The European Journal of Finance

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Fintech development and bank risk taking in China

Rui Wang , Jiangtao Liu & Hang(Robin) Luo

To cite this article: Rui Wang , Jiangtao Liu & Hang(Robin) Luo (2020): Fintech
development and bank risk taking in China, The European Journal of Finance, DOI:
10.1080/1351847X.2020.1805782

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THE EUROPEAN JOURNAL OF FINANCE
https://doi.org/10.1080/1351847X.2020.1805782

Fintech development and bank risk taking in China

Rui Wang, Jiangtao Liu and Hang(Robin) Luo
School of Economics, Xihua University, Chengdu, People’s Republic of China

ABSTRACT ARTICLE HISTORY

This paper empirically tests the effect of FinTech development on bank risk taking Received 16 August 2019
using unbalanced bank-level panel data from China for the period from 2011 to 2018. Accepted 28 July 2020
We use the media’s attention paid to FinTech-related information to gauge FinTech KEYWORDS
development. We find robust evidence that the development of FinTech exacerbates FinTech;
banks’ risk taking in general. The heterogeneity analysis further indicates that the asset financial-technology; bank
quality deterioration effect brought about by prosperous FinTech is more salient in risk-taking; China
banks with larger sizes, lower efficiency, more shadow banking business and more
interest-based income. Moreover, the nexus between FinTech and banks’ risk taking is a JEL CLASSIFICATIONS
U-shaped trend, with FinTech initially intensifying and then weakening banks’ risk tak- F21; G32; Q55
ing. Moreover, the banks’ responses regarding the U-shaped effect are heterogeneous
among different ownership structures. The responses by state- and jointly owned
banks are not notable, while those of city banks, foreign banks and rural banks are more
sensitive.

1. Introduction
With the rapid development of technologies such as big data, cloud computing, blockchain and artificial intelli-
gence, financial technology (‘FinTech’ for brevity) is now spreading worldwide. ‘FinTech’ can be broadly defined
as technologically enabled financial innovations that could result in new business models, applications, processes
and products with associated material effects on financial markets, financial institutions and the provision of
financial services (Financial Stability Board 2017; International Organization of Securities Commissions 2017).
FinTech innovations, which are emerging in many aspects of finance, such as retail finance, wholesale payments,
investment management, insurance, credit provision and equity capital raising, are not only competing with
traditional financial services but also promoting their innovations and transformation (An and Rau 2019; Di,
Yuan, and Zeng 2020; Gai, Qiu, and Sun 2018; Gomber, Koch, and Siering 2017; Milian, Spinola, and Carvalho
2019; Panos and Wilson 2020; Zavolokina, Dolata, and Schwabe 2016). Despite the emergence of financial inno-
vations in the financial industry, the effects of FinTech on the financial system are less understood (Li, Spigt, and
Swinkels 2017; Phan, Narayan, and Rahman 2019).
As a core component of financial institutions, banks play a vital role in allocating scarce financial resources
between borrowers and lenders. The stability of the banking system is considered the primary impact affect-
ing economic growth, notably in less developed economies (Levin 1997). While the crises witnessed in recent
decades, particularly the recent global financial crisis, have promoted a flourishing literature that suggests that
banks’ excessive risk taking is a leading reason for the subsequent financial turmoil (Acharya and Naqvi 2012;
Beck, Demirgüç-Kunt, and Levine 2006; Diamond and Rajan 2012; etc.), the research on the determinants of
bank risk taking remains incomplete.

CONTACT Hang(Robin) Luo [email protected]

© 2020 Informa UK Limited, trading as Taylor & Francis Group

2 R. WANG ET AL.

Given this background, this paper empirically investigates the impact of FinTech development on bank risk
taking in China. We consider China for several reasons. First, China has a history of some of the most dras-
tic restrictions towards cryptocurrencies. In 2013, the People’s Bank of China (PBOC) issued a notice banning
banks from transactions relating to Bitcoin.1 Despite this, China was a hotbed for digital asset exchanges until
2017. On September 4, 2017, PBOC banned all organizations and individuals from raising funds through ini-
tial coin offerings (ICOs) and asked local regulators to inspect the remaining exchanges.2 China’s ambition of
developing digital currency has been slowly gathering momentum, rather than been dampened. On April 2020,
PBOC launched the pilot trial of digital currency / electronic payment (DC/EP) in several cities. Unlike the
cryptocurrencies issued through ICOs, DC/EP is not blockchain based and centralized with a ‘loosely coupled’
twist.3
Second, China is emerging as a leading FinTech market, not only in the Asia-Pacific region but also globally
(DBS and EY 2017). In 2018, the world’s largest FinTech investment was Alibaba’s Ant Financial from China,
which raised $14 billion.4 In addition, Chinese FinTech companies occupied four places in the Top 10 FinTechs
Ranking in 2018.5 Additionally, according to the ‘2019 Global FinTech Adoption Rate Index’ reported by EY,
the consumer FinTech adoption rates in China and India are both 87%, which is substantially greater than the
global average of 64%; moreover, China’s SME FinTech adoption rate of 61% also leads the world, followed
by the United States at 23%.6 It has been clear that China’s prohibition policies relate specifically to ICOs and
cryptocurrencies, rather than the underneath blockchain technology. On October 24, 2019, President Xi Jinping
addressed the Communist Party of China Central Committee Political Bureau (CCCPB) on the development
and trend of blockchain technology. He underlined the importance of blockchain technology, urging continued
progress with the view to positioning China as a leader in defining international standards.7
Third, China is a typical bank-based financing country, with banks still constituting the dominant part of the
financial system and serving as the major financing source, indicating that excessive bank risk taking could have
more detrimental effects than those in the countries that are less bank dependent (Kroszner, Laeven, and Klinge-
biel 2007). In addition, a large number of commercial banks are currently involved in the FinTech wave, and they
are closely connected with FinTech through various forms, such as investment and shareholding, business coop-
eration or competition. Hence, we believe that China provides an interesting case study to analyze how FinTech
influences bank risk taking in a context of the strictest policy environment towards ICOs and cryptocurrencies
in the world.
In this paper, we assess whether Fintech development affects banks’ risk-taking levels in China, after control-
ling for many other potential risk determinants. We find consistent evidence that banks’ riskiness is significantly
associated with the development of Fintech; in particular, Fintech increases the risk-taking of banks. We also
find that the impact of Fintech on banks’ risk-taking is heterogenous upon bank characteristics, such as size,
efficiency, scale of shadow banking and income share. Moreover, there exists an inverted U-shaped relationship
between FinTech and bank risk taking, i.e. bank risk taking increases initially and then begins to decrease as
FinTech further develops.
Our panel models extend, as well as make a number of new contributions to, the literature. First, we empir-
ically investigate the effects of FinTech growth on financial institutions. Despite the emergence of financial
technologies and their perceived influence on the financial industry, the effects of FinTech growth on the finan-
cial system using empirical microlevel data are less understood. Li, Spigt, and Swinkels (2017) examined the
effects of FinTech on the stock prices of incumbent retail banks and concluded that there is a positive relation-
ship between the growth of FinTech funding or deals and the contemporaneous stock returns of banks. Phan,
Narayan, and Rahman (2019) investigated the growth of FinTech firms regarding Indian banks and found that
FinTech negatively predicts bank performance. Building on the prior literature, we further test the impact of
FinTech on bank risk-taking behaviors.
Second, we use the media’s attention paid to FinTech-related information to measure FinTech development.
Prior studies have mainly adopted the number of FinTech companies emerging as competitors to traditional
banks to reflect the development of FinTech (Li, Spigt, and Swinkels 2017; Phan, Narayan, and Rahman 2019).
However, this indicator only captures one aspect of the whole picture. In China, the development of FinTech is
not only manifested by the growth of banks’ external competitors, but it also includes various forms taken by
banks themselves to develop FinTech; therefore, a more comprehensive variable is needed. In a certain period,
 THE EUROPEAN JOURNAL OF FINANCE 3

