The effect of financial innovation on bank stability: Evidence from the OECD countries

Abstract

The rapid rate of financial innovations in the past decades has emerged a widespread academic and political debate about the effects of financial innovations. However, the Global Financial crisis of 2007-2009 has spurred renewed widespread debates on the effects of financial innovation. This period has highlighted the limitations and hazards of financial innovation while dimming the lights on its core benefits for an economy. This has led to a shift in the regulatory framework of banks. Motivated by this change, this research is going to investigate whether financial innovation affects bank stability. Measures for both inputs as outputs of financial innovation are used to test if financial innovation affects banks' stability. Using a sample of 9260 banks out of 35 OECD countries for the period 2010-2019, this research finds weak evidence for a link between financial innovation and bank stability. This is in contrast with previous studies from before the crisis. These findings show that policymakers might have succeeded in their job to mitigate the negative effects of financial innovations. Furthermore, in countries other than the United States, fintech companies positively affect the stability of banks, and off-balance sheet activities only seem to affect the stability of commercial banks negatively.