Economic analysis of Information system Investment in Banking Industry

Yasuharu Ukai, Editor

Economic Analysis of Information System Investment

in Banking Industry

Yasuharu Ukai, Editor

Economic Analysis of

Information System

Investment in

Banking Industry

Springer

Yasuharu Ukai

Director and Professor, Research Center of Socionetwork Strategies

Kansai University

Suita, Osaka 564-8680, Japan

This English translation is based on the Japanese original, Yasuharu Ukai, editor; Economic Analysis

of Information System Investment in Banking Industry, Published by Taga-shuppan Co., Tokyo

© 2003 Yasuharu Ukai

Library of Congress Control Number: 2005921901

ISBN 4-431-24204-X Springer-Verlag Tokyo Berlin Heidelberg New York

This work is subject to copyright. All rights are reserved, whether the whole or part of the material is

concerned, specifically the rights of translation, reprinting, reuse of illustrations, recitation, broadcasting,

reproduction on microfilms or in other ways, and storage in data banks.

The use of registered names, trademarks, etc. in this publication does not imply, even in the absence of a

specific statement, that such names are exempt from the relevant protective laws and regulations and

therefore free for general use.

Springer is a part of Springer Science+Business Media

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© Springer-Veriag Tokyo 2005

Printed in Japan

Typesetting: Camera-ready by the editor

Printing and binding: Hicom, Japan

Printed on acid-free paper

To Dale W. Jorgenson,

and Shozaburo Fujino

Preface

This is an academic book that explains in reahty, examines theoretically, and

analyzes statistically information system investment in the banking industry

with regard to the process of the information technology revolution. This kind

of comprehensive research on the banking industry is the first in the world. It

could be seen as an application study for Japanese financial deregulation after

1997. However, our project, the Workshop of Information System Investment,

is a theoretical research venture, consisting originally, when it began in 1994,

of economists and computer scientists. It aimed to measure the effect of com￾puter hardware and software on the modern economy, based on the microdata

of each firm, and to extend the frontiers of economic science. It was, coinci￾dentally, the time when this project began full-scale operation, in July 1997,

that the voluntary closure of Yamaichi Securities was decided. The failure of

the Hokkaido Takushoku Bank was disclosed in November of the same year,

and the breakdown, temporary nationalization, buying out, and mergers of

several banks succeeded one another. Our research therefore suddenly got into

the social spotlight on the application stage.

Part I is the first history and strategic guidelines of information systems in

the banking industry. Part II summarizes the economic analyses of informa￾tion system investment in the United States, Europe, and Japan. These parts

are foundations for the statistical analyses in Part III. Part III categorizes

information system investments in the banking industry into three types and

analyzed them. The treatment of system development and personal expence in

economics is quite different from it in accounting theory. First, the investments

in computer hardware, peripheral equipment, computer software, knowledge

asset concerning system development, and computer related human resource

are defined as Information System Investments I. The accumulated value of

this kind of investments are defined as Information System Assets I. Sec￾ond, the investments in computer hardware, peripheral equipment, computer

software, and knowledge asset concerning system development are defined as

Information System Investments II. The accumulated value of those are de￾fined as Information System Assets IL These types of investments and assets

VIII Preface

will be explained in Chapters 5-9. Third, the investments on the informa￾tion system including strategic planing, product development, and customer

service are defined as Information System Investments III. The accumulated

value of those are defined as Information System Assets III. This definition

will be critical for the analysis in Chapter 5. Information System III is near

concept of strategic information system (SIS) in the USA. Finally, computer

hardware and software investment, and its asset will be analyzed in Chapter

9.

The results of our analyses contradict the prevailing pessimistic expecta￾tions for the financial technical revolution in Japan. First of all, based on

replies to our questionnaires, the positive effect of information system invest￾ment I and II on the market value of a bank is considerable. Its numerical

value is not greatly different from that in the USA manufacturing industry

during the boom. Second, we also found out that the computer software had

a much stronger effect on firm's performance than the hardware.

This conclusion will shock economists performing econometric analysis on

the basis of disclosed data on the industry and macroeconomic levels. We are

preparing ourselves for strong criticism and are looking forward to constructive

discourse.

As this research advanced further, we faced the stark fact that individ￾ual statistics of computer investment by Japanese firms had not been com￾pletely disclosed. The computer-related items in public financial statements

were scattered among computer hardware and software items, and the prin￾ciples of accounting procedure were not unified until April 1999. Therefore,

we are deeply grateful to the information system specialists at each bank for

their academic advices. We will withhold their identities, because the material

they provided must be kept confidential. However, we want to mention Mr.