the number of news stories on a specific topic largely reflects its popularity and the attention paid to it by society
(Askitas and Zimmermann 2009). In the era when the Internet has become the main medium for information
dissemination, more information and news related to FinTech indicate more prosperous general FinTech devel-
opment. Therefore, we apply media’s attention paid to FinTech information to capture the overall development
of FinTech.
Third, we contribute to a growing body of literature on the determinants of bank risk and vulnerability, pro-
viding evidence that the development of FinTech is an important factor impacting the quality of bank assets
that cannot be ignored. For one thing, China’s bank-based financing structure indicates that banking risks are
critical to financial stability and economic development. For another, FinTech has flourished and received exten-
sive attention worldwide in recent years, while China’s FinTech is in the leading position worldwide. Therefore,
how such a technology-based emerging business format affects the risks of Chinese commercial banks is an
important research question, but it has received little attention from academics.
Fourth, we further enrich the literature by analyzing the heterogeneity of bank characteristics for the FinTech-
bank risk-taking nexus. Our results also show that FinTech has heterogeneous impacts on bank risk taking with
different bank characteristics. For example, factors such as size, efficiency, share of noninterest income, and size
of shadow banking might have differential effects on the FinTech-bank risk-taking relationship, indicating that it
is necessary for banks to fully understand their own development status to manage the adverse effects of FinTech
shocks.
Finally, our research also contributes to the literature by examining the nonlinear relationship of the FinTech-
bank risk-taking nexus. There is an inverted U-shaped relationship between FinTech and bank risk taking.
Specifically, the initial development of FinTech poses a threat to the profits of commercial banks and aggra-
vates their risk taking; later, due to the cooperation between commercial banks and external FinTech companies,
bank stability is enhanced, indicating that FinTech will prompt commercial banks to upgrade their technology,
innovate their businesses, and optimize their services. Moreover, we find that banks with different ownership
structures might also have heterogeneous effects in the inverted U-shaped relationship, revealing that different
types of banks have differential abilities to absorb, use, and transform financial technology; thus, the impact is
also heterogeneous.
Our conclusions are of great significance to both individual banks and the whole banking industry. Banks
should be alert to the negative impacts of FinTech development and undertake measures to minimize these
effects, while also actively participating in the construction of FinTech in accordance with their own circum-
stances. Moreover, the rational implementation of advanced technology will have a profound impact on the
long-term stability of the banking industry by generating new business processes, fresh products and services,
and innovative financing models.
This study is organized into six additional sections. The related literature is developed in Section 2, which is
followed by the proposal of the theoretical analysis between FinTech and bank risk taking in Section 3. Section
4 introduces the data, main variables and econometric method. The baseline empirical results and robustness
tests are demonstrated in Section 5. Section 6 considers the heterogeneity of the nexus. Section 7 concludes the
paper.

2. Literature review
2.1. Bank risk taking
Bank risk-taking behavior is a well-studied phenomenon, and academicians regard it as an important policy issue
for the economy’s overall financial stability (Saunders, Strock, and Travlos 1990). Many theoretical and empir-
ical studies have investigated the determinants of the risk-taking behavior of banks. Historically, researchers
have mainly focused on two aspects, with one stream of literature focusing on bank characteristics, such as
size (Afonso, Santos, and Traina 2014; Laeven and Levine 2009; Saunders, Strock, and Travlos 1990), capital
adequacy ratio (Furlong and Keeley 1989), liquidity (Diamond and Dybvig 1983; Diamond and Rajan 2012),
diversification of funding sources (Demirgüç-Kunt and Huizinga 2010), corporate governance (Agoraki, Delis,
and Staikouras 2010; Chen et al., 2017a, 2017b), and so on. The factors affecting bank risk-taking behavior also
4 R. WANG ET AL.

result from the external environment, for example, the degree of bank competition (Beck, Demirgüç-Kunt, and
Levine 2006; Beck, Jognhe, and Schepens 2013; Boyd and De Nicoló 2005), monetary policy (Borio and Zhu
2012; Chen et al., 2017b), deposit insurance (Angkinand and Wihlborg 2010; Demirgüç-Kunt and Detragiache
2002), external regulation (Barth, Caprio, and Levine 2004; Klomp and Haan 2012; Laeven and Levine 2009),
political institutions (Ashraf 2017; Chen et al. 2015; Wang and Sui 2019), and financial inclusion (Gamze and
Amine 2020).

2.2. FinTech and its impact on bank operations

A large number of studies have found that information technology is conducive to reducing banks’ transac-
tion costs, improving service quality, optimizing business structures, and promoting business transformation
and upgrading (Lapavitsas and Dos Santos 2008; Martín-Oliver and Salas-Fumás 2008; Shu and Strassmann
2005), while some other studies have claimed that information technology could bring enormous challenges to
commercial banks (Holland, Lockett, and Black 1997).
FinTech, a new information technology term, has achieved strong growth over the past decade. Despite the
ever-increasing interest in FinTech academically and practically, there remains a lack of consensus regarding
its definition. Lee (2015) defined FinTech as an innovator and disruptor of the financial system. FinTech com-
panies have new business models that have greater flexibility, security, efficiency, and opportunities than those
of traditional financial institutions. Gai, Qiu, and Sun (2018) believed that FinTech is a series of information
application technologies adopted by financial companies to improve service quality. Milian, Spinola, and Car-
valho (2019) and Demir et al. (2020) reported that FinTech describes the connection between Internet-related
technologies, such as cloud computing and mobile Internet, and financial services, such as loans and payments.
Zavolokina, Dolata, and Schwabe (2016) introduced lists of definitions of FinTech provided by different authors
and institutions and concluded that FinTech has three dimensions, as follows: input, which is the combination of
technology, organization, and capital flows; mechanism, which creates, improves, changes or disrupts the origi-
nal model; and output, which is the creation of a new service, product, process or business model. Currently, a
more authoritative definition is from the Financial Stability Board (2017), as follows: FinTech refers mainly to
emerging business models, new technology applications and new product services that have significant impacts
on the financial market and the provision of financial services and that come from frontier technologies, such
as big data, blockchain, cloud computing and artificial intelligence.
The effects of FinTech on banks are less understood. Frame and Wall (2018) believed that FinTech prompts
banks to reconsider and redesign the business models on which they depend. Li, Spigt, and Swinkels (2017)
examined the impact of FinTech on bank stock prices and concluded that there is a positive correlation between
the growth of FinTech funds or transactions and the banks’ stock returns. Phan, Narayan, and Rahman (2019)
found through empirical analysis that the growth of Indian FinTech companies negatively affects the profitability
of banks, and this effect is more pronounced in state-owned banks. Acar and Citak (2019) believed that FinTech
companies and commercial banks should strengthen their cooperation because of the advantages of FinTech
companies. Building on the existing research, we aim to study the impact of FinTech on commercial banks’ risk
taking.

3. Theoretical analysis in the Chinese context

Commercial banks in China are currently in the midst of a FinTech development wave in various forms, which
could impact banks’ risk taking to varying extents.
First, commercial banks themselves are actively involved and participate in the deployment of FinTech (Acar
and Citak 2019). On the one hand, commercial banks increase their investment in FinTech research and accel-
erate the application of technological means (Serge, Clovis, and Alain 2019). For example, China Merchants
Bank invested 6.502 billion yuan in information technology in 2018, with a year-on-year increase of 35.17%.
On the other hand, commercial banks establish FinTech companies with full or partial control, such as the CIB
FinTech of Industrial Bank8 , One Connect of Ping An Bank9 , and Everbright Technology of China Everbright
Bank.10 These bank-controlled FinTech subsidiaries mainly serve the group and its subsidiaries by providing
 THE EUROPEAN JOURNAL OF FINANCE 5

