Does Financial Innovation Improve Perfromacne An Analysis of Process Innovation Used in Pakistan

DOES FINANCIAL INNOVATION IMPROVE PERFORMANCE?
AN ANALYSIS
OF PROCESS INNOVATION USED IN PAKISTAN
Safdar Husain Tahir, Said Shah, Fatima Arif, Gulzar Ahmad, Qaria Aziz, Muhammad
Rizwan Ullah
De Boeck Supérieur | « Journal of Innovation Economics & Management »
2018/3 n° 27 | pages 195 à 214

ISBN 9782807391901
DOI 10.3917/jie.027.0195
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Does financial innovation
improve performance?
An analysis of process
innovation used
in Pakistan
Safdar Husain TAHIR
Division of Finance, Lyallpur Business School
Govt College University
Faisalabad, Pakistan
drsafdar@gcuf.edu.pk
Said SHAH
University of Swabi, KPK, Pakistan
saidshah64@yahoo.com
Fatima ARIF
Lyallpur Business School

Govt. College University
fama.fatima@yahoo.com
Gulzar AHMAD
Lahore Garrison University
Lahore, Pakistan
gulzar818@gmail.com
Qaria AZIZ
Department of Public Administration
Govt. College Women University
qariaaziz@gmail.com
Muhammad Rizwan ULLAH

Lyallpur Business School
Govt. College University
mrizwanullah@gmail.com
n° 27 – Journal of Innovation Economics & Management 2018/3 195

Safdar Husain TAHIR, Said SHAH, Fatima ARIF, Gulzar AHMAD,
Qaria AZIZ, Muhammad Rizwan ULLAH
ABSTRACT
The study aims at quantifying the impact of innovative methods of payment used in
Pakistan on the efficiency ratio (ER). Secondary data issued by the State Bank of Pakistan
for the period 2007-2016 is used. Through the unit root test, the issue of stationary imper-
fection connected with unsynchronized arrangement information is settled before using
multiple regression models. The result of the study indicated a significant positive relation
of transactions on the Web/Internet on ER. But the results for Automated Teller Machines
(ATM), Point of Sale (POS), and Mobile Banking (MOB), were found to be statistically
non-significant. Furthermore, the Granger impact appraisal revealed that no innovative
products had a critical effect on ER, but they did have a significant effect on the value of
transactions. Thus, it is suggested that innovative methods should be redesigned in such a
way that customization would enable a customer to access all banking services and reduce
transaction costs.
KEYWORDS: Automation, Service Innovation, Least Developed Country, Technological
Change, Bank Efficiency
JEL CODES: O, O3, O31, O310
The term ‘financial innovation’ means the inclusion of new financial instru-
ments in financial intuitions and markets through new technologies. It
includes process, product and institutional innovation. Process innovation
is new ways of operating business and implementing information technol-
ogy, such as the Automated Teller Machine (ATM), mobile banking, online
banking, etc. (Abor, 2005). Product innovation 1 includes new financial

products such as securitized assets, derivatives, weather derivatives, foreign
currency mortgages, hedge funds, exchange-traded funds, private equity
and retail structured products, etc. An institutional innovation is the pro-
cess of introducing new types of financial firms such as discount broking
firms, internet banking, specialist credit card firms, etc.. All these types of
innovation improve payment systems used in the borrowing and lending of
funds, which ultimately opens up a quick way of dealing with customers. In
addition, they include innovations in technology, equity generation, and risk
transfer, which increase the available credit for borrowers and provide finan-
cial institutions with a new and low-cost way to raise capital.
In an economy, the mode of payments plays an essentially important role
in the smooth functioning of the sectors of finance as well as real estate. An
efficient system of payments is one that provides instantaneous settlement
of financial transactions and expedites the exchange of goods and services
in a prompt, protected, and reliable manner. In the last few decades, these
financial innovations have extended global acceptance and provided as new
financial instruments, processes, services, institutions, and market segments
1. Financial Times ft.com/lexicon (http://lexicon.ft.com/Term?term=financial-innovation)
196 Journal of Innovation Economics & Management 2018/3 – n° 27

