The Impact of Internet Banking on the Performance of the Korean Banking Industry: An Empirical Analysis

Abstract

This paper aims to verify the hypothesis that Internet banking, rapidly expanding in the Korean banking industry, allows banks to reduce cost and ultimately contributes to higher profitability. Our analysis, based on the quarterly financial statements of 20 Korean banks from 2000 to 2002, suggests that Internet banking, especially when it expands, contributes to reduction of banks’ cost, while it does not affect their profitability. It implies that the primary objective of introducing Internet banking, which was to reduce the operating cost such as branch maintenance expenses, has been accomplished, but this cost-reduction effect has not reached the stage in which beneficial effects of Internet banking overcome the negative effect of initial investment on the profitability of banks. Considering that the growth potential of Internet banking consists in its cost efficiency, this also indicates that Korean banks’ strategies of expanding Internet banking would ultimately bring positive outcomes. The findings of this paper offer an important implication that Internet banking has increased social welfare by making banks distribute the benefit of cost reduction to customers in various forms such as preferential interest rates and fee exemption, rather than internalize the benefits to the banks’ profits. This paper also finds an indirect evidence that benefits to the Internet banking customers has been primarily provided through the interest rate channel rather than non-interest service channel. In addition, we found that the people’s preference for face-to-face transaction may be very low in Korea, which supports the hypothesis that the cost for securing customer base will be much reduced. From the results of empirical analyses, it can be also anticipated that the profit-enhancing effect of Internet banking will become more significant in the near future since the cost-reduction effect of Internet banking will be stronger with the technology development that reduces the cost of maintaining Internet banking system.