technology-driven business solutions, while seeking to expand to external markets by exporting their financial
technologies to other financial institutions. However, the overall investment in FinTech is enormous, especially
in the initial stage. In addition, the establishment and layout cycle of financial technology is long, thus lowering
the investment conversion rate in the short term. These factors could increase bank operational costs and erode
bank profits in a short period of time, thereby increasing bank risk.
Second, Internet giants usually actively cooperate with large commercial banks, using their mature cutting-
edge technologies and Internet application scenarios to promote banking business transformation (Bömer and
Maxin 2019; Meinert 2017). For example, Alibaba and Ant Financial developed strategic cooperation with China
Construction Bank; Suning Holding Group and Suning Financial Services Co., Ltd., signed a strategic coopera-
tion agreement with Bank of Communications; Baidu collaborated with Shanghai Pudong Development Bank,
etc. However, it usually requires a long period from the signing of cooperation agreements to the introduction
of new products or services. Moreover, the negotiation process is cumbersome and time consuming due to the
problems of access rights and data confidentiality, which involve cooperation between the two parties. In addi-
tion, how to evaluate the effectiveness of the cooperation and how to share the results of the cooperation also
bother both sides. These factors can likely become sources of uncertainty in bank operations.
Third, some small and medium-sized banks strengthen cooperation with professional financial technology
service providers to achieve mutual benefit. Due to their small size and weak capital strength, these banks have
difficulty cooperating independently with Internet giants, such as Ali, Baidu, and JD; they have difficulties inno-
vating by themselves; and they have no financial ability to invest in technology subsidiaries. Therefore, these
banks choose to use professional FinTech companies’ advanced technologies to achieve precise marketing, intel-
ligent customer acquisition, risk control assistance and so on. However, banks usually require a large amount
of initial investment at the beginning and high maintenance costs in later periods, exacerbating their finan-
cial pressure. For FinTech technology providers, due to their own technical displays, it is difficult to satisfy the
various demands of banks, aggravating the inequality of input and output, in turn increasing banks’ business
risks.
Fourth, commercial banks also face competition from FinTech companies that provide similar services as
banks (Jun and Yeo 2016; Phan, Narayan, and Rahman 2019). For example, Ant’s online payments platform
had more than 700 million active users and completed more than $8 trillion worth of transactions in 201711 ;
moreover, Ant manages the largest money market mutual fund in the world at $219 billion. By adopting more
advanced technologies, FinTech companies such as Ant provide services, including lending, payments, asset
management and financial consulting, which belonged to traditional banks (Brandl and Hornuf 2017; Chishti
and Barberis 2016). Moreover, these companies have advantages in terms of customer acquisition, operating
costs, and information sharing (KPMG 2018; PWC 2017). Therefore, the development of ‘bank-like’ FinTech
companies could seize the business of traditional banks, increase their costs, and, finally, erode their profits,
exacerbating the risk taking of banks through the substitution effect.
Whether banks participate in the construction of FinTech or face competition from bank-like competitors
outside of FinTech, there is no doubt that the development of FinTech services is a substitute for and com-
plement to banks. In the long run, it can improve the stability of the entire banking industry (PWC 2017).
Commercial banks can rely on their own historical consumer data and actively engage in business innova-
tion through research and development into FinTech methods and by strengthening cooperation with FinTech
companies, thereby improving their operational efficiency and bank stability. Moreover, according to the ‘Tech-
nology spillover theory’, the FinTech innovation effect, competition reversal effect, and talent turnover effect
will prompt commercial banks to upgrade technology, innovate business, and optimize services, respectively,
thereby increasing productivity and profits and hence reducing the motivation to take risks.
As the above analysis suggests, how FinTech development affects bank risk taking remains to be empirically
studied, and it is the focus of this study. These conflicting results imply two opposing hypotheses regarding the
effects of developed FinTech on bank risk taking:
Hypothesis I. (H1a): FinTech development strengthens (weakens) the risk-taking behaviors (stability) of
banks.
Alternative Hypothesis I. (H1b): FinTech development weakens (strengthens) the risk-taking behaviors
(stability) of banks.
6 R. WANG ET AL.

4. Data, variables and model

In this study, we build an unbalanced bank-level panel for the period from 2011 to 2018.12 We collect the bank-
level data from BVD’s BankFocus database. To avoid duplication of parent and subsidiary banks, we choose
unconsolidated data if possible and only use consolidated data when the former are not available. To minimize
possible bias due to heterogeneous objectives and operations, we exclude banks with other specializations, such
as central banks, savings banks, investment banks, cooperative banks and bank holding companies, and we only
include commercial banks. We remove banks with missing values for relevant information (e.g. total assets and
ROA), and banks with fewer than three consecutive observations are also deleted. Appendix A provides the
number of banks per year. Moreover, the share of total assets in our sample, on average, accounts for approxi-
mately 80% of all of the banks in China, ensuring the representativeness of the sample. The variable notations,
definitions and data sources are displayed in Appendix B.

4.1. Bank risk taking

We choose the Z-score as our primary indicator of bank risk taking, not only because it is widely adopted in
the literature (Ashraf 2017; Chen et al. 2015; Chen et al., 2017a; Laeven and Levine 2009; Wang and Sui 2019)
but also because the Z-score can reflect the overall risks of a bank, including risks from a bank’s interest-based
business and noninterest business. The time-varying Z can be expressed as follows:

ROAit + EAit
Zit = (1)
σ(ROAit )

where ROAit represents the return on assets of bank i in year t; EAit denotes the ratio of equity to total assets; and
σ (ROA)it is the standard deviation of the return on assets.13 Roy (1952) interpreted the Z-score as the number
of standard deviations of profits that must be less than its mean to bankrupt the bank, and it is viewed as the
inverse of the probability of bank failure. Therefore, a higher Z-score suggests higher overall bank stability or
lower exposure to insolvency risk.14 We later apply other indicators as robustness tests.

4.2. FinTech index

We use the media’s attention paid to FinTech-related information to measure the FinTech development, mainly
using news headline searching and factor analysis.
Since FinTech is a compound word composing of ‘finance’ and ‘technology’, we build the initial vocabulary
(in Chinese) for FinTech by considering modern financial functions and technical foundations, with the for-
mer focusing on the financial roles, while the latter addresses the technology part. There are five functions of
modern finance, including information transmission, risk management, resource allocation, clearing and pay-
ment settlement (Merton 1995), while FinTech’s technological foundation includes cloud computing, big data,
blockchain, artificial intelligence, and biometrics (Gai, Qiu, and Sun 2018; Gomber, Koch, and Siering 2017).
Combining financial functions and technological bases, we build the initial vocabulary for FinTech from five
dimensions.
Second, we use the ‘Baidu Index’ from Baidu, which is China’s largest search engine, to count the number
of news headlines containing each word in Table 1 on a quarter-by-quarter basis during the sample period.15
The sources of statistics include both computers and mobile phones. The number of press releases is closely
related to the attention received from different genders and strata of the society (Askitas and Zimmermann 2009;
Askitasklau, Askitas, and Zimmermann 2015; Holt et al. 2013). In an era when the Internet is the main medium of
information dissemination, more online news related to the keywords in Table 1 and more attention and opinions
received from the public indicate more prosperous development of FinTech. We count the number of news
headlines corresponding to each keyword from Table 1 and the total number of news headlines corresponding
to all of the keywords during the sample period. Then, we use the latter as the denominator and the former as
the numerator to quantify the frequency of news for each word.
Table 1. FinTech word list.
Dimension Keyword
Information transfer (Infor) E-bank Internet bank Online bank Abbreviation for online bank Network banking Internet banking
Risk management (Risk) Internet finance Credit information system Online insurance Network car insurance Online finance Internet insurance
Resource allocation (Resource) Online lending Network investment P2P Internet investment Crowdfunding Smart investment
Clearing and payment (Payment) Cross-bank clearing Online payment Internet payment Mobile payment Network payment Third-party payment
Technical base (Tech) Big data Cloud computing Artificial intelligence Blockchain Biometrics Strategic decision support
This table presents the word list used to construct the FinTech index.

THE EUROPEAN JOURNAL OF FINANCE

7
8 R. WANG ET AL.

Table 2. Factor analysis.

Index FinTech_Infor FinTech_Risk FinTech_Resource FinTech_Payment FinTech_Tech
KMO .68 .58 .55 .62 .71
LR-c2 303.63*** 144.61*** 78.20*** 144.78*** 100.41***
(p-value) (.00) (.00) (.00) (.00) (.00)
Common factor 1 2 1 2 1 2 3 1 2 1 2
Variance contribution 77.70% 17.15% 62.49% 17.46% 42.03% 25.93% 17.95% 63.45% 20.49% 52.42% 27.29%
rate
Cumulative variance 94.85% 79.95% 85.91% 83.94% 79.71%
contribution rate
This table presents the factor analysis statistics.

