The dark side of bank digitalization: Bank liquidity creation and digital innovation failure

The digitalization of financial services, including that of commercial banks, has seen a rapid proliferation in the recent years. I therefore examine how the creation of digital banks can affect liquidity creation using a novel setting that exploits Indonesia's unique regulatory environment, which only allows the establishment of new digital banks through mergers and acquisitions (M&As). My results document that bank liquidity creation is lower after digital M&As relative to non-digital M&As. Further tests show that banks transformed into digital banks are smaller in size, limiting their capacity to quickly adopt and integrate new digital technology. This stumbling block undermines their business efficiency and market power, ultimately reducing liquidity creation. This evidence offers novel insights into the potential adverse effect of digital transformation in the banking sector.