Yoshiaki Sugita (former director of the system planning department at Fuji

Bank), who was one of the leaders in the field of information technology in

the banking industry.

We also wish to gratefully acknowledge the following persons: Prof. Dale

W. Jorgenson (Harvard University), Dr. Daniel E. Sichel (Federal Reserve

Board), Prof. Erik Brynjolfsson (Massachusetts Institute of Technology), Prof.

Marshall Van Alstyne (Boston University), Dr. Charles King, Prof. Akihiko

Shinozaki (Kyushu University), Prof. Kazuyuki Suda (Waseda University),

Prof. Mitsuru Iwamura (Waseda University), Prof. Kenji Shiba (Kansai Uni￾versity), Ms. Lilia Shiba, Prof. Yoichi Iwasa (Kansai University), Prof. Koichi

Takeda (Hosei University), Prof. Hiroaki Aoki (Hannan University), Prof.

Hideki Nishimoto (Ryukoku University), Mr. Toshitaka Hagiwara (Financial

Accounting Standards Foundation), Mr. Hajime Mizuno (Bank of Japan), Dr.

Kimiaki Aonuma (Bank of Tokyo-Mitsibishi), Mr. Kiyoshi Maenaka (Resona

Bank), Mr. Torn Moroga (Resona Bank), Mr. Shigeo Kiuchi (Resona Bank),

Mr. Yoshiki Oshida (Resona Bank), Mr. Junjiro Kunihiro (Resona Bank), Mr.

Sunao Fujimoto (Resona Bank), Mr. Kenichi Tanai (Resona Research Insti￾tute), Mr. Tokuya Sugamiya (Hitachi Corporation), Mr. Toshikazu Yonekura

Preface IX

(Hitachi Corporation), Mr. Motohiko Ohnishi (The Center for Financial In￾dustry Information Systems). In particular, I deeply appreciate the academic

advice received from Prof. Jorgenson since 1981 when I first set foot in Boston

as a Fulbright Fellow at Harvard University.

This research project has received six grants from Japan Society for the

Promotion of Science, as follows. Grants-in-Aid for Scientific Research, C(l)

1997-2000, "Economic Analyses of Information System Investment in the

Banking Industry" (project number 09630061); B(2) 1999-2002, "The Devel￾opment of an Economic Evaluation Method of Information System Investment

in the Financial Industry" (project number 11553001); B(2) 2001-2004, "The

Micro Data Analyses of Information System Investment in IT-related Indus￾tries" (project number 13430019); Ministry of Education, Culture, Sports,

Science and Technology, Academic Frontier Promoting Project, 2002-2006,

"Policy Studies of Network Strategies as a Social Infrastructure"; Grant-in￾Aid for Publication of Scientific Research Results, 2002 and 2004 "Economic

Analysis of Information System Investment in Banking Industry." (project

numbers 145261 and 165256)

Our research raised many questions that need to be addressed in microe￾conomics, financial systems, and information technology analysis. We hope

that it becomes a milestone in the new academic field of information system

investment.

