Impact of internet banking in profitability on commercial bank

(A Panel Data Approach)

ABSTRACT
The onset of economic and financial reforms has changed the functioning of banking system in
India. E-banking is one of the highly important and modern application, witnessed a massive
expansion in Indian Banking sector. The banks are offering services mainly through e-banking
system. However, the existing literatures related to assessing impact of e-banking on the bank
performance are limited in India. Against this background, this current paper examines the
impact of electronic banking on performance of Indian commercial banks for the period 2009 –2015. Return on
asset and return on Equity are considered as bank performance variables,
whereas number of ATMs installed, total number of online transactions, and total amount of
online transactions are considered as e-banking variables. The present study covers 48 banks
including 26 Public sector banks, 19 Private Banks and 3 Foreign banks operating in India. Other
independent variables, such as, Size, Capital Adequacy Ratio, Asset Quality, Liquidity, and
Market Share are also considered in this study. The study employs panel data technique and the
results were estimated using fixed and random effect models. The result shows that the impact of
e-banking variables is found to be significant with bank performance variables in case of public
sector banks. On the other hand, performance of private banks and foreign banks exhibit
insignificant relationship with e-banking variables. Overall, the results indicate that asset quality,
size, liquidity, market share, and total amount of online transaction are having significant impact on the
performance of commercial banks in India.

Keywords: Electronic Banking, Bank Performance, Indian Banking.

1. INTRODUCTION
Indian financial system has gone through tremendous changes since 90’s. The initiation of
financial sector reforms in early 1990’s changed the entire banking industry in India. The initial
phase of banking reforms in the banking sector was initiated by the recommendations of
Narasimhan Committee in 1991(Ahluwalia, 2000) followed by the licensing of the new private
sector banks. As a result, the main challenge faced by Indian banks was to maximize operational
efficiency which is suitable for modern financial intermediation. Further, the recommendations
of the Committee on Banking Sector Reform in 1998 (RBI Report, 2001) brought structural
measures and an improvement in standards of disclosure and transparency in the Indian banking
sector including modernization and technology up gradation.
Banking sector is the back bone of any economy, and also frames out the progress of the entire
economy of the country. The continuous up-gradations in the technology have brought huge
impact on business operations and particularly carried out a paradigm shift in the banking
operations. Banking industry in India has witnessed major developments due to changes in the
information technology. Information technology was identified as a crucial element to improve
productivity and render efficient service in the banking sector. The computerization of bank
operations in India have begun in a big way in late 1990s. ICICI bank is the first bank to introduce
E-banking facility in 1997 followed by Citi Bank and HDFC bank in 1999. Several initiatives
were taken by the Indian Government as well as RBI for the development of E-Banking in India.
Two areas in which the use of technology was clearly visible were computerization of branches
and installation of ATMs E-banking allows the customers to carry out financial transactions on a secured
website operated by the institution, which can be a retail bank, virtual bank, or credit union. It offers many
benefits to the customers and banks both. The evolution of E-banking has dramatically
transformed the traditional way of operations in the bank and also the user’s way to reach the
bank for various banking activities. Hence it is essential to understand the contribution of e-banking services in
the growth of banking performance