Subsequently, factor analysis is applied to obtain the common factor for each dimension. The reason that we
apply factor analysis is that, for each dimension, we have 6 words, so we must use this method to extract common
factors to synthesize a FinTech index for each dimension. Table 2 reveals that the KMO values corresponding
to the factor analysis based on each dimension are mostly greater than 0.60, and the P-values of the LR test are
all 0.00, indicating that the data are suitable for factor analysis, and the model construction is also significant.
Based on the above statistical analysis, we next extract the common factors with eigenvalues greater than 1 in
the factor analysis. The common factor for each dimension of FinTech and its variance contribution are also
demonstrated in Table 2. It can be observed that the cumulative contribution of the extracted common factors
is greater than 79.50%, indicating that the common factor can reflect most of the original information.
Next, we calculate the factor score for each dimension. The factor structure is rotated according to the prin-
ciple of variance maximization, and the factor scores of each sample after the factor analysis are estimated.
Finally, we synthesize the general FinTech index. The factor score criterion is set within the [0,1] interval using
the method of range conversion, and we synthesize the FinTech index by combining the normalized factor score
for each subindex and the common factor variance contribution rate. The synthesized FinTech index is used to
study the nexus between financial technology and banks’ risk taking.16

4.3. Control variables

Six bank-level variables are controlled for since a wide array of the literature has confirmed their decisive roles
in banks’ risks. To remove outliers from the sample, we excluded values less than 1% and greater than 99% of
the sample distributions.
Size, which is calculated as a natural logarithm of total assets, is expected to impact bank risk taking but
with ambiguous effects(Afonso, Santos, and Traina 2014; Cubillas and González 2014). Liquidity, defined as the
ratio of liquid assets over total assets for individual banks, represents the banks’ ability to liquidate (Acharya
and Naqvi 2012; Hartlage 2012; Hong, Huang, and Wu 2014). The third factor is Leverage calculated as a bank’s
equity as a share of its total assets (Berger and Bouwman 2017; Diamond and Rajan 2012; Vazquez and Federico
2015). Next, we include bank Efficiency measured as the ratio of noninterest operating costs to total income
(Berger and Deyoung 1997; Fiordelisi, Marques, and Molyneux 2011; Sturm and Williams 2004). Then, we con-
trol Income diversification constructed as the share of noninterest income in total income (Demirgüç-Kunt and
Huizinga 2010; Fishburn and Porter 1976). Finally, Shadow banking business is considered. A growing literature
has indicated that China’s rising shadow banking is inextricably linked to banks’ balance-sheet risks (Li, Hsu,
and Qin 2014).
We also control for a group of macro variables. The macro-level variables are obtained from the IMF’s
International Financial Statistics and the World Bank’s World Governance Indicators. GDP and Inflation are
considered to capture the impacts of business cycles on bank risks(Jiménez, Salas, and Saurina 2006; Marcucci
and Quagliariello 2009; Pederzoli and Torricelli 2005; Soedarmono, Machrouh, and Tarazi 2011). Monetary pol-
icy, which is measured as the first-order difference in one-year lending interest rates, is included in our model
(Adrian and Shin 2010; Borio and Zhu 2012; Diamond and Rajan 2012). Another important factor that cannot
be ignored in the explanation of bank risk/stability is the market structure (Beck, Jognhe, and Schepens 2013;
 THE EUROPEAN JOURNAL OF FINANCE 9

Boyd and De Nicoló 2005). We use the Herfindahl-Hirschman Index (HHI), which is calculated as the sum
of the squares of individual bank’s market shares, to measure the banks’ market structure, denoted as Market
structure. Following the literature on ‘law and finance’, we include in the regression the quality of the institution,
using the indicator of the rule of law as the proxy (Kaufmann 2010).

4.4. Descriptive statistics

Table 3 reports the descriptive statistics for the main regression variables. The Z-scores of the sample banks are
distributed with a mean value of 4.292 and a standard deviation of 0.871. The values range between a minimum
of 2.518 and a maximum of 7.024. With respect to FinTech, the mean value is 8.774, and the standard deviation is
1.875. The observations fall within the range between 4.488 and 10.832, suggesting considerable heterogeneity
in FinTech development in the years of the sample.
Figure 1 demonstrates the development of China’s FinTech growth in recent years. From 2011 to the beginning
of 2016, the FinTech index continued to rise, indicating that the public’s awareness and attention paid to FinTech
were gradually increasing. In the second half of 2016 and 2017, the FinTech index declined. Such a reduction
could result from the emergence of a number of ‘pseudo-FinTech’ companies in the market that defraud financ-
ing, causing the capital and social attention to gradually settle down. Beginning in the second half of 2017, with
the gradual clearing of the market, the development of FinTech picked up again until 2018. Currently, some
head enterprises in the field of FinTech have entered the short-term growth stage, gradually forming a relatively
mature financial industry. In the future, the development of FinTech enterprises will continue to improve.
The pairwise correlations between the key variables are reported in Appendix C. The correlation between the
Z-score and FinTech is negative and statistically significant. This fact suggests lower stability of banks with higher
development of FinTech. The bank characteristic variables and macro variables are found not to be strongly cor-
related with each other, implying that a joint inclusion of these variables will not cause serious multicollinearity
problems.

4.5. Model
We apply the following model to investigate the effect of FinTech on bank risk taking:

BankRiski,t = γ0 + γ1 · Fintecht + γ2 · BankChari,t−1 + γ3 · Macrot + fi + i,t

Table 3. Summary statistics of main variables.

Variables Obs. Mean Std. Dev Min. Med. Max.
Z-score 1698 4.292 .871 2.518 4.221 7.024
FinTech 1698 8.774 1.874 4.488 8.866 10.832
Size 1698 15.326 1.533 12.338 15.129 20.856
Liquidity 1698 23.492 .789 5.043 21.754 74.720
Leverage 1698 14.513 5.199 9.800 13.310 72.920
Efficiency 1698 36.931 9.937 18.79 34.76 85.024
Income 1698 21.843 18.631 2.808 16.522 85.824
Shadow 1698 8.181 8.339 .000 5.389 39.060
GDP 1698 4.583 .056 4.476 4.601 4.658
Inflation 1698 2.321 2.176 .074 2.227 8.151
Monetary policy 1698 −.175 .505 −.895 −.054 1.095
Market structure 1698 7.577 .883 6.580 7.614 9.418
Rule of law 1698 .378 .116 .220 .410 .540
This table reports summary statistics of the main variables. Z-score is the main proxy of bank risk-taking.
FinTech is the proxy of FinTech development. Size is the natural logarithm of real total assets. Liquidity
is the ratio of bank liquid assets to total assets (%). Leverage is the ratio of equity to total assets (%).
Efficiency is the share of overhead cost in the banks’ operating income (%). Income is the ratio of non-
interest income to total income (%). Shadow is the share of the interbank business in total assets (%).
GDP is the natural logarithm of the real GDP. Inflation is the growth rate of CPI. Monetary policy is the
first order difference of the 3-month deposit interest rate. Market structure is the HHI index. Rule of law
describes the law environment.
10 R. WANG ET AL.

Figure 1. FinTech indicator from 2011 to 2018.

In this expression, the subscripts i, and t denote bank i in year t. BankRiski,t is the risk-taking measure of bank
i in year t. FinTecht reflects the proxy of financial-technology development over time. BankChari,t and Macrot
represent the bank characteristics (Size, Liquidity, Leverage, Efficiency, Income, and Shadow) and macroeconomic
conditions (GDP, Monetary policy, Market structure, and Rule of law), respectively. The variable fi is the time-
invariant bank-specific effect, and  it is the idiosyncratic error. We apply a one-year lag period for each bank
characteristic variable for the purpose of endogeneity mitigation.
We estimate our baseline model using the bank-specific fixed-effects method for two reasons. On the one
hand, since we use bank-level panel data, the unobservable bank-level individual effects that can vary from
bank to bank over time are allowable with the fixed-effects model. On the other hand, such a model also allows
the bank-level time-invariant effects to be correlated with the explanatory variables, supported by the results of
Hausman’s test.17 We use heteroskedasticity and within-panel serial correlation robust standard errors, which
cluster at the bank level. Alternative methods are also applied as robustness checks.