Does financial innovation improve performance?
An analysis of process innovation used in Pakistan
etc. Of these several financial innovations, the effect of each innovation

may be different depending on its role in the financial system. Following the
global trend of gradually shifting from paper-based transactions to electronic
payment systems, Pakistan initiated this payment system in the 2000s.The
last decade has witnessed the increased use of electronic payments as the
growth rate has increased from 19.7 percent to 44.6 percent during the period
2006-2012. In the same period, paper-based transactions fell from 80 percent
to 55 percent.
In the realities and challenges of today’s world and in particular the eco-
nomic condition of the country, the banking sub-sector must be repositioned
in its key strategic role of balancing its performance through various profit-
ability ratios, such as return on equity, return on assets, profit before tax,
etc.. To achieve the objectives of economic growth and to realize the 2025
vision, the Federal Government of Pakistan has enhanced Foreign Direct
Investment (FDI) and national savings. The banking sector is the key pillar
of fund intermediation. In achieving these mandates there are a number of
challenges to cope with, including non-performing loans, specifically in the
oil and gas sector, which is currently facing price volatility in the internal
market, thus influencing the economy in a detrimental way. The situations
faced by this market, call for the efficient and effective performance of banks.
Through the efficient use of various sophisticated banking technologies,
along with applications of Information and Communication Technology

(ICT) in banking operations, became one reason to relocate banks’ deposit
money towards an unexpected improvement in the arrangement of banking
products and various instruments, which are key ways in which to stimulate
customer needs and preferences (Victor, Obinozie, Echekoba, 2015). Various
financial innovative products such as web/internet banking, automated teller
machines, and mobile banking, are a vital force for the diversification of
banks, generating revenue, and diminishing the cost to both banks and cus-
tomers, as customers can access their accounts through the above-mentioned
financial innovation products (Abubakar, Tasmin, 2012).
Regarding the various products of financial innovation employed by
banks as a strategic tool to compete with their competitors, deposit money
banks improve their financial performance by simultaneously being able
to enhance and maintain their efficiency and effectiveness in the market
(Kamau, Oluoch, 2016). The effectiveness and efficiency of a bank is meas-
ured by various financial ratios, easy and quick measures for deposit money
banks to access financial performance from their resources. The most com-
monly employed ratios are return on assets, return on equity, and profit
margin ratios. In this era of globalization, technological advancement and

development has not only increased the number of banking institutions

working worldwide but also the level of sophistication in the form of financial
products employed by banks to service their customers’ needs and demands.
Therefore, this era has created robust competition among banking institu-
tions as developments in payment systems have evolved and created an alter-
native for hard currency, in this way affecting a key part of banking opera-
tions (Victor, Obinozie, Echekoba, 2015).
Researchers have established a nexus between financial innovation and
the efficiency of the banking industry for both developed and emerging econ-
omies around the globe. According to Nkem and Akujinma (2017), the bank-
ing sector in the developing economy is strengthened due to financial inno-
vations in various payment methods/systems, such as the use of automated
teller machines, mobile banking, and electronic banking. This technological
progress has increased competition in the banking sector as the numbers
of institutions have grown. Many studies have found a positive relationship
between financial innovation products and enhanced bank efficiency, as well
as on customer satisfaction.
The study by Nkem and Akujinma (2017) has been conducted in Nigeria,
on the African continent, while the current study has been conducted in
Pakistan, Asia. Both countries have developing economies and share some
similarities and dissimilarities. Asia differs from the former continent in

many prominent ways, such as being the most populous continent, with
almost 60% of the total global population, while Nigeria has 57.7 million
users of the Internet and Pakistan has 35 million users. Pakistan is an emerg-
ing economy; a current study measures the impact of financial innovative
products on banking efficiency ratios, using the latest data set from 2007-
2016, while the former study employed data from 2006-2014. The current
study makes a real contribution in filling the gap identified in the literature
in Asia, and the implications of the study can be carried out in all developing
countries in Asia.
Only a few studies have been conducted before which incorporates all the
latest financial innovative products in Asia, particularly in Pakistan. One
recent study conducted by Shabbir, Rehma and Shabbir (2016) measured cus-
tomer satisfaction by taking ATM and e-banking channels used in the banks
of Pakistan. Our study makes a real contribution in comparison with the for-
mer as we have measured the efficiency ratio of banks in Pakistan by using all
the innovative products, such as the use of ATMs, mobile banking, Point of
Sale and web banking, taking data from 2007-2016. Another study conducted
in Pakistan by Usman (2016) measured the impact of financial innovative
products on bank performance, risk and economic growth. However, he used

a number of online branches, ATMs and credit cards for financial innova-
tions, which was quite different from this study. In addition, this study has
taken into account the limitations of the study conducted by Usman (2016).
His study indicated that the Unit root test had not been applied to the data
to produce results. But our study applied the unit root test, the RESET speci-
fication test, and the fixed effect model on the data. Therefore, our study has
made an honest contribution by employing the complete set of innovative
products used by Pakistani banks.
In the context of Pakistan as an emerging economy, a few studies have
been conducted to comprehend the impact of financial innovation on bank-
ing performance. The current study fills the gap found in the literature and
presents novelty in the area, particularly for Pakistan’s banking sector. It will
also help policy makers, and with managerial implications. Therefore, the
objective of the study is to mainly evaluate the relationship between financial
innovation and bank efficiency, as well as to measure the impact of various
financial innovative products on the efficiency ratio of deposit money banks
in Pakistan. The rest of this paper is organized as follows: relevant litera-
ture review, methodology, results and discussion, and finally conclusion with
study recommendations.
Review of literature