2. REVIEW OF LITERATURE
Use of e-banking and its products are growing rapidly, mainly due adoption of latest modern
information technologies. Empirical studies related to e-banking have not received much
attention in the literature. Stoica, Seyed Mahdian & Alina Sargu (2013), in their paper
investigates the impact of e-banking on the efficiency of the banks. Data Envelopment Analysis
(DEA) and Principal Component Analysis (PCA) were used to access the efficiency
performances. The result show that out of 45 banks only 15 banks achieved 100% efficiency and
most of the banks operated at an extremely low efficiency. The result reveals that only few
Romanian banks efficiently use e-banking services to enhance their performance. Another study
by Abaenewe, Zeph Chibueze (2013), in their study analyses the profitability performance of
Nigerian banks during the pre- and post e-banking adoption period using returns on equity
(ROE) and returns on assets (ROA). The result indicates that the e-banking has significantly
improved the performances during post-reform period.
Mohammad O. Al-Smadi and Saad A. Al-wabel (2011), in their study examined the impact of
electronic banking during 2000 – 2010 for 15 Jordanian banks by using bank performances as
dependent variable and a set of bank specific and macroeconomic variables as independent
variable. The results from pooled OLS regression reflects that e-bank, size, capital is having positive impact on
performances, whereas expenses management and liquidity exhibits negative
impact. Another study by Ceylan Onay, Emre Ozsoz, Ash Deniz (2008), analyse the impact of e-banking of 13
Turkish banks performance for the period 1996 and 2005 by employing GLS. The
study found that online banking has no significant impact on the performance.
Study by Jui-Chu Lin, Jin-Li Hu and Kang-Liang Sung (2005), investigates the effect of e-banking for the period
1995 to 2001 using stochastic frontier analysis (SFA) for 35 commercials
banks in Taiwan. It is found that there is a positive relationship between the numbers of ATM
installed and number of branches with cost efficiency. On the other hand, total assets and
operating years found to be insignificant with cost inefficiency. The result also indicates that
more bank branches lead to more inefficiency of banks. Another study by Stephen K. Callaway
(2011) analyse the impact of internet banking on performances of 369 banks for the period of
2008 in USA. The result found that internet users and the number of external links are having a
significant impact on deposits per branch. The study concludes that the independent variables
measuring e-banking are found to have insignificant relationship with bank performance
variables. Milind Sathye (2005) in his article investigates the impact of internet banking on the
performance of 62 credit unions in Australia using data envelopment analysis for the year 2002.
The study concludes that internet banking has no significant impact on performance during the
study period.
It is evident from the literature that existing study related to e-banking performance yield mixed
results, and most studies concludes that impact of e-banking on performance is insignificant.
A study by Pooja Malhotra and Balwinder Singh (2009), investigates the impact of Internet
banking on banks’ performances for the period 1998-2007 for 85 scheduled commercial banks in India. The
results indicate that operating efficiency and profitability in internet bank is higher as
compared with non-internet bank. Results also reveal that there is no significant relationship
between profitability and Internet banking. The study by M. S. Saluja and T. Wadhe (2015),
investigates the relationship between e-banking and profitability of 31 Indian scheduled
commercial banks using Multiple Regression analysis for the period of 2006 – 2014. The result
indicates that there is a positive effect on nationalized and old private sector banks’ profitability
while using e-banking. R. K. Uppal (2011), in his paper investigates the performances of
commercial banks in India using ratio analysis. The result suggests that branch and labour
productivity exhibit significant growth during the e-banking period as compared with pre e-banking period. It is
also found that the labour and branch productivity is significantly high in
foreign banks. Overall, it is evident form the results that there is an increase in the profitability
after introduction of e-banking services.
A study by Vikas Gautam (2012), measures the effect of e-banking on the profitability,
efficiency and service quality of 14 Indian banks. It is found that e-banking has significantly
increased the profitability and reduces the cost. A study by Pooja Malhotra and Balwinder Singh
(2007) attempts to analyse factors affecting adoption of e-banking of 88 banks in India during
1998 to 2005. The results found that probability of adoption of e-banking is determined by size,
deposit, and expense ratio, whereas age and market share are having significant negative impact.
Overall, it is found that in order to increase the branch network private banks have used e-banking facilities
more effectively. Literature related to Indian banks is also leading mixed results and many conclude that
e-banking has insignificant relationship with performance of banks Most of the studies employ regression
analysis to identify the impact of electronic banking without considering existence of heterogeneity among the
bank groups. It is essential to select an appropriate methodology for the empirical estimation while analysing
the performance. The present study attempts to employ panel data regression to the estimate determinants of
bank performance which is more appropriate while considering large number of banks which are
heterogeneous in nature. The main objective is to analyse the impact of electronic banking on
return on asset and return on equity

3. METHODOLOGY
3.1 Panel Data
Presence of heterogeneity is a natural phenomenon while studying large number of individuals
banks over the period of time. Panel data regression, which considers both cross section and time
series data, is more suitable to deal with such heterogeneity. The general form of panel data regression
equation can be written as:

Where, ‘i’ refers cross-sectional unit and ‘t’ is the tth time period and X’s are non-stochastic and
error term follows the below assumption:

Equation 1 can be rewritten as:

