Fintech, Foreign Bank Entry and Financial Sustainability in Developing Countries: Role of Financial Freedom

Abstract

Financial technology (FinTech) innovations and the rise of foreign banks have led to changes in the nature of financial services in many emerging markets and transition economies. While the increased use of digital finance may lead to improved efficiency, accessibility and inclusion, the introduction of foreign banks may provide competition and modernized banking practices; the ultimate impact of these two trends on long term financial sustainability remains unclear, especially in regions like those in the Central Asia Regional Economic Cooperation (CAREC) group, where there exists a wide range of institutional environments. Additionally, weak regulatory frameworks, susceptibility to external economic shocks and uneven levels of financial freedoms will add additional complexity to the integration of digital finance into traditional financial services. The study examined the impacts of FinTech development and foreign bank entry on financial sustainability in 11 CAREC member states between 2008-2020, with a focus on the moderating effect of financial freedoms. In this study, FinTech adoption was defined as the number of digital payment transactions and/or ATM penetration in each country. Foreign bank presence in each country was represented by the percentage of foreign bank assets to total bank assets. Finally, banking stability and credit depth were measured by the bank's Z-score and credit-to-deposit ratios. Secondary panel data were collected from several international databases and used to perform descriptive analysis, correlation analysis, regression analysis and moderation analysis to evaluate the relationship between FinTech and banking sustainability, foreign bank entry and banking sustainability and how financial freedom acts as a moderator in the relationship between FinTech, foreign bank entry and banking sustainability. Results indicate that digital payments have a significant and positive relationship to both banking stability and credit depth, however excessive foreign bank presence has a negative relationship to both of these variables. ATM penetration had mixed results and contributed positively to credit growth but did not contribute to banking stability. Lastly, the study found that financial freedom had a moderate influence on the relationship between FinTech and banking sustainability, enhancing the positive relationship of FinTech to banking sustainability, and also moderating the relationship between foreign bank entry and banking sustainability. This study contributes to the literature by integrating three previously separate fields: digital finance, foreign banking and institutional quality into one empirical model, providing policymakers in developing economies with relevant insights on how to manage competing priorities in promoting financial openness, innovation and long-term financial sustainability.