Financial Innovation
Financial innovation is considered to be one of the key forces for the perfor-
mance of banks as it has an impact on consumers, because it has the potential
to improve the efficiency and profitability of the banking industry (Silber,
1983; Kane, 1981). Financial and organizational innovation is primarily a
product that banks used to reduce costs and improve the industry as a whole.
In the relevant literature there are three theories, namely, the theory of con-
straint outcome, the theory of application and its outcome, and the theory of
the contestable market, upon which the work of Silber (1983) and Kane (1981)
is largely based. All these theories are based on the conception that financial
innovation is the vital force and has the critical potential to improve banking
performance. Kamau and Oluoch (2016) examined the question of whether
the banks were originally and critically efficient in their operations or not.
The efficiency of banks can be measured by the capabilities and abilities of the
banks to generate the optimal level of revenue through their resources. The
role of Information and Communication Technology (ICT) cannot be ignored
when considering financial innovation products in the banking sector.

Selected Financial Innovation Products in Pakistani

Automated Teller Machine (ATMs)
The cash dispensing machine allows customers to withdraw cash from his/
her account anywhere, at any time, and the withdrawal amount is spontane-
ously debited from the account (Ojokuku Odetayo, Sajuyigbe, 2012). These
cash dispensing machines are usually placed within the banks’ premises or
designated locations created by banks. This facility saves customers’ time in
service delivery and utilizes the time saved in other productive activities.
The authors further said that ATMs are cost efficient in producing higher
productivity and are placed in restaurants, hotels, shopping malls, stores, fuel
stations, and so on.
Pakistan started to use the Automated Teller Machine (ATM) in 1987.
The growth rate of the installed ATMs and its users were very low until the
1990s. The State Bank of Pakistan (SBP) mandated all banks to issue cards
to their customers and made the necessary arrangements to connect their
ATMS to either of two links, i.e. 1 link and MNET in 2002, through a cir-
cular order. The State Bank of Pakistan later directed, in 2006, that the two
links should interconnect, which made it possible for any customer of any
scheduled bank to take cash out from any ATM of any bank across Pakistan.
The SBP has shown consistency to draft new regulations to improve the
quality of service distributed through the e-banking facility and to declare
that the cardholder´s service should not be stopped. The data was used for

analysis from 2007 when the service of ATMs was in full swing. Based on
previous studies that have been conducted, the current study concludes the
alternative hypothesis as follows:
H1: There is an association between automated teller machines and the effi-
ciency ratio of deposit money banks.
Mobile Banking
This refers to the provision of banking services through mobile devices.
Mobile devices such as smart phones play a key role in the instigation,
endorsement and completion of transactions instead of traditional methods
of banking. In Pakistan, thirty-five million people (18% of the total popula-
tion) are using internet connections through their laptops, tablets and mobile
devices. Mobile phones have clearly been the key factor in the recent expan-
sion in internet users that has almost doubled from 2016. Mobile banking
provides a wide range of services to receive or to pay cash with a single click
(Onuoha, Fatokun, 2014). In addition, they stated that this mode of transac-
tion has numerous benefits for both banks and end-users. Furthermore, it is
considered to be one of the cheapest sources for evaluating financial services

with a minimum transaction cost, saving time in service delivery, and it is a

good option to use for those users who might feel less privileged visiting tra-
ditional branches. Because of previous studies that have been conducted, the
current study concludes the alternative hypothesis as follows:
H2: There is an association between mobile banking and the efficiency ratio of
deposit money banks.
E-Banking (Electronic Banking)

Bradley and Stewart (2003) said that electronic banking provides real time
premium services to its customers while they are sitting in their homes or
offices, where the Internet is available. It is actually the blend of internet and
telecommunication services that provide a great variety of valued products
and services for ease of use for end-users. In a country like Pakistan, however,
this kind of E-banking has only recently begun. Online banking systems
present to their customers a set of information-related benefits that favor the
adoption of E-banking, including the facility for customers to control their
bank accounts at any time and in any place, and to access the information
content to make investment and financing decisions (Howcroft, Hamilton,
Hewer 2002). Due to competition between the banks in Pakistan, these want
to provide services that are more efficient, rapid, and enhance the banking
system. Therefore, the objective of E-banking is to create such a working
environment where customers can easily find out about the information they

require to perform financial transactions. On the basis of previous studies
conducted, the current study concludes the alternate hypothesis as follows:
H3: There is an association between electronic banking and the efficiency ratio
of deposit money banks.
Relevant Review of Literature

Technological advancement is considered to be one of the driving forces
to create new opportunities for the development of the banking sector.
Technological innovations are of great value to gain competitive advan-
tage and in today’s world this has changed the outlook and approach of the
banking sector when compared with traditional banking services (Shabbir,
Rehma, Shabbir, 2016). Victor, Obinozie and Echekoba (2015) critically exam-
ined the impact of various applications of Information and Communication
Technology (ICT) and financial innovation on the financial performance of
banks. The data were gathered from the banks’ annually published reports
from 2001-2013. The study concluded that the financial performance of
banks was not improved significantly by E-banking services.

