Bank Competition Amid Digital Disruption: Implications for Financial Inclusion

This papers studies how banks compete amid digital disruption and resulting distributional effects on financial inclusion. Using survey data, we document that digital consumers (younger, more-educated and higher-income) have adapted to mobile banking, whereas non-digital consumers still heavily rely on brick-and-mortar branches. We build a model of bank competition with endogenous branching and entry decisions to show that the shift of digital consumers’ preference from branch to digital services affects how banks compete which results in negative spillovers to non-digital consumers. We empirically test the model predictions by exploiting the staggered expansion of 3G networks across the U.S., and our identification strategies rely on difference-in-differences and instrumental-variable (the frequency of lightning strikes) analyses. We find that (1) banks close costly branches, especially in regions with more young people; (2) banks enter new markets with fewer branches which intensifies local competition; and (3) branching banks increase their prices, whereas non-branching banks lower prices. Consequently, non-digital consumers pay a higher cost to access financial services and thus face the risk of financial exclusion. Approximately, this channel causes 2.5 million previously banked individuals to lose banking access. Overall, the evidence highlights the role of banks’ endogenous responses to digital disruption in widening digital inequality.