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Digital Transformation and Risk Differentiation in the Banking Industry: Evidence from Chinese Commercial Banks

Abstract This paper studies the impact of digital transformation on the ex post risk differentiation of large and small banks, measured by nonperforming loan (NPL) ratios. It uses the Digital Transformation Index of Commercial Banks compiled by the Institute of Digital Finance of Peking University, which contains data on three dimensions—cognition, organization and products—for 97 banks from 2011 to 2018. The three main findings are: (1) the digital transformation of cognition and organization only affects the NPL ratio through the digital transformation of products; (2) the digital transformation of products only increases the NPL ratio of small banks, but not large banks; and (3) the reason for the above results is that, in fulfillment of the mandatory requirement of lending to the micro-, small, and medium-sized enterprises (MSMEs), digital transformation makes it easier for large banks to discount commercial bills held by MSMEs, thereby pushing small banks to extend corporate loans to MSMEs, which have higher risks.