Digital reshaping of banking stability: the dual role of transformation in systemic risk

Background and Motivation

The rapid integration of big data, blockchain, artificial intelligence, and other digital technologies has fundamentally transformed the banking sector. In China, commercial banks have actively pursued digital transformation, supported by national policies such as the Guidance on Digital Transformation of Banking and Insurance Industry (2022) and the Action Plan for Promoting High-Quality Development of Digital Finance (2024). While digitalisation promises enhanced efficiency and innovation, it also introduces new risks, including cybersecurity threats, operational contagion, and regulatory challenges. The balance between technological advancement and financial stability remains a critical yet underexplored issue. This study investigates how digital transformation influences systemic risk within China’s banking system, providing timely insights for regulators and financial institutions navigating the digital era.

Methodology and Scope

Using quarterly unbalanced panel data from 36 listed commercial banks in China between 2011 and 2020, the research employs a fixed-effects model to analyse the relationship between digital transformation and systemic risk. Digital transformation is measured through text analysis of bank reports, capturing keywords related to AI, blockchain, cloud computing, and big data. Systemic risk is decomposed into two components: bank-specific tail risk and systemic linkage to extreme market shocks, estimated using extreme value theory. The study further examines heterogeneity across bank types, cost-saving mechanisms, and nonlinear effects to offer a comprehensive view of digitalisation’s impact.

Key Findings and Contributions

• Overall Impact: Digital transformation significantly reduces banks’ systemic risk by lowering both bank-specific tail risk and systemic interconnectedness.
• Heterogeneity: The risk-reducing effect is more pronounced in national commercial banks (state-owned and joint-stock) compared to regional banks, largely due to stronger cost-saving benefits and diversified operations.
• Mechanism: Cost reduction emerges as a key channel through which digital transformation mitigates risk, particularly in banks with higher pre-digitalisation management expenses.
• Nonlinearity: The relationship follows an asymmetric pattern: moderate digital transformation decreases systemic risk, but excessive digitalisation may increase it, indicating a “digital tipping point”.
• Regulatory Relevance: Findings highlight the need for differentiated macro- and micro-prudential policies tailored to bank size, ownership, and digital maturity.

Why It Matters

As digitalisation accelerates globally, understanding its implications for financial stability is crucial for policymakers, regulators, and bank managers. This study provides empirical evidence that digital transformation can enhance resilience but also warns against unchecked technological expansion. It bridges gaps between technological adoption, risk management, and regulatory frameworks, offering a balanced perspective essential for sustaining financial system integrity in the digital age.

Practical Applications

• Banks should adopt phased and measured digital strategies, prioritising cost-efficient technologies and avoiding over-digitalisation that could heighten risk exposure.
• Regulators are advised to implement dynamic, bank-specific supervision, such as digital sandboxes for large banks and shared technology platforms for smaller institutions, to foster innovation while containing systemic vulnerabilities.
• Policy makers can use these insights to design guidelines that encourage sustainable digital integration, emphasising monitoring, stress testing, and adaptive regulatory responses to emerging digital risks.

Discover high-quality academic insights in finance from this article published in China Finance Review International. Click the DOI below to read the full-text!