Gakure and Ngumi (2013) used descriptive research design to measure the
profitability of commercial banks in relation to financial innovations. They
applied multiple linear regression analysis to gauge the statistical significance
of independent variables; automated teller machines, point of sale terminals,
debit and credit cards, e-banking, mobile banking, and e-funds transfer on
the dependent variable, profit before tax. The independent variable financial
innovation was measured based on the Likert scale. The study demonstrated
that the financial performance of banks was moderately influenced by finan-
cial innovation products.
The study conducted by Simiyu, Ndiang’ui and Ngugi (2014) estimated
the impact of financial innovations on the market size of firms, focusing pre-
cisely on the return on equity. They employed the case design approach and
used both quantitative and qualitative data. A sample of 200 respondents
was selected from the population and interview sessions that were conducted.
There was signficant impact of financial innovations on the profitability of
the banks. The analysis documented that there was also an effect on advances
(loans) issued or sanctioned by banks on the assets, and in aggregate on the
performance of the banks. The results of the correlation suggested no sig-
nificant link between the various channels of transactions employed and the
market. On the other hand, there was also a significant relationship between
various market needs and the products developed. The study recommended
that more financial innovations must be employed to enhance customer sat-

isfaction and value, and eventually to expand the size of the market.
A research study was arranged by Jegede (2014) to measure the influ-
ence of ATMs on the performance of banks, using convenience sampling
design; data were collected from 125 employees of five randomly selected
banks. Through the software package for social sciences (SPSS), Chi-square
analysis technique was applied to the data collected through questionnaires.
The study confirmed that the financial performance of banks was moder-
ately improved due to the deployment of ATMs. Cherotich, Sang, Shisia
and Mutung’u (2015) concluded that the financial performance of banks was
positively influenced by financial innovations. The results were drawn from
the population of forty-four banks operating at that time.
To investigate the impact of technological innovation on the delivery of
banking services, the study was carried out by Ilo, Wilson and Nnanyelugo
(2014). Qualitative data were collected through questionnaires. 436 question-
naires were returned from respondents out of 1,250. The time period for the
study was from 2008-2013. Pearson Correlation statistics were applied to the
data. The results revealed that there is a positive connection between finan-
cial innovation and banks’ performance. Customer retention rate and the

level of satisfaction were improved by the use of information and communi-

cation technology innovations.
Kashmari, Nejad and Nayebyazdi (2016) examined the influence of finan-
cial innovation on the share of each bank in attaining deposits as one of the
most critical goals and competitive tools of a bank. Secondary data were col-
lected from twenty-three banks from the period 2007-2013. The Panel Data-
Vector Autoregressive methods (Panel-VAR) and Granger Causality Test
were applied to data. The study concluded that the SWIFT system, Point of
Sale terminal, mobile banking, ATM machines, and personal identification
number (PIN), and other banking facilities provided by each bank, showed
that a causal relation in improving the share was caused by innovation. A
bilateral relation among the share of deposits and facilities provided by the
bank was also found. The impact of financial innovation on banks’ financial
performance as the major players in the sector over a period of five years was
examined by Malak (2014). Sixteen registered commercial banks with the
Central Bank of South Sudan were selected from 2009-2013 and a causal
research design was used to collect data. The study concluded that financial
innovation products significantly influenced the financial performance of
commercial banks operating in South Sudan.
The study conducted by Gichungu and Oloko (2015) investigated the
impact of ATMs, web banking, agency banking and mobile banking on the
financial performance of banks. The data were collected from forty-three

commercial banks from their annually published reports for the time period
2009-2013. The time span from 2009-2013 was selected because of major tech-
nological innovations that were implemented by the banks during this time
period. The data were analyzed using Multiple Regression, along with the
Pearson Product Moment Correlation Coefficient test, to gauge the impact
of financial innovations on the performance of the banks. The statistical
result of the correlation coefficient test showed the direction and magnitude
of the dependent and independent variables relationship and revealed that
in the dependent – independent variable relationship there is a 95% confi-
dence level and a 5% level of significance. The study concluded that there is
a strong positive impact of financial innovation on the financial performance
of banks during 2009-2013 in the banking sector.
Ongore and Kusa (2013) assessed the interconnection between techno-
logical advancements and the financial performance of the banking sector,
and for key interest variables of the study. The data were collected from pub-
lished reports of banks registered with the Central Bank. Data were collected
from forty-four commercial banks and regression analysis was conducted to
gauge the relationship between the study’s interest variables. The findings