Equation 2 is known as fixed effect model. It assumes that the intercept for each cross sectional
bank vary and the slope coefficient are constant. The difference in the incept coefficient is
mainly due to managerial capability of each bank
Restricted F test can be used to compare the ordinary least square method (OLS) over fixed
effect model. If OLS is considered as restricted model and FE model is unrestricted, the
following F statistics can be calculated.
The Equation 5 assumes that the individual error values are not correlated with each other and
there is no auto-correlation. Hausman test statistics used to choose between fixed and random
effect model. The null hypothesis under the Hausman test statistics is that there is no significant
difference between random effect and fixed effect estimator. Fixed effect model is considered to
be more appropriate over the random effect model, if the null hypothesis is rejected

3.2 Data and Sources

Data for the present study are extracted from Reserve Bank of India website and various annual
reports of 91 banks. The number of banks finally selected for the study is 48 and rest 43 banks
were not considered due to non-availability of relevant data. The selection of banks include 26
Public sector banks, 19 Private banks and 3 foreign banks, which account for 96.25% of the total
assets of commercial banks in India, making the sample of this study more comprehensive. The
study focuses on estimating the impact of e-banking on bank’s performance for the period of 7
years ranging from 2009 to 2015.

3.3 Variables
The proposed model for the present study is expressed as following

The above equation 6 and 7 are estimated as stage I, considering only e-banking variable as
independent variables. Equation 8 and 9 refers to stage II, which includes banks specific as well
as e-banking variables in the estimation process
Where,

• ROA is a ratio of total profits to total assets. A bank with higher ROA indicates that
banks had utilized its assets more efficiently to generate the profits in comparison of them
counter parts.

• ROE is the ratio of post-tax profits to total equity. A higher ratio indicates that the equity
capital is channelized in productive manner, hence generating more profits.

• LATM is the log value of total number of ATMs installed onsite and offsite of each bank.

• LTAT refers to the log value of total amount of online transactions made by all the
account holders of bank. The coefficient of this variable is expected to have a positive
sign.

• LTNT refers to log value of total number of online transactions made by all the account
holders of bank, which includes RTGS, NEFT, and ECS. A bank with high number of
online transaction is expected to generate more income in the form of charging
transactional charges, facility charges etc. Thus, the expected sign is positive.

• LSize is log value of total assets have been used as a measure of size.

• LMS is refers to log value of total deposit which is defined as sum of demand deposits,
saving bank deposit of branches within India and outside India.

• Liq is calculated as the ratio of total loan to total deposits. A high ratio reflects that bank
is having a close attention on issuing the loans and accepting the deposit.

• CAR is calculated as the amount of the bank core capital as a percentage of its riskweighted assets. A high
ratio indicates that bank is strong and investors will be more
protective.

• AQ is measured using a ratio of net NPA to net advances. A high ratio indicates that
banks are more non-performing assets against the total advances leading to more credit
risk.

• ‘i’ - Number of Banks (1.2………..48)

• ‘t’ - Time periods (2009, 2010…..2015)

4. EMPIRICAL RESULTS AND DISCUSSION

Table 1 represents the descriptive statistics for all commercial banks considered in this study.
The average of return on asset is 0.99% and return on equity is 13.34 for the selected sample
banks for the period of 2009-2015. Average capital adequacy ratio is 13.72 and asset quality is
calculated as 1.37. The average number of ATMs installed is found to be 2,160 implies that the
installation of large number of ATMs across the banks. Overall, the descriptive statistics reflects
the sound position of commercial banks in India.

Insert TABLE 1
The empirical estimation carried out in the study follows two stages. In Stage I, e-banking
variables such as total number of ATMs installed, total number of online transactions, and total
number of online transactions were used as independent variables and are regressed on ROA and
ROE.
The estimated results using ordinary least square regression and panel data regression for all
commercial banks and are reported in table 2. Restricted F statistics computed using R2
values of OLS model and fixed effect model suggest that, panel data model is more appropriate than OLS
model. Hausman’s test statistic suggest that random effect model is found to be appropriate
while using ROA as dependent variable, whereas fixed effect model is found to be more
appropriate while using ROE as dependent variable. The estimated result indicates that number
of ATMs installed is found to have negative impact on ROA, which is highly significant. On the
other hand, total amount of online transaction found to have significant positive impact on ROA.
It is clear from the results that increase in number of ATMs installation reduces the ROA, which
is probably due to the customers are preferring to use other mode of transaction than using
ATMs. It is also observed that total number of transactions is insignificant with ROA

Insert TABLE 2
The estimate from the fixed effect model indicates that number of ATMs installed is found to
have significant negative impact, reflecting increase in the number of ATMs installed reduces the
ROE across all selected banks. On the other hand, total amount of online transaction and total
number of transactions are found to be insignificant with ROE.
Empirical results related to impact of e-banking variables on ROA and ROE are estimated for
public, private and foreign banks separately. The results for public sector banks are reported in
table 3. All three e-banking variables are found to be significant with ROA as well as with ROE.
Number of ATMs installed and total numbers of online transactions are found to have negative
impact with ROA and ROE, whereas total amount of online transactions is found to be positive
and significant.