5. Empirical results
5.1. Benchmark regressions
This section presents the empirical results regarding how FinTech influenced bank risk taking in China from
2011 to 2018. Table 4 demonstrates the basic empirical results. We report the Z-score results in column (1) and
then replace the Z-score using its three components in columns (2)-(4), respectively, as follows: the return on
assets (ROA), which represents the bank’s profitability; the equity-asset ratio (EA), which represents the bank’s
leverage risk; and the standard deviation of the return on assets (σ (ROA)), which represents the bank’s portfolio
risk.
It is shown in column (1) that the coefficient on FinTech is statistically negative at the 5% level, implying
that the bank Z-score declines as financial technology develops. Three possible explanations can be provided
for this finding. First, technological investment, especially the establishment of a FinTech company by a com-
mercial bank, usually involves a large amount of capital. However, the long conversion cycle of technological
achievements can exert great financial pressure on banks, thus increasing their risk level in the short term. Sec-
ond, regardless of cooperation with Internet giants or specific technological service providers, high cooperation
costs, such as transaction costs, communication costs and coordination costs, can also increase bank operational
 THE EUROPEAN JOURNAL OF FINANCE 11

Table 4. The effect of FinTech on bank risk taking

Z-score ROA EA σ (ROA)
Dependent variable: (1) (2) (3) (4)
FinTech −.199** .003 −.358*** .028*
(.109) (.008) (.045) (.014)
Size −.373* −.173*** −1.435*** .010
(.206) (.050) (.378) (.029)
Liquidity −.145*** −.151*** .037 .035***
(.055) (.022) (.072) (.009)
Leverage .022** −.003 .432*** −.000
(.009) (.003) (.037) (.002)
Efficiency −.011* −.022*** −.014* .001*
(.006) (.001) (.007) (.000)
Income .002 −.000 .001 −.000
(.002) (.000) (.002) (.000)
Shadow −.013** −.005*** −.038*** .001**
(.005) (.001) (.006) (.000)
GDP 1.301 1.580*** 2.606*** .019
(2.467) (.514) (.209) (.316)
Inflation −.149** −.043*** −.112*** .015
(.078) (.004) (.020) (.011)
Monetary policy .882*** .115*** −.009 .104***
(.216) (.025) (.098) (.031)
Market structure −.947** .145*** 1.691*** .134**
(.443) (.040) (.172) (.059)
Rule of law 4.365*** .269*** .301 −.553***
(1.216) (.092) (.436) (.165)
Observations 1698 1698 1698 1698
R2 .133 .561 .455 .107
This table reports the empirical results of the impact of FinTech development on
bank risk- taking. Z-score is the main proxy for bank risk taking. FinTech is the
proxy for FinTech development. Size is the natural logarithm of real total assets.
Liquidity is the ratio of bank liquid assets to total assets (%). Leverage is the ratio
of equity to total assets (%). Efficiency is the share of overhead cost in the banks’
operating income (%). Income is the ratio of noninterest income to total income
(%). Shadow is the share of the interbank business in total assets (%). GDP is the
natural logarithm of the real GDP. Inflation is the growth rate of CPI. Monetary
policy is the first-order difference in the 3-month deposit interest rate. Market
structure is the HHI index. Rule of law describes the legal environment. We apply
a fixed-effects estimator with heteroskedasticity and within-panel serial cor-
relation robust standard errors. Standard errors are displayed in parentheses.
*** indicates the 1% significance level; ** indicates the 5% significance level; *
indicates the 10% significance level.

costs and reduce their profits, thereby increasing their risk taking. Third, as FinTech has developed, increasing
numbers of companies providing specialized financial services through advanced technology have emerged.
These companies are operating at lower prices and with greater efficiency. They can attract consumers from
traditional financial institutions, thus eroding banks’ profits and stimulating banks to accept higher risks.
Quantitatively, the impact of FinTech is also notable. The stability of banks tends to decrease by 0.20% for
each percentage by which FinTech increases. In other words, were FinTech to rise by one standard deviation
(0.009, or stated differently, 0.9%), the average stability of banks would decrease by nearly 22.1% in response,
holding other control variables unchanged at their mean values. Moreover, we consistently find that FinTech is
negatively associated with EA (column (3)) but positively associated with σ (ROA) (column (4)), indicating that
FinTech development impedes financial stability by encouraging more leverage risks, translating into lower and
more volatile returns. However, we find no significant impact of FinTech on ROA (column (2)) or, for example,
no evidence for the effect of FinTech on banks’ profitability.
Generally, the significance of the lagged bank-specific variables also confirms the previous findings, sug-
gesting that bank-level variables affect bank risk taking separately from macroeconomic trends. First, the
significantly negative sign of Size suggests that large banks seem to produce more nonperforming loans than
12 R. WANG ET AL.

those of small banks due to the ‘too big to fail’ hypothesis (Afonso, Santos, and Traina 2014). Second, the coef-
ficient of Liquidity is statistically negative, consistent with the global bank regulation framework of Basel III,
which emphasizes the importance of liquidity to withstand unexpected outside shocks (Hong, Huang, and Wu
2014). We also find evidence showing that lower leverage or higher capital adequacy can increase bank stability
due to the significantly positive of the Leverage coefficient, in line with studies emphasizing the role of capital in
the capacity of banks to withstand financial crises (Berger and Bouwman 2017). Fourth, a higher cost–income
ratio is associated with a lower Z-score, supporting the ‘management hypothesis’ that lower cost efficiency from
higher credit monitoring costs could translate into higher portfolio risks (Fishburn and Porter 1976). Moreover,
the evidence of shadow banking is also significantly negative, implying that more interbank business results in
more problem loans.
Regarding the macroeconomic variables, we find that a higher inflation rate is related to a lower Z-score,
which is contrary to the ‘cyclical nature of bank stability’ but in line with the theory that it is the risks built
up during expansions that lead to high default rates during recessions (Jiménez, Salas, and Saurina 2006). The
coefficient of Monetary policy is statistically positive, consistent with the theory of the ‘bank risk-taking channel
of monetary policy’, i.e. that an expansionary monetary policy encourages bank risk-taking through the channels
of ‘search for yield’, ‘adverse selection’ and ‘leverage adjustment’ (Borio and Zhu 2012). We also find that a higher
market concentration implies lower bank stability, supporting the ‘competition-stability’ view, which states that
a monopoly might allow banks to charge higher rates, thus exaggerating adverse selection (Boyd and De Nicoló
2005). Finally, a better legal environment is found to benefit bank stability since a sound legal system guarantees
the implementation and enforcement of policies (La Porta et al. 1998).

5.2. Robustness checks

A series of robustness tests are applied to check whether the baseline results are consistent after adopting
alternative measures of FinTech development, different risk indicators and different econometric methodologies.
First, we re-estimate our model using alternative indicators of FinTech development. Following Phan,
Narayan, and Rahman (2019), we first use the number of FinTech companies (in the form of the natural log-
arithm) registered in a year to measure the development of FinTech, denoted as FinTech corporate. However,
we consider a much broader composition of FinTech companies than Phan, Narayan, and Rahman (2019),
who treated them only as bank-like competitors. FinTech companies are divided into three types in China:
the first category is FinTech subsidiaries held by banks, mainly providing technical support for the group and
its subsidiaries; the second category is professional FinTech companies cooperating with commercial banks by
providing technical services; and the third category is ‘bank-like’ FinTech companies that have a competitive
relationship with banks. These three types of companies are all pioneers and promoters of China’s FinTech inno-
vation and development. Therefore, an increase in the number of these firms can reflect the FinTech development
in China to some extent. It is shown in column (1) of Table 5 in Panel A that the coefficient on FinTech corporate
is significantly negative, indicating that bank stability could be weakened by the growth of FinTech firms, in line
with our baseline findings.
Then, we apply the price of Bitcoin in dollars (in the form of the natural logarithm) to measure the devel-
opment of FinTech, denoted as Bitcoin price.18 Bitcoin, by definition, is a decentralized cryptocurrency, and
transactions with bitcoin involved do not require the appearance of a central authority, such as commercial banks
(Wang, Lin, and Luo 2019). That is, the application of bitcoin and its underlying technology blockchain will
mitigate the need for commercial banks, thus eroding their profits and forcing them to take risks.19 Moreover,
the price of bitcoin captures the enthusiasm for virtual money investment worldwide, reflecting the prosper-
ous development of the most important technique of FinTech. Therefore, we expect that a higher Bitcoin price
leads to lower bank stability. As is shown in column (2) of Table 5 in Panel A, the coefficient of Bitcoin price is
significantly negative with Z-score, in line with our baseline results.
Second, we replace our original bank risk-taking measure with alternative indicators that other studies have
frequently adopted to measure banks’ risk, including: the ratio of the loan loss reserve to gross loans (LLR), which
measures the bank’s credit risk; σ (net profit), which represents the bank’s profitability risk; and the Sharpe ratio,
which indicates the bank’s business risk (Laeven and Levine 2009; Chen et al. 2015; Chen et al., 2017a; Wang and
 THE EUROPEAN JOURNAL OF FINANCE 13

Table 5. The robustness checks: alternative measures.

