Digital innovation as a bank risk mitigator: Empirical insights from Chinese commercial banks

The rapid spread of digital technologies has led traditional banks, long-standing pillars of the financial sector, to embrace digital innovation. This study investigates how digital innovation influences bank risk. We develop a new hand-collected index that captures five dimensions of digital innovation, namely volume, quality, agency, generativity, and convergence. Using a panel of 391 Chinese commercial banks from 2009 to 2018, we find that banks with higher levels of digital innovation tend to engage in less excessive risk-taking. This negative relationship is robust across multiple identification strategies, including difference-in-differences, instrumental variables, Heckman two-stage estimation, and change-on-change regressions, which address concerns of endogeneity. Two mechanisms explain this effect. First, digital innovation strengthens market discipline by improving bank transparency. Second, it enhances market power by improving loan quality and reducing information asymmetries between banks and borrowers. The bank stabilizing effect also varies across different dimensions and strategic goals of digital innovation. In addition, the risk-reducing effect is more pronounced for banks located in provinces with greater digital innovation by other financial service providers, for non–state-owned banks, for banks lacking national geographic reach, and for those in provinces with stronger legal enforcement or more developed credit markets. These findings highlight the strategic role of digital innovation in shaping bank risk and provide important implications for managers, regulators, and other stakeholders concerned with financial stability.