Impact of digital banking on banks' profitability : study on Sri Lankan banking industry

Abstract

Information Technology is widely used in development and outspreading of banking options. Banking sector is more into digital banking in the current world. A number of studies are carried out on digital banking worldwide. In Sri Lankan context, a quantitative analysis on the bank performance and digital banking aspects was not found. This study attempts to fill this gap by analyzing quarterly data from year 2010 to 2018. Data were obtained from Payment and Settlement Department of Central Bank of Sri Lanka and Central Bank Web site. Bank performance is identified by the return on assets (ROA) before tax. From number of digital banking aspects, the variables used in this study are, number of internet banking transactions, number of point-of-sale (POS) machine transactions and number of mobile banking transactions (MOBT). Time effectiveness and the cost effectiveness of digital banking is discussed in the study. Augmented Dickey Fuller Test was used to check the stationarity of the variables. Since the stationarity test revealed that all the four variables become stationary at the 1st difference, cointegration of the variables were drawn through Johansen Cointegration Test. Trace test indicated four cointegration equations and Max-Eigen Statistic test indicated only one cointegration equation at the 5% level. Hence Vector Error Correction Model (VECM) was fitted to determine the long run equilibrium. Model showed that there exists a very stable long run association that, when the system is deviated from the equilibrium, it is corrected by 63.36% increase in the ROA per quarter. Impulse Response Function was employed to illustrate the importance of each digital banking aspect to banking sector profitability when a shock is imposed to the system. It is observed that the POS transactions affects profitability positively, while internet banking and mobile banking showed a negative impact on profitability. In the short run, internet banking and POS transactions showed an association with profitability. This study recommends that adequate consideration must be given to digital banking in policy implementation with regards to banking sector.