Insert TABLE 3
The estimated results for private sector banks were reported in table 4. Hausman test statistics
suggests that fixed effect model is more appropriate while considering ROA as dependent
variable and on the other hand random effect model is considered more appropriate while
considering ROE as dependent variable. The estimated results indicate that none of the e-banking
variables found to have significant impact with ROA and ROE.

Insert TABLE 4
Similarly, the results of foreign banks are reported in table 5. The impacts of e-banking variables
are found to be insignificant except, the number of ATMs installed. In the case of foreign banks
there are no significant differences in the results estimated using OLS model and Panel data
model. This may be due to the number of banks considered in this study were very small.
Overall, it is clear from the results that e-banking has a significant impact on performance of
public sector banks, whereas it is insignificant in private and foreign banks. The value of R2
which ranges from 0.03 to 0.15 indicates that the contribution of e-banking on the bank
performance is very minimal.
Insert TABLE 5
In stage-II estimation, capital adequacy ratio, asset quality, liquidity, market shares, size along
with e-banking variables were considered to analyze their impact on the performance. Results
obtained from all estimation of all commercial banks are reported in table 6.
Hausman test statistic suggests that fixed effect model is more appropriate while considering
ROE and ROA as dependent variables. The results suggest that asset quality, size, and total
amount of online transaction are found to have negative impact with ROA, whereas market share
have positive impact. Similar results were found in the case of ROE. The negative relation
between asset quality with ROA and ROE implies that the existence of huge amount of non-performing assets
in proportion to the total advances in the selected sample banks under the
study.

Insert TABLE 6
The estimated results for the public sector banks are reported in table 7. The results indicate that
capital adequacy ratio and total number of online transactions are found to be positive and
significant with ROA and ROE, whereas asset quality and total amount of transaction are found
to have significant negative impact. Size, liquidity, market share and number of ATMs installed
are found to be insignificant with bank performance variables.

Insert TABLE 7
The estimated results for private sector banks were reported in table 8. The results from random
effect model indicates that Capital adequacy ratio, liquidity and market share are having
significant positive impact with ROA, whereas asset quality, number of ATMs installed and total
number of online transactions are found to have significant negative impact. Capital adequacy
ratio, market size is found to have significant positive impact on ROE, and asset quality, size,
total amount of online transaction, total number of online transactions are having significant
negative impact.

Insert TABLE 8
Similarly, results for the foreign banks are reported in Table 9. The result from random effect
model indicates that none of the independent variable are significant with ROA. On the other
hand, asset quality if found to have significant positive impact with ROE, whereas capital
adequacy ratio is negative.

Insert TABLE 9
Overall, the study reveals that e-banking variables are having significant negative impact on
ROA and ROE in case of public sector banks, whereas it is insignificant in the case of private
and foreign banks.

SUMMARY & CONCLUSION

Empirical results estimated using OLS, fixed effect, and random effect model were presented in
this study in two stages. While stage I considers only e-banking variables on bank performance,
stage-II focuses on considering other banks specific variables along with e-banking variables for
the performance assessment. The sample banks selected for the study accounts for 96.25% of
total assets of commercial banks operating in India.
Empirical result related to of e-banking variables on bank performance is found to be significant
with public sector banks and insignificant with private and foreign banks. The results also found
that the contribution of e-banking on the bank performance is very minimal. It is evident from
the results that, the number of ATMs installed is found to have negative impact on ROA and
ROE, implying that increase in the number of ATMs installed reduces the ROA and ROE. In the
case of public sector banks, total amount of online transaction is found to be positive and
significant with ROA and ROE, implies that huge number of online transactions generate
significant income for the banks.
The empirical result from the stage II analysis indicates that asset quality, size, total amount of
online transaction is having negative impact with ROA. It is a clear indication of existence of
huge amount of non-performing assets in proportion to the advances. On the other hand, market
share and liquidity are found to have positive significant impact on ROA. Similar results were
found while considering ROE as dependent variable in the case of public sector banks, capital adequacy ratio,
liquidity is found to be positive and
significant with ROA, whereas asset quality and total amount of transaction are negative.
Similarly, capital adequacy ratio, liquidity and market share are having significant positive
impact on ROE, whereas asset quality and size are negative.
In the case of private banks, asset quality, number of ATMs installed and total amount of online
transactions are having significant negative impact on ROA, whereas, capital adequacy ratio,
liquidity and market share are fund to have significant positive impact. Similar results were
found while considering ROE as dependent variable.
In the case of foreign banks, all the independent variables are insignificant with ROA, whereas
capital adequacy ratio is having significant relation with ROE.