Independent variable FinTech corporation Bitcoin price
Panel A (1) (2)
Z-score −.224* −.047*
(.123) (.025)
Bank controls Yes Yes
Macro controls Yes Yes
Observations 1698 1698
R2 .133 .086
Dependent variable LLR σ (net profit) Sharpe ratio
Panel B (3) (4) (5)
FinTech .723*** .263*** −4.321*
(.229) (.076) (2.606)
Bank controls Yes Yes Yes
Macro controls Yes Yes Yes
Observations 1439 1395 1439
R2 .080 .070 .127
This table reports the robustness tests in which alternative measures are applied.
Panel A reports the results when alternative measures of FinTech indices are
used. Columns (1)- (2) report the results when the independent variables,
respectively, are the number of FinTech corporations in natural log form and the
price of Bitcoin in natural log form. Panel B report the results when alternative
measures of bank risk taking are applied. Columns (3)-(5) report the results when
the dependent variables, respectively, are loan loss reserve to gross loans (LLR),
banks’ profitability risk (σ (net profit)), and banks’ business risk (Sharpe ratio).
For brevity, only the coefficients on FinTech indicators are included, while all of
the other control variables, as shown in Table 4, are considered. Standard errors
are displayed in parentheses. *** indicates the 1% significance level; ** indicates
the 5% significance level; * indicates the 10% significance level.

Sui 2019). Specifically, LLR is designated as the ratio of the loan loss reserve by the bank to net total loans, with
a higher value signaling a higher credit risk. σ (net profit) is calculated as the standard deviation of net profit,
and a higher value of σ (net profit) reveals greater profitability volatility. Sharpe is defined as the return on equity
divided by the standard deviation of the return on equity using a 3-year rolling time window; the higher that the
ratio is, the higher that the return obtained by the bank is per risk, indicating a lower business risk. It is reported
in Table 5, Panel B, that improved FinTech development is associated with more credit risk (column (7)), greater
profitability volatility (column (8)), and higher business risk (column (9)).
Third, we apply a different econometric methodology to test the nexus between FinTech development and
banks’ risk. It might be argued that the prevailing risk proneness in the economy, as reflected in a typical bank’s
risk-taking behavior, promotes the development of FinTech; hence, this reverse causality would lead to biased
results. We address this endogeneity issue by employing the 2SLS instrumental variable test. One instrumental
variable for the FinTech indicator is selected, namely Communication technology. We first search for the two
keywords ‘5G’ and ‘4G’ in the Baidu index, and then we obtain the sum of the average number of occurrences
of the two words in news headlines during the sample period, representing the social attention paid to and the
popularity of them. We then calculate the natural logarithmic form and denote the new variable as the IV for
FinTech.
Thanks to the improvement of the speed and stability of mobile networks, the application scenarios of finan-
cial technology relying on cloud computing, big data, artificial intelligence, blockchain and other technologies
have begun to appear. High-speed mobile communication technology has increased exponentially in terms
of data production, transmission, and computation, providing core infrastructure and a more stable network
environment for financial technologies. Therefore, we anticipate the development of the communication tech-
nologies that are represented by 4G and 5G will be positively related to the development of FinTech. Nevertheless,
it is less likely that the underlying technology itself would affect the risk of banks directly, suggesting that it is a
proper instrumental variable for FinTech. The results of 2SLS instrumental variable tests are presented in Table 6.
14 R. WANG ET AL.

Table 6. The robustness checks: endogeneity concerns.

Dependent variable Z-score
Second-stage
FinTech −.085*
(.046)
Bank controls Yes
Macro controls Yes
Observations 1698
R2 .123
First stage
Communication technology 1.717***
(.047)
Hausman test (p-value) .042
Stock and Yogo (F-statistic) 32.048
This table reports the 2SLS instrumental variable test. The instru-
mental variable for FinTech is Communication technology, which
is calculated from the natural log form of the number of news
headlines that include ‘4G’ and ‘5G’ during sample period. In
the upper panel ‘Second-stage’, we exhibit the estimates of the
impact of FinTech on bank risk taking in the second-stage regres-
sion. In the lower panel ‘First-stage’, we report the impact of the
instrumental variable on FinTech. We also report the p-value of
Hausman’s specification error test, the F-statistic of the Stock and
Yogo test and the p-value of Sargan’s test. For brevity, only the
coefficients on the FinTech indicator and instrumental variables
are included, while all of the other control variables, as shown in
Table 4, are considered. Standard errors are displayed in paren-
theses. *** indicates the 1% significance level; ** indicates the
5% significance level; * indicates the 10% significance level.

We find that the IV of Communication technology is statistically positive in the first-stage regression, in line
with our expectation, while we also find that the F-statistic is larger than the critical value constructed by Stock
and Yogo (2005), providing support for our choice of the IV in the first-stage regression. Moreover, the null
hypothesis cannot be rejected due to the insignificance of the Hansen statistics, proving that our IV does not run
into overidentifying restrictions. For the second-stage regression, the IV results are rather robust. Specifically, the
coefficients remain negative and significant, and the results confirm our basic finding that higher development
in FinTech induces more risk taking by banks.

6. Extended regressions
6.1. Bank characteristics
Having found that developed FinTech increases bank risk taking, we next examine the relevant factors con-
tributing to the heterogeneity of the FinTech-bank risk taking nexus. In this section, we test whether the effect
of FinTech development on bank risk taking varies across banks’ features.
First, we divide the sample of banks based on size. Large banks are defined as banks with assets that exceed
the median value of the banking sector’s distribution of total assets. Small banks are those less than the dis-
tribution median. The impact of FinTech on bank risk taking can differ between large and small banks. For
one thing, large banks often participate in the FinTech wave by establishing FinTech subsidiaries themselves
or cooperating with Internet giants. The establishment of a FinTech company involves high initial costs, while
the technological conversion rate is slow, and the cooperation costs are high. For another, large banks usu-
ally have a complete business operational system. The financial services that they provide, including product
design, production, management, sales, and risk control, are generated and implemented within the organiza-
tion. Conversely, bank-like FinTech competitors offer more specialized and segmented services, coupled with
more advanced technology, so they can secure their customers more accurately. Therefore, by being involved
in the FinTech wave, large banks are more sensitive due to their high investment costs, complex organizational
 THE EUROPEAN JOURNAL OF FINANCE 15

Table 7. The effect of FinTech on risk taking under different bank characteristics.

Large Small High Low High noninterest Low noninterest High shadow Low shadow
Dependent variable: Size size efficiency efficiency income income banking banking
Z-score (1) (2) (3) (4) (5) (6) (7) (8)
FinTech −.291** −.147 −.090 −.230** .012 −.270* −.289** −.124
(.125) (.568) (187) (.104) (.210) (.145) (.133) (.207)
Bank controls Yes Yes Yes Yes Yes Yes Yes Yes
Macro controls Yes Yes Yes Yes Yes Yes Yes Yes
Observations 921 777 746 952 863 835 831 867
R2 .195 .175 .165 .141 .161 .138 .144 .144
This table reports the results of the heterogeneity analysis of the FinTech-bank risk-taking nexus by considering bank features. Bank size is consid-
ered in columns (1) and (2). Large banks are defined as banks with assets that exceed the median value of the banking sector’s distribution of
total assets. Small banks are those less than the distribution median. Bank efficiency is considered in columns (3) and (4). Highly efficient banks
are defined as banks with efficiency values less than the median value of the banking sector’s distribution of cost/income ratio. Low efficient
banks are greater than the distribution median. The banks’ noninterest income share is considered in columns (5) and (6). High noninterest
income banks are defined as banks with noninterest income shares that exceed the median value of the banking sector’s distribution of non-
interest income. Low noninterest income banks are those less than the distribution median. Shadow banking is considered in columns (7) and
(8). High shadow banking banks are defined as banks with interbank business shares that exceed the median value of the banking sector’s total
distribution. Low shadow banking banks are those less than the distribution median. In all of the regressions, we use a full set of independent
variables. For brevity, only the coefficients on Fintech are included, while all of the other control variables, as shown in Table 4, are considered.
Standard errors are displayed in parentheses. *** indicates the 1% significance level; ** indicates the 5% significance level; * indicates the 10%
significance level.

