How IT-Related Financial Innovation Influences Bank Risk-Taking: Results from an Empirical Analysis of Patent Applications

Abstract

This research investigates the effect of IT-related financial innovation on banks' risk-taking based on the patent applications of the 100 largest U.S. Bank Holding Companies (BHCs) from 2005 until 2015. The results show that financial innovation within the research period is not only product-focused and in contrast mainly determined by IT-related innovations like risk management systems, credit scoring models and risk or pricing algorithms. The present empirical analysis furthermore addresses the simultaneous causality between innovation and risk-taking, which causes an endogeneity problem in the regression analysis. Two potential instrumental variables for innovation have been examined, which focus on the open-mindedness of the banks' headquarter environments in terms of racial and ethnic diversity and sexual orientation. The results underline the positive effects of an open-minded environment on the innovativeness of the financial industry. Innovation, synthesized by the instrumental variable Ssex, tends to decrease bank risk-taking.