REFERENCES
• Abaenewe, Z. C., Ogbulu, O. M., Ndugbu, M. O. (2013). Electronic Banking And Bank
Performance In Nigeria. West African Journal of Industrial & Academic Research, 6 (1),
171-187.

• Aduba, J., Kingoo, N. (2012). The relationship between Electronic Banking and Financial
Performance among Commercial Banks.Journal of Finance and Investment Analysis,
1(3), 99 -118.

• Ahluwalia, M. (2000).Reforming India’s Financial Sector: An Overview. Planning

Commission, Government of India. Retrieved from Planning Commission website
http://planningcommission.nic.in/reports/articles/msalu/index.php?repts=finreform.html

• Al-Smadi, M. O., Al-Wabel, S. A. (2011). The Impact of E-Banking in the Performance

of Jordanian Banks. Journal of Internet Banking & Commerce, 16(2), 2-10.

• Ayo, C. K, Adewoye J. O, 1oni A. A. (2010). The State of e-Banking Implementation in

Nigeria: A Post-Consolidation Review. Journal of Emerging Trends in Economics and
Management Sciences, 1 (1), 37-45.

• Basel Committee on Banking Supervision (2003) “Risk Management Principles for

Electronic Banking” Switzerland Bank for International Settlements.

• C.A., J. (2014). Effects of Automated Teller Machine on the Performance of Nigerian

Banks.American Journal of Applied Mathematics and Statistics, 2(1), 40-46.

• Callaway, S. K. (2011). Internet Banking & Performance: The Relationship of website

traffic rank and bank performance. American Journal of Business, 26(1),12-25.

• Corrocher, N. (2002), “Does Internet banking substitute traditional banking? Empirical

evidence from Italy”, working paper, No. 134, November, CESPRI.

• Deutsche Bank Research (2005). Five online banking trends in 2005. E-banking snapshot
13.

• Deutsche Bank Research (2006). Online banking: What we learn from the differences in
Europe. E-banking snapshot 16.

• DeYoung, R. (2005). The performance of Internet-based business models: Evidence from

the banking industry. Journal of Business 78 (3), 893–947.

• DeYoung, R., Lang, W. W., & Nolle, D. L. (2007). How the Internet affects output and
performance at community banks. Journal of Banking & Finance, 31(4), 1033-1060.

• Dinh V, Le U, Le P (2015). Measuring the Impacts of Internet Banking to Bank

Performance: Evidence from Vietnam.Journal of Internet Bank Commerce, 82-103.

• Echekoba, F.N., Egbunike, Francis, C., Kaise, E. G. (2014). Determinants of bank

profitability in Nigeria: Using Camel rating model (2001-2010). IOSR Journal of
Business and Management, 16(9), 44-50.
• Egland, K., Furst, K., Nolle, D. and Robertson, D. (1998), “Banking over the internet”,
Quarterly Journal, 17 (4), Office of the Comptroller of the Currency.

• Frust, K., Kang, W.W., Nolle, D. E. (2002). Internet banking.Journal of Financial

Services Research, 1(2), 95-117.

• Genchev, E. (2012). Effects of Market share on bank’s profitability. Review of Applied

Socio- Economic Research, 3(1), 87-93

• RBI, Annual Publication, Sep 2008, Evolution of Banking in India

• Reserve Bank of India. (2001). Report on Banking Sectors Reform (Narasimhan

Committee II, 1998),p 1-35. Retrieved from Reserve Bank of India website
http://rbidocs.rbi.org.in/rdocs/PublicationReport/Pdfs/24157.pdf