structures and large-scale business processes. Columns (1) and (2) of Table 7 present the results, showing that
the coefficient on FinTech is statistically significant for large banks. This finding indicates that large banks are
more vulnerable to FinTech development than small ones.
Second, we examine whether the impact of FinTech on bank risks is heterogeneous across banks with differ-
ent efficiency levels. On the one hand, if banks participate in FinTech through direct investment or shareholding
or through cooperation with other technology companies, the inefficient banks might further suffer from higher
costs incurred in these ways, in turn aggravating bank risk taking. On the other hand, bank-like FinTech compa-
nies apply leading technologies to deliver services in a more efficient and cost-saving manner. While less efficient
banks often incur higher marketing costs, such as those aimed at absorbing and maintaining customers, the cus-
tomer conversion ratio is much lower, leading to a disproportionate increase in revenues and costs. Therefore,
the development of FinTech has a greater impact on inefficient banks. Using approaches from past studies, we
compute bank efficiency as the ratio of cost to income, for which a higher value can be interpreted as lower
efficiency. We then divide our sample into two groups (greater than and less than the median points of the effi-
ciency distribution) and regenerate the estimates. The results are presented in columns (3) and (4) of Table 7.
The coefficients associated with FinTech growth are significantly negative for banks with low efficiency. Specif-
ically, when facing FinTech development, low efficient banks might incur higher risks, while such an adverse
impact can be ignored for highly efficient banks.
Third, we test whether bank income diversification matters for the FinTech-bank risk nexus. In the same vein,
we separate the observations according to the share of noninterest income and group as ‘high (low) noninterest
income banks’ those with values greater than (less than) the median of the distribution. The results are displayed
in columns (5) and (6) of Table 7. We find no evidence that banks with income mainly coming from sources other
than loans are affected by the increase in FinTech, while the coefficient of FinTech is significantly negative for
banks with incomes mainly depending on the traditional loan business. On the one hand, when banks partic-
ipate in FinTech development through direct investment or cooperation, banks with diversified incomes can
effectively resolve the high costs incurred by these forms, thus weakening the banks’ high risk taking. On the
other hand, when banks face competition from external FinTech companies, which usually focus on specific
or certain technological advantages, more diversified bank business can go beyond the scope of these FinTech
companies. Therefore, relying on the resources of customers to perform other noninterest services that FinTech
companies cannot provide is one of the breakthroughs of commercial banks.
Finally, we examine whether the heterogeneity of the nexus between FinTech and bank risk taking is related
to the size of shadow banking. After the 2008 financial crisis, China’s banking industry became increasingly
16 R. WANG ET AL.

strict. To avoid restrictions, such as deposit-loan ratios and capital adequacy ratio requirements, many banks
have launched shadow banking services, including interbank lending and interbank deposits. These businesses
support the rapid expansion of bank assets and have become a new profit growth point for the banking industry;
however, shadow banking incurs more risks due to limited regulations. Whether the development of FinTech will
weaken or exacerbate bank risks resulting from shadow banking remains a research question that requires more
attention. We divided our sample according to the share of interbank assets over total assets and labeled them
high (low) shadow-banking banks’ if their values were greater than (less than) the median of the distribution. The
results are displayed in columns (7) and (8) of Table 7. We find that the development of FinTech will intensify
the risks of banks with more shadow banking. One possible explanation is that, in the face of the impacts of
financial technology, leading to the loss of deposit and loan customers, banks with a large proportion of shadow
banking business are more motivated to increase the proportion of their shadow banking business to obtain
higher returns, in turn leading to higher risks.

6.2. Nonlinear relations

Facing higher technology investment and higher cooperation costs from FinTech construction and the loss of
customers from FinTech competitors, traditional commercial banks must increase their risk taking to maintain
revenue. However, commercial banks could also benefit from the continuous development of technologies. To
test the above analysis, we include a squared term for the FinTech index to test the nonlinear relationship between
the FinTech index and bank risk-taking.
It is shown in column (1) of Table 8 that such a nonlinear relationship is essentially nonlinear. In particular,
when a squared term, FinTech2 , is introduced into the quadratic regression, the coefficient of FinTech remains
negative and significant ( = −1.780, standard error = 0.544), whereas FinTech2 takes on a positive and signifi-
cant coefficient ( = 0.130, standard error = 0.036). To interpret the economic significance of a nonlinear relation
between the FinTech index and bank risk taking, assume that bank A is initially affected by financial-technology
development, and the impact increases from zero to one; i.e. FinTech increases from zero to 1. Based on the
results in column (1) of Table 8, the bank stability will decrease by −1.78*1 + 0.13*12 = −1.65. However, if Fin-
Tech further increases (to 13.7), the bank stability will decrease to zero; if FinTech keeps growing, then bank
stability will increase. This finding reveals that, as FinTech continues to develop, bank risk taking (stability) will
initially increase (decrease) but later decrease, showing that FinTech will gradually encourage commercial banks
to actively adopt technological means to improve their stability.
We further investigate whether the above nonlinear nexus is related to the bank ownership structure. The
interactive term of FinTech2 and an ownership dummy variable are included. We label the 5 state ownership

Table 8. The nonlinear relation between FinTech and bank risk taking.
Dependent variable: All banks Dummy (State) Dummy (Joint) Dummy (CCB) Dummy (Foreign) Dummy (Others)
Z-sore (1) (2) (3) (4) (5) (6)
FinTech −1.780*** −1.785*** −1.760*** −1.737*** −1.901*** −1.689***
(.544) (.545) (.543) (.546) (.543) (.544)
FinTech2 .130*** .130*** .129*** .128*** .137*** .123***
(.036) (.036) (.036) (.036) (.036) (.036)
FinTech2 _Dummy (ownership) .003 −.003 .003** .008*** .002*
(.004) (.003) (.001) (.002) (.001)
Bank controls Yes Yes Yes Yes Yes Yes
Macro controls Yes Yes Yes Yes Yes Yes
Observations 1698 1698 1698 1698 1698 1698
R2 .133 .133 .134 .137 .139 .136
This table reports the results of the nonlinear relation between FinTech and bank risk taking. FinTech2 is the square of FinTech, Dummy (ownership)
is a dummy variable for ownership equaling State, Joint, City, Foreign and Others. State denotes the five state-owned banks. Joint represents
12 jointly owned banks. City means city commercial banks. Foreign indicates the foreign-owned banks, while Others stands for rural commercial
banks. In all of the regressions, we use a full set of independent variables. For brevity, only the coefficients on FinTech, FinTech2 and the interac-
tions are included, while all of the other control variables, as shown in Table 4, are considered. Standard errors are displayed in parentheses. ***
indicates the 1% significance level; ** indicates the 5% significance level; * indicates the 10% significance level.
 THE EUROPEAN JOURNAL OF FINANCE 17

banks as State, the 12 joint-stock banks as Joint, the city commercial banks as CCB, the foreign banks as Foreign,
and the rural commercial banks as Others. The results are demonstrated in columns (2)-(6) of Table 8. We find
that the interactive terms are significantly positive for city banks, foreign banks and rural commercial banks,
whereas they are insignificant for state banks and joint-stock banks. This finding shows that state-owned banks
and joint-stock commercial banks are less sensitive to the spillover effects brought by financial technology, and
the increase in bank stability is smaller than that experienced by city commercial banks, foreign banks and rural
commercial banks. One possible explanation is that city commercial banks, foreign banks and rural commercial
banks are more affected by FinTech companies, and their willingness to strengthen cooperation with them is
more salient. Moreover, due to their small scale, their ability to absorb, use and transform is relatively stronger,
while state-owned banks and joint-stock banks are more affected by the negative impact of FinTech development,
and their risk adjustment is much slower.

