Can digital transformation expand the boundaries of the earnings potential of commercial banks? Evidence from China

Digital transformation (DT), as a multidimensional indicator for reshaping the profitability models of commercial banks, has become the focus of attention in the banking sector. This paper models a two-stage banking technology that incorporates DT as an intermediate variable to measure its effects on banking earning potential (EP). Moreover, nonparametric local polynomial regression and coupling analysis are adopted to examine the mechanism through which DT affects banking EP. Additionally, a comparative analysis is conducted to assess the heterogeneous effects of three subdimensions of DT and three bank types. For the empirical analysis, 175 Chinese commercial banks are used as samples for the period 2010–2021. DT has a nonlinear positive effect on banking EP, with state-owned commercial banks outperforming joint-stock commercial banks and small commercial banks. However, there are potential conflicts among the three subdimensions of DT. With respect to the disaggregation of banking EP, DT expands banking EP primarily by increasing potential profits. However, DT has the potential to increase the degree of credit risk exposure associated with nonperforming loans. Finally, sensitivity analysis confirms the stability of the results and calculates the importance of each variable in shaping banking EP. This paper can provide theoretical insights and practical guidance for Chinese commercial banks in optimizing DT strategies while balancing profitability enhancement with risk management.