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. We therefore examine how digital transformation 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. Our results document the negative impact of digital transformation on bank liquidity creation within small-sized banks. These findings are driven by the high cost associated with digital infrastructure and digital banks' inability to achieve economies of scale due to their small business size, leading to higher business costs and lower operating efficiency. This evidence offers novel insights into the potential adverse effect of digital transformation in the banking sector.