What is the relationship between digitalization and profitability of banks in the Eurozone, and how is it moderated by corporate sustainability?: A two-step approach to analyzing digitalization in the banking sector

Abstract

In recent years, banks in the Eurozone have been facing a challenging market en- vironment causing them to struggle with profitability. In an attempt to improve performance, many banks have indulged in digitalization strategies. However, it is still unclear to what extent digitalization efforts drive profitability. This paper inves- tigates as a first step the relationship between digitalization and profitability in the banking sector. As a second step, the moderating effect of corporate sustainability is examined. Using a sample of 54 listed banks within the Eurozone over the period 2012-2021, we determine a cost-efficiency frontier to retrieve the technological gap for each bank per year. Through innovation, banks can reduce the technological gap. Because innovation in the banking sector is mainly caused by technological change, the sustained improvement of the technological gap is taken as a proxy for digitalization. Regressing digitalization on the profitability measurements ROE and ROA shows that digitalization does not have a consistently significant correlation with bank profitability. This indicates that without other factors, banks face a profitability paradox in the sense that digitalization is not a guarantee for improved profitability. However, including different corporate sustainability metrics in the regression, it appears that the controversies score acts as a moderator. Consequently, this in- dicates that banks can materialize their digitalization efforts by being involved in fewer controversies and hence improving their reputation and customer trust.