of the study revealed that ATM machines offer more than just acting as
cash dispensers and are transformed as a tool of superior customer relation-
ship management, eventually creating long-term customer value and loyalty.
Mobile banking was one of those factors that directly influence the profitabil-
ity of the banks, as operations become smoother, and web banking provides
the convenience of conducting most of the banking operations at a time
and place (office, home) that best suits the customers. A credit card provides
the banks with a greater opportunity to improve income and diminishes the
credit and liquidity risk of operations.
The study carried out by Kamau and Oluoch (2016) examined the impact
of internet banking, debit cards, credit cards, agency banking, mobile banking
and ATMs on the financial performance of banks. The data were collected
from the annually published financial statements of the banks. Eleven commer-
cial banks were selected using correlation research design to assess the causal
impact of financial innovations on the banks’ performance from 2012-2015.
Secondary data were collected and statistics of the descriptive analysis showed
that average bank performance was 23.7%. Correlation analysis revealed that
banks’ financial performance was greatly influenced by ATM banking. The
study concluded in aggregate on the basis of regression analysis that ATMs,
debit and credit cards, mobile banking, and web banking and agency banking,
all have a strong influence on commercial banks’ performance.

The review of relevant literature subsequently cited the succeeding theo-
ries that support the current study. The first is the ´financial innovation of
Schumpeter´. This theory stated that technological advancement produces
opportunities for new profits because of enhanced investments made by
financial institutions/banks in new innovative products. The second theory
is based on the resources employed by the financial institutions to gain com-
petitive advantage and sustainability based on the resources, capabilities and
abilities employed (Barney, 991; Peteraf, Bergen, 2003). The effective perfor-
mance of the banking sector, based on resource-based theory, is customer
centered, hence banks strive to provide superior customer value, attain a
lower level of transactional cost, and achieve higher market share and greater
financial performance. The competitive edge of the banks created long-term
value for their customers while lowering the cost for firms generating superior
value for their customers. Prabha, Dayal and Bhist (2013) stated that innova-
tive products of information and communication technology in the field of
banking not only enhance competitive advantage but also improve adminis-
trative efficiency and aid in diminishing the transaction cost for customers.
The current study aims to fill the gap in the literature and presents origi-
nality in the area, particularly for Pakistan’s banking sector. It will also help

policy makers and the State Bank of Pakistan and have managerial implica-
tions for Pakistan’s banking sector to make further policies and betterment in
this capacity. Therefore, the objective of the study is to measure the impact
of various financial innovative products on the efficiency ratio of deposit
money banks in the country.
Methodology
The study aims at quantifying the impact of innovative methods of pay-
ment used in Pakistan on the efficiency ratio (ER). Secondary data issued by
the State Bank of Pakistan ranging from the period 2007-2016 was used for
analysis. After 2006/2007, the growth rate of e-banking increased tremen-
dously. The decision on time period was to capture the e-installment chan-
nels exchange after the combination practice of 2006/2007. After the com-
bination program of 2006/2007, money deposit banks in Pakistan removed
mechanically determined items to remain in business. The number of inhab-
itants in the study comprised twenty-three (23) banks authorized by the State
Bank of Pakistan (SBP). These banks present their monetary proclamation/
financial statements to the State Bank of Pakistan (SBP) in accordance with
control and authorization procedures. The secondary data for both depend-
ent and independent variables were collected from the annual financial

reports of banks submitted to the State Bank of Pakistan on a yearly basis.
The annual financial statements of all the banks operating in Pakistan can
be found on the official website of the State Bank of Pakistan (www.sbp.org.
pk). Banks’ performance was measured with the help of the efficiency ratio.
This was the measure of aggregate overhead costs against operating income.
E-Views 8.0 was used in this paper to run the entire test applied to secondary
data to measure the financial performance of banks influenced by financial
innovative products. The study has employed four different e-payment meth-
ods used in Pakistan as proxies of financial innovation. These four different
channels are namely: automated teller machines (ATMs), through the Web/
Internet, Point of Sale, and mobile internet. The dependent variable of the
study was measured with the help of the efficiency ratio, while the independ-
ent variables of the study were measured as the value of the transaction at
the ATM (VATM), the value of the transaction on the Web or the Internet
(VWEB), the Value transaction of mobile banking (VMOB), and the Value
of the Point of Sale (VPOS). The algebraic equation of the independent –
dependent variable relationship is as follows:
EFRt= f (VATM, VWEB, VMOB, VPOS)...........................................3.1

