The Economic Effects of Technological Progress: Evidence from the Banking Industry

The Economic Effects of Technological Progress:Evidence from the Banking Industry Allen N. Berger (bio) Abstract This paper examines technological progress and its effects in the banking industry. Banks are intensive users of both IT and financial technologies, and have a wealth of data available that may be helpful for the general understanding of the effects of technological change. The research suggests improvements in costs and lending capacity due to improvements in "back-office" technologies, as well as consumer benefits from improved "front-office" technologies. The research also suggests significant overall productivity increases in terms of improved quality and variety of banking services. In addition, the research indicates that technological progress likely helped facilitate consolidation of the industry. This paper examines the available evidence on technological progress and its effects in the banking industry. Innovations in information processing, telecommunications, and related technologies—known collectively as "information technology" or "IT"—are often credited with helping fuel strong growth in the U.S. economy, although questions remain about the relative importance of IT versus other factors. The extensive research on the banking industry may help in the general understanding about the effects of technological change. The category of Depository and Nondepository Financial Institutions—of which banking is an integral part—is the most IT-intensive industry in the U.S. as measured by the ratio of computer equipment and software to value added (Triplett and Bosworth 2002, Table 2). [End Page 141] Banks are also significant users of financial technologies that employ economic and statistical models to create and value new securities, estimate return distributions, and make portfolio decisions based on financial data. Examples include financial engineering used to create new financial derivatives, credit risk and market risk models employed to improve portfolio management, and modern credit scoring and discriminant analysis used to evaluate credit applications. These financial technologies often depend heavily on the use of IT to collect, process, and disseminate the data, as well as on economic and statistical models to evaluate the data. Technological progress in the banking industry is also important because of the key roles of banks in providing financing, deposit, and payments services to other sectors of the economy. We assess the effects of technological progress on productivity growth in the banking industry and on the structure of this industry. The use of a single industry with relatively homogenous inputs and outputs may help mitigate problems of combining data from heterogeneous industries. Research on banking benefits as well from detailed data on individual firms to specify cost and profit functions and control for differing business conditions when measuring productivity change, scale economies, and other performance indicators. Some special banking data sets also allow for observation of specific technological changes and measurement of some of their effects. In addition, detailed information on the scale, geographic spread, and merger and acquisition (M&A) activity of individual banks aid in evaluating the effects of technological progress on the structure of the industry, i.e., the extent to which technological progress facilitates industry consolidation. Study of the banking industry also demonstrates some of the general problems in measuring the effects of technological progress and how these problems might be addressed. For example, to the extent that markets are competitive, the benefits from technological advances in an industry may be competed away and passed through to customers or factors of production and not measured as productivity increases in that industry. As shown below, banks may have essentially "given away" the benefits from the ATM technology in the 1980s as the industry became more competitive due to deregulation, and rents from market power shifted to consumers. It has been shown elsewhere how new products and quality improvements from technological progress are often neglected in government statistics and may lead to overstatements of inflation and understatements of productivity growth. In banking, there are many new products and quality improvements that are not easily captured in standard productivity measures, and we show how some may be measured in alternative ways. The paper is organized as follows. Section 1 shows some background statistics on changes in the banking industry over time. Section 2 reviews microeconomic research on examples of technological changes in the banking industry...