7. Conclusions
This paper has attempted to examine the crucial question of whether FinTech development has an impact on the
risk taking of traditional banks in China, a country that experienced phenomenal growth in FinTech from 2011
to 2018. With a dataset comprising a panel of approximately 320 banks, we find robust evidence that the devel-
opment of FinTech intensifies banks’ risk taking. Moreover, the heterogeneity analysis demonstrates that the
above nexus is heterogeneous among banks with different characteristics, such as size, efficiency, scale of shadow
banking and income share. Further examination shows an inverted U-shaped relationship between FinTech and
bank risk taking for the full sample in general and for city commercial, foreign and rural commercial banks in
particular; i.e. bank risk taking increases initially and then begins to decrease as FinTech further develops.
Some important implications can be drawn from our empirical results. First, we find that banks with low
operational efficiency are more affected by FinTech. Therefore, commercial banks should simplify their business
processes and optimize their organizational structures to improve their ability to respond to environmental
changes more rapidly. Second, to mitigate the negative impact of FinTech, we emphasize the diversification of
banks’ income sources. Third, our results show that banks with more shadow banking business are more sensitive
to the negative impact of FinTech, indicating that banks have incentives to transfer risks through unregulated
shadow banking. Therefore, it is necessary for the regulatory authorities to strengthen the supervision of shadow
banking as FinTech develops. Fourth, although FinTech development has a nonlinear impact on bank risk taking,
active cooperation between banks and FinTech companies is essential.
Although our findings are robust, their weaknesses should be explicitly acknowledged, and a future research
agenda should be identified. First, while our sample is limited to Chinese banks, future studies could extend to a
cross-country context, enabling more explicit generalization of the results. Second, although the FinTech index
that we constructed can roughly reflect the trend in FinTech development in China, the accuracy of the measure
is largely correlated with the choice of keywords; therefore, its stability must be improved. Third, the FinTech-
bank risk nexus can be further explored by comparing different forms of FinTech participation, such as Fintech
technology investment, FinTech company investment, cooperation with Internet giants and cooperation with
specific FinTech service providers; thus, the method of text mining based on bank annual reports can be used
to construct the measure.

Notes
1. https://www.bbc.co.uk/news/technology-25233224
2. https://www.ft.com/content/bad16a88-d6fd-11e6-944b-e7eb37a6aa8e
3. https://decrypt.co/33866/dcep-an-inside-look-at-chinas-digital-currency
4. http://www.chinadaily.com.cn/cndy/2018-06/09/content_36356946.htm
5. https://www.chinainternetwatch.com/27323/top-10-FinTechs-ant-financial
6. https://assets.ey.com/content/dam/ey-sites/ey-com/en_gl/topics/banking-and-capital-markets/ey-global-FinTech-adoption-
index.pdf
7. http://www.xinhuanet.com/english/2019-10/25/c_138503254.htm
8. http://www.cibFinTech.com
9. https://www.ocft.com/?s = en/
18 R. WANG ET AL.

10. https://www.ebchinatech.com
11. https://seekingalpha.com/article/4205317-ant-financial-financial-disrupter
12. Our study begins in 2011, mainly because a large scale of FinTech has emerged since then in China
13. A three-consecutive-year rolling window is applied to determine the σ (ROA)it.
14. Due to the highly skewed character of a Z-score, we use the natural logarithm (1+ Z-score) to smooth higher values (Beck,
Jognhe, and Schepens 2013). Using (1+ Z-score) instead of simply Z-score avoids the truncation of the Z-score at zero. We
denote ln(1+ Z-score) as the Z-score in the latter part of the paper for brevity.
15. When we count news headlines at the technical level, prefixes such as "financial” or “banking"are added before each technology,
for example, "financial, big data", banking,
" big data", "financial, cloud computing", banking,
" cloud computing", etc. Therefore, the
word frequency calculated in the dimension of "technical foundation"reflects various technologies applied in the financial field,
rather than over a wider scope.
16. In the regression, we aggregate the quarterly indices of each FinTech sub-index to obtain the annual index.
17. For example, when the Z-score is used as the dependent variable, Hausman’s test χ 2 statistic is 44.80, and the p-value is 0.0024
when all of the control variables are included. The χ 2 measure is significantly different from 0 at 1%.
18. https://cn.investing.com/crypto/everex/evx-btc-historical-data?cid = 1057496
19. We thank the anonymous referee for this suggestion.

Disclosure statement
No potential conflict of interest was reported by the author(s).

Funding
The author(s) disclosed receipt of the following financial support for the research, authorship, and/or publication of this article: This
research is financially supported by the National Science Foundation of China (Funding No: 71971174), Key Scientific Research
Fund of Xihua University (Funding No: ZW17136), Social Science Planning Project of Sichuan Province (Funding No: SC19B121)
and Key Project of Sichuan Society for Finance and Banking (Funding No: SCJR2020072).

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 THE EUROPEAN JOURNAL OF FINANCE 21

Appendices
Appendix A. Variable definition

Variable Definition Data source

Bank risk-taking
Z-score Natural logarithm of [1+(ROA + EA)/σ (ROA)]. ROA represents the BankFocus and authors’ own
return on assets, EA is the equity-to-assets ratio, andσ (ROA) is calculation
the standard deviation of the return on assets. A higher score
suggests a lower probability of bank insolvency or, alternatively
speaking, a higher degree of financial stability.
FinTech development
FinTech We first build the initial vocabulary (in Chinese) for FinTech by Authors’ own calculation
combining financial functions and technological bases; then,
we calculate the number of news headlines containing the
keywords in the initial word list through the Baidu Index;
next, we apply the ratio of the number of news headlines
corresponding to each keyword to the total number of news
headlines corresponding to all keywords as the word frequency
to quantify the keywords; subsequently, factor analysis is used
to obtain the common factor; and finally, we calculate the
factor score and synthesize the FinTech index. A higher value
suggests a higher public perception, thus indicating more
FinTech development.
Bank controls
Size Bank assets as a share of the total assets of the banking sector (%). BankFocus and authors’ own
calculation
Liquidity The ratio of liquid assets to total assets (%). BankFocus
Leverage The ratio of equity to total assets (%) BankFocus
Efficiency The ratio of cost to total income (%). BankFocus
Income Shadow The ratio of noninterest income to total income (%)The ratio of BankFocus and authors’ own
interbank assets to total assets (%). calculationBankFocus and authors’
own calculation
Macroeconomic controls
GDP Inflation Monetary policy Natural logarithm of real GDP.Growth rate of CPI.First order International Financial Statis-
difference of the 3-month deposit interest rate (%). ticsInternational Financial
StatisticsInternational Financial
Statistics
Market structure Herfindahl-Hirschman Index, defined as the sum of the squared BankFocus and authors’ own
shares of bank assets to total banking sector assets within a calculation
given country in a year.
Rule of law The Rule of Law subindex from the World Bank’s Worldwide World Governance Indicator
Governance Indicators (WGI). Higher values indicate stronger
law and order.
This table presents the variable notations, definitions and data sources.

Appendix B. The number of banks of each type per year.

2011 2012 2013 2014 2015 2016 2017 2018

State 5 5 5 5 5 5 5 5
Joint 12 12 12 12 12 12 12 10
City 101 104 107 113 115 115 109 43
Foreign 22 25 23 26 26 26 24 4
Others 40 66 127 160 167 169 160 78
Total number of banks 180 212 274 316 325 327 310 140
This table presents the number of banks of each type per year. State denotes the five state-owned
banks. Joint represents 12 jointly owned banks. City means city commercial banks. Foreign indicates
the foreign-owned banks, while Others stands for rural commercial banks.
22 R. WANG ET AL.

Appendix C. Pairwise correlation matrix

Monetary Market Rule

Z-score FinTech Size Liquidity Efficiency Leverage Income Shadow GDP Inflation policy structure of law
Z-score 1.000
FinTech −.090 1.000
Size .224 −.104 1.000
Liquidity −.196 .213 −.241 1.000
Efficiency −.075 .053 −.238 .033 1.000
Leverage .011 −.057 −.241 −.105 .319 1.000
Income −.033 .067 .046 .100 .041 .002 1.000
Shadow .035 .068 .449 −.213 −.087 −.123 .126 1.000
GDP −.120 .411 .052 .405 .017 −.081 .280 −.022 1.000
Inflation .110 −.655 .058 −.186 −.004 .057 −.065 −.051 −.380 1.000
Monetary policy .155 −.702 .040 −.259 −.019 .056 −.129 −.050 −.525 .893 1.000
Market structure .139 −.734 .005 −.381 −.042 .079 −.240 −.014 −.905 .553 .706 1.000
Rule of law .137 −.176 −.086 −.351 −.011 .058 −.289 .029 −.859 .072 .203 .714 1.000
This table presents the pairwise correlation coefficients of the variables. The figures in bold denote the correlation coefficients with a significance
level less than 10%.