Logarithmically changing the variables in the model for the simple eluci-
dation of the coefficients, condition 3.1 is now:
Log EFRt = α0 + α1 Log VATMt + α2 Log VWEBt + α3 Log MOBt
+ α4 VPOSt + Et ...............................................................................3.2
Whereas EFRt was used as the efficiency ratio of deposit money banks in
Pakistan, α0 was constant and α1, α2, α3 and α4 were the coefficient values for
independent variables of the current study, and Et is the error term for the
given time period.
Data analysis and discussion

Descriptive Statistics
The descriptive statistics for dependent and independent variables are presented
in Table 1. The efficiency ratio, the value of the transaction at the Automated
Machine (VATM), the Web/Internet (VWEB), Point of Sale (VPOS), and
Mobile Banking (VMOB), showed mean values 82.0002, 126134, 41235.34,
65765.67 and 35789.09 respectively. The maximum values are for the efficiency
ratio 183.7901, 3567987 for VATM, 89291.04 for VWEB, 419070.0 for VPOS,
and 112809.5 for VMOB. The value of Skewness for each variable given in
the table showed that the data set is positively skewed towards normality. The

values for Jarque-Bera demonstrated that all the taken variables for the current
study are not disseminated confidently, except EFR, owing to the inconsequen-
tial level of probability values (p-value) at the 5 per cent level of significance.
Tableau 1 – Descriptive Statistics
Source : E-views software 8.0

Serial Correlation LM Test

The serial LM test in the current study was employed to measure the serial
correlation effect present in the model/equation and to measure the effect of
autocorrelation in the absence of the Durbin Watson test. The test suggested if
the p-value of the F-statistic is insignificant at the 5% level of significance then
there is no autocorrelation among the residual values. On the other hand, if the
P-value of the F-statistic is significant at the 5% level of significance, autocorre-
lation exists among the residual values. The correlation results of this test show
the insignificant P-value, indicating that residual values are not serially corre-
lated. The results of the test stated below in Table 2 showed that the serial cor-
relation effect is present among the study’s interest variables, while the Durbin
Watson results showed that variables are independent from autocorrelation.
Tableau 2 – Serial Correlation LM Test Result
Heteroskedasticity Test
In the classical linear regression, variance of the residuals must not show
the increasing trend in relation to the dependent variable. Table 4.2b pro-

vides substantiation of the claim that the model employed in this study is
not linked with Heteroskedasticity using the Harvey test. If the P-value of
the F-statistic is momentous at the 5% level, disturbances are present in the
population and are not homoskedastic in nature. There would be no heter-
oskedasticity test existing in the model if the p-values of the F-statistic are
not significant at the level of 5%. The P-values of F-statistic are insignificant
at the 5% level; therefore, the model used in this study has not developed
heteroskedasticity as shown in Table 3.
Tableau 3 – Heteroskedasticity Test Result
RESET Specification
This test particularly gauges the fitness of the model, either whether it was
properly specified or not. The Ramsey Reset null hypothesis specification

stated that the model is quantified as there are no absent variables. The
Ramsey Reset test suggests that if the P-value of the F-statistic is higher than
5% compared to the conventional P-value, null hypothesis of the correct
specification would not be rejected and vice versa. Table 4 demonstrated that
the p value of model fitness at the level of 5% is insignificant (F-statistics),
signifying that the model is free from an endogeneity- causing biased coef-
ficient. The results are presented below in Table 4.
Tableau 4 – Ramsey RESET Specification Result
Stationarity Test
There is an urgent need to consider the time series property of data. The
non-stationarity of time series data has always been regarded as abnormal
in empirical analysis. To avoid the inappropriate and erroneous results from
which implications would become meaningless, the stationarity of data was
checked using the Augmented Dicky-Fuller (ADF) and Phillips-Perron tests.

