will increase bank competition and reduce unbanked rates. However, we highlight that its impact can vary in the presence of a “digital divide”—as not everyone has the skill and the devices to embrace new technology. The reason is that banks also adjust their competing strategies in response to digital disruption. In particular, banks with higher reliance on physical branches maintain more branches, and the customers who are not tech-savvy and who are captive to these branches face higher prices for the services these banks provide. Higher unbanked rates are also seen among the less tech-savvy consumers, due to the higher costs. These findings help us better understand the cost of transitioning to a different model of banking and identify who are those who are left behind. In this sense, digital banking is a solution to financial inclusion for some demographics but it is not a one-size-fits-all solution, at least in the current stage of transition. 

Q: Do you think digital banking will eventually replace physical branches? 

Asst Prof Yu: Not likely in the short run. First, consumers can still value physical branches for their face-to-face interactions and immediate assistance, at least sometimes. Second, digital banking still holds some drawbacks given the current technology empowering it. One concern is security and privacy. Despite measures such as encryption and two-factor authentication, online transactions are subject to the risks of personal data breaches and scams. Another example is that digital banking can become problematic if network connectivities disrupt its functioning. So it is important to have physical banking for consumers, at least for now.

Q: How can the effects of digital disruption in banking be mitigated? 

Asst Prof Yu: Our model evaluates a particular policy of imposing a cap on the percentage of branches that are allowed to close. Authorities could introduce regulations that restrict branch closures to limit the impact on certain groups of consumers. This helps to protect consumers who are less tech-savvy from being excluded from the financial system and becoming increasingly unbanked. In practice, regulators are becoming more aware of the possible negative consequences of branch closures. For example, in the United Kingdom, regulators are updating guidance to supervise branch closures. Australia sees a parliamentary inquiry about big banks’ branch closures in certain areas. Our research underscores the need for policy discussions on financial inclusion to take into account how banks adapt and compete amid the ongoing digitization transformation. Other feasible approaches that we have not yet formally assessed include subsidising banks to sustain branches or educating consumers to enhance their proficiency in interacting with digital service technologies.