Digital transformation in banking: Curbing procyclical leverage to strengthen financial stability

Digital transformation is revitalizing the banking system. By applying NLP techniques, this study aims to analyze the trends of digital transformation in Chinese commercial banks and explore how this transformation contributes to banks' deleveraging and stabilization. We construct a framework for digital transformation in banking across five dimensions, emphasizing the critical role of digitalized risk control. The findings reveal that digital transformation, particularly when integrating digitalized risk control, significantly contributes to deleveraging. Among the sub-dimensions, technological digitalization, risk control digitalization, and product digitalization have strong effects in reducing bank leverage. The deleveraging impact of digital transformation is especially pronounced in banks owned by the government, with higher capital adequacy ratios, in regions with weaker financial regulation, with a fintech subsidiaries, and listed as systematically important. In terms of mechanisms, digital transformation helps mitigate procyclical leverage behavior, thereby stabilizing the financial system. Shifting the focus to off-balance sheet activities and systemic risk, an intriguing phenomenon emerges: banks with fewer types of wealth management products, a preference for shorter maturities, and higher yield caps demonstrate a more pronounced deleveraging effect during digital transformation. Additionally, the dual effects of digital transformation on both deleveraging and systemic risk control are also examined.