The principle of the Augmented Dicky-Fuller test is the null hypothesis of
non-stationarity. To reject the null hypothesis, the ADF statistic must be
more negative than the critical values and significant. On the other hand,
the Phillips-Perron test varies because it is a strong test for serial correlation
and time-dependent heteroskedasticities.
Augmented Dickey – Fuller (ADF) Test

The results presented in Table 5 below demonstrated stationarity among all
variables and the data set released from the defect of time series data.
Tableau 5 – ADF test result
Level of significance (*) at 1% and level of significance (**) at 5%

Phillips Perron (PP) Test

To further gauge the stationarity of the variables of the study, the Phillips
Perron (PP) test was directed. The results are presented in Table 6 and dem-
onstrated that variables are stationary.
Tableau 6 – PP test result
Level of significance (*) at 1% and level of significance (**) at 5%
Fixed Effect Model Relationship Financial Innovation

and Efficiency of Deposit Money Banks
The Hausman test is the appropriate tool for panel data to check whether

the random effects model (REM) or the fixed effects model (FEM) could be
applied. In this case, FEM is preferred under the alternative hypothesis due to
higher efficiency, while under the null hypothesis REM is at least as consist-
ent and thus preferred. In Table 7 below, the Hausman test shows that FEM
is preferred to be applied as the Ch-Sq value 87.22 at a significant level is less
than 5 per cent. The R square value is 82 per cent and the adjusted r-square
is 81 per cent as well. The F-statistics are also found to be significant.
The regression test (fixed effect model) results are explained in Table 8.
The values of transactions through ATMs and POS have shown an insignifi-
cantly negative impact with the efficiency ratio. The value of MOB has also
shown a positive but insignificant impact with the dependent variable. The
fourth construct of the independent variable, transactions through the Web/
Internet, has a statistically significant positive relationship with the depend-
ent variable.
A one-unit upsurge in the values of transactions on the Web/Internet and
on mobile banking enhances the value of the dependent variable, namely
the efficiency ratio, by 0.1% and 0.03% respectively. The findings of the cur-
rent study deduce that the ratio of total overhead expenses to operating
profit of deposit money banks can be reduced by the deployment of more

automated teller machines and point of sale terminals and, vice versa, that
this can be achieved for the other two channels, namely through the Web/
Internet and mobile banking. In other words more investments by money
deposit banks in ATMs and POS decrease the operating expenses of the
banks, but such a case is not same for the investment in web/internet bank-
ing. VWEB increases their operating income and it is statistically proven at
the 5% level of significance.
The adjusted R-square shows that those 81% distinctions in the depend-
ent variable (efficiency ratio) of deposit money banks in Pakistan were a
result of change in four channels of transactions, financial innovation i.e
ATMs, web banking, POS and MOB. The p-value and f-statistics 0.000012
and 32.26 respectively showed a good fit of the model.
Tableau 7 – Hausman Test
Tableau 8 – Fixed Effect Model Regression Results

Level of significance at (*) 5%

Impact of financial innovation on bank efficiency

The current study has employed the Granger Causality assessment test to
cautiously gauge the impact of financial innovative products on the banking
sector’s efficiency, and the results are reported in Table 9. The results showed
that there is no significant impact of financial innovation on banks’ efficiency
as the value of transactions through ATMs, the Web/Internet, Point of Sale
(POS), and mobile banking of deposit money banks in Pakistan. On the
other hand, the results of the applied Granger Causality test demonstrated a
unidirectional relationship among the study’s interest variables. It can cau-
tiously be stated that the efficiency ratio exercised a statistically significant
influence on the value of transactions through ATMs. Thus, banks’ operat-
ing income is a contributing factor to investment in ATM infrastructure.
The higher the net operating income, the greater the deployment of ATMs
and also the supplementary maintenance cost.
Assessment Criteria of Granger Causality Result

In the Granger Causality test, if the value of the F-statistic is less than 0.05
then null hypothesis is rejected and vice versa. In the current study, the
results presented in Table 9 demonstrated that the null hypothesis is accepted,
which is; Financial innovation products (ATMs, POS, Mobile Banking, and
the Web/Internet) do not have a significant impact on the efficiency ratio of

deposit money banks in Pakistan.
Tableau 9 – Granger Causality Result
Conclusion of study
The role of financial innovation products, namely, ATMs, the Web/Internet,
POS, and mobile banking in Pakistan, and their impact on the financial
performance of money deposit banks, is quite irrefutable, in spite of the

consistently floating fraudulent risk associated with e-payment platforms

in Pakistan. After the banking consolidation reforms in Pakistan in 2004-
2005, the financial activities of the deposit money banks in Pakistan quickly
increased as they tried, with their foreign competitors, to attain a competi-
tive advantage through the utilization of advanced technologies. The results
of the study revealed that infrastructural investment in automated teller
machines (ATMs) and Point of Sale (POS), relative to the efficiency ratio,
are negatively related, or it can be stated that total transaction value through
ATMs and POS diminishes the operating expenses to net operating income
ratio of Pakistani banks. In aggregate, it is concluded that the four various
products of financial innovation used in the study have no significant impact
on the efficiency ratio of deposit money banks in Pakistan. It is actually the
efficiency ratio that governs the infrastructure of technological advance-
ment, for example financial innovation products. Cautiously, it is concluded
that the efficiency ratio determines the deployment of financial innovation
(information technology) products in the banking sector of Pakistan.
Implications of Study
The negative nexus of ATMs and POS with the efficiency ratio gives prefer-
ence to these two methods as cost effective and efficient for deposit money
banks. The relation of the Web/Internet and mobile banking transactions

with the efficiency ratio is affirmative and cost ineffective. Hence, the
deposit money banks should invest more in ATMs and POS channels as this
decreases the operating expenses to next income ratio, while the other two
existing platforms of the Web/Internet and mobile banking infrastructure
should be managed and utilized effectively, rather than establishing new ones
that will swallow a larger portion of net operating income. However, these
two methods should be redesigned in such a manner that customers would
have easy access to these channels, which would diminish the transaction
cost, enhance customer satisfaction, and eventually improve banks’ efficiency
ratio. In Pakistan, about 35 million people have access to the Internet. Thus,
the State Bank of Pakistan should also take steps to establish financial lit-
eracy programs to teach and to make the public aware of how to use these
innovative products in their best interests. On the basis of the above discus-
sion, there is an urgent need to hold discussion and mediation sessions with
various mobile service providers operating in Pakistan. In other developing
countries like India, 371 million people have access to the Internet, there are
73 million users of the Internet in Bangladesh, while in Nigeria the figure is
about 57.7 million users of the Internet. Thus, the result of the current study
is appropriate for these countries.

Study Recommendations
The study makes the following recommendations based on empirical results
and conclusions:
a) The State Bank of Pakistan (SBP) should take necessary action to
decrease the fraudulent risk associated with electronic payments that
ultimately increases customer trust in using these modes of payments.
b) The SBP should set a target of efficiency ratios to be achieved for
financial institutions.
c) In order to control the operating expenses and increase the efficiency
ratio, the study suggests infrastructural investment by banks in automa-
ted teller machines (ATMs) and Point of Sale (POS).
d) Future research may be conducted incorporating other variables such
as monetary policy and the cash reserve ratio of banks in relation to fi-
nancial innovations.
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Does Financial Innovation Improve Perfromacne An Analysis of Process Innovation Used in Pakistan

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DOES FINANCIAL INNOVATION IMPROVE PERFORMANCE?

De Boeck Supérieur | « Journal of Innovation Economics & Management »

2018/3 n° 27 | pages 195 à 214

Distribution électronique Cairn.info pour De Boeck Supérieur.

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Powered by TCPDF (www.tcpdf.org)

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Muhammad Rizwan ULLAH

n° 27 – Journal of Innovation Economics & Management 2018/3 195

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1. Financial Times ft.com/lexicon (http://lexicon.ft.com/Term?term=financial-innovation)

196 Journal of Innovation Economics & Management 2018/3 – n° 27

etc. Of these several financial innovations, the effect of each innovation

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n° 27 – Journal of Innovation Economics & Management 2018/3 197

development has not only increased the number of banking institutions

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198 Journal of Innovation Economics & Management 2018/3 – n° 27

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n° 27 – Journal of Innovation Economics & Management 2018/3 199

Selected Financial Innovation Products in Pakistani

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200 Journal of Innovation Economics & Management 2018/3 – n° 27

with a minimum transaction cost, saving time in service delivery, and it is a

E-Banking (Electronic Banking)

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Relevant Review of Literature

n° 27 – Journal of Innovation Economics & Management 2018/3 201

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202 Journal of Innovation Economics & Management 2018/3 – n° 27

level of satisfaction were improved by the use of information and communi-

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n° 27 – Journal of Innovation Economics & Management 2018/3 203

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204 Journal of Innovation Economics & Management 2018/3 – n° 27

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n° 27 – Journal of Innovation Economics & Management 2018/3 205

Data analysis and discussion

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Source : E-views software 8.0

206 Journal of Innovation Economics & Management 2018/3 – n° 27

Serial Correlation LM Test

Tableau 2 – Serial Correlation LM Test Result

Source : E-views software 8.0

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Tableau 3 – Heteroskedasticity Test Result

Source : E-views software 8.0

n° 27 – Journal of Innovation Economics & Management 2018/3 207

Tableau 4 – Ramsey RESET Specification Result

Source : E-views software 8.0

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Augmented Dickey – Fuller (ADF) Test

Tableau 5 – ADF test result

Level of significance (*) at 1% and level of significance (**) at 5%

208 Journal of Innovation Economics & Management 2018/3 – n° 27

Phillips Perron (PP) Test

Tableau 6 – PP test result

Level of significance (*) at 1% and level of significance (**) at 5%

Fixed Effect Model Relationship Financial Innovation

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n° 27 – Journal of Innovation Economics & Management 2018/3 209

Tableau 7 – Hausman Test

Tableau 8 – Fixed Effect Model Regression Results