Yasuharu Ukai

Director, Research Center of Socionetwork Strategies, Kansai University

Senriyama, Osaka, Japan,

December 2004

Contents

Part I Past and Present of Information System Investment in the

Banking Industry

1 Past and Present of Information Systems in Banks 3

1.1 Chronological Changes in Information Systems in Banking.... 3

1.1.1 Off-Line Systems 3

1.1.2 Progress of On-Line Systems 5

1.1.3 Networks around the Banking Industry 16

1.2 Accidents That Affected On-Line Systems and the Lessons

Learned 17

1.2.1 Setagaya Cable Fire 17

1.2.2 The 1992 London Explosion 20

1.2.3 Great Hanshin Earthquake 21

1.2.4 The Year 2000 (Y2K) Problem 23

1.3 Roles of the System Department 24

1.3.1 History of the System Department 25

1.3.2 The Changing Roles of the System Department 27

2 Information System Strategy of Nationwide Banks 29

2.1 Current Banks and Systems 29

2.2 Management Subjects of the Banking System 30

2.2.1 Countermeasures for Changing Conditions 30

2.2.2 Strategy for Competitive Advantage 30

2.2.3 Adjustment to New Technology 32

2.2.4 Strategic Support System 32

2.2.5 Improvement of Customer Services 32

2.2.6 Risk Management 34

2.2.7 Maximizing Business Efficiency 34

2.2.8 System Management 35

2.3 Revolution of Delivery Channels 35

2.3.1 Changes to the Point of Business in the Bank 36

XII Contents

2.3.2 Network Banking Strategy 39

2.4 Creation of Mega Banks and System Problems 42

2.5 Issues 44

2.5.1 Technical Issues 44

2.5.2 System Management 47

Part II Review of Information System Analyses

3 Limit of Aggregate Level Analysis of Information System

Investment 55

3.1 Introduction 55

3.2 Productivity Paradox 57

3.3 Studies of the Whole Economy 58

3.3.1 Growth Accounting 59

3.3.2 Macro Production Function and Cost Function 62

3.3.3 Effect on Consumer-Surplus 63

3.4 Industry-Level Studies 64

3.5 IT Effect on Employment for the Whole Economy 67

3.6 Summary 68

4 Firm-Level Analysis of Information Systems Investment .. . 71

4.1 Introduction 71

4.2 Studies on Productivity 72

4.3 Contribution of IT Capital to Firm Value 78

4.4 Analysis of Organization Effect and Management Strategy

Effect 81

4.5 Effect on Working Conditions 84

4.6 Summary 86

Part III Positive Analyses of Information System Investment in

the Banking Industry

5 Outlook and Study Process of Questionnaires 91

5.1 Background and Study Process of Questionnaire Surveys 91

5.2 The Concept of Information System Investment 99

5.3 Accounting Problems in Information System Investment 101

5.4 Lessons from Questionnaire Surveys 104

6 Disclosure and Circumstances Concerning Information

System Assets 107

6.1 Introduction 107

6.2 Accounting Procedure of Information System Assets 108

6.2.1 Accounting Procedure (1): Computer Software Assets . . 108

Contents XIII

6.2.2 Accounting Procedures (2): Computer Equipment 109

6.2.3 Accounting Procedure of Research and Development

Costs 110

6.3 Computer Software as an Asset 110

6.4 Types of Cooperate Disclosure Il l

6.4.1 Legal and Voluntary Disclosure Il l

6.4.2 Necessity of Disclosure 112

6.5 Information System Assets in Japanese Banks 113

6.5.1 Information System Assets 116

6.5.2 Computer Software 118

6.5.3 Computer Equipment 120

6.5.4 Planned Budget for Information System 122

6.6 Classification of Banks by Information System Assets 123

6.7 Summary 125

Cross-Section Analysis of Information Syste m Investment . 127

7.1 Introduction 127

7.1.1 Definition of Information System Investment and

Questionnaire Items 128

7.1.2 Financial Index and Total Employee Number in

Answering Banks 129

7.2 Various Statistics of Questionnaires 130

7.3 Results of Regression Analysis 143

7.3.1 Information System Development Cost and Loan and

Bills Discounted 144

7.3.2 Information System Development Cost and Total Assets 144

7.3.3 Information System Development Costs and Number

of Personnel 145

7.4 Management Strategy and Investment Activity 146

7.5 Conclusions 148

Analysis of Information Syste m Investment Using

Questionnair e Dat a 149

8.1 Introduction . 149

8.2 Estimated Model and Data Set 151

8.2.1 The Market Value Model: Brynjolfsson and Yang

Type Model 151

8.2.2 Dat a Sources and Construction 153

8.3 Estimated Results 157

8.4 Conclusion 162

Analysis of Information Syste m Investment Usin g Publi c

Dat a 165

9.1 Introduction 165

9.2 Analytical Tools and Data Set 166

XIV Contents

9.2.1 Formation: Model for Panel Data 167

9.2.2 Data Sources and Construction 167

9.2.3 Unbalanced Panel Data and Balanced Panel Data 172

9.3 Estimation 173

9.3.1 Estimation (1) Unbalanced Panel Data Analysis 174

9.3.2 Estimation (2) Balanced Panel Data Analysis 180

9.4 Concluding Remarks: Future Directions and Opportunities

for Research 182

10 Conclusion 187

Part IV Appendix

A Information System Investment Questionnaires 1995-1997 . 193

B Documents about Accounting Standards 207

C Mathematical Appendix 217

References 221

Index 231

Authors

Yasuharu Ukai Director and Professor, Research Center of Socionetwork

Strategies, Kansai University

3-3-35 Yamate-cho, Suita, Osaka, Japan 564-8680

ukaiQrcss.kansai-u.ac.jp

Shinji Watanab e Assistant Professor, College of Integrated Arts and Sci￾ences, Osaka Prefecture University

1-1 Gakuen-cho, Sakai, Osaka, Japan 599-8531

shinj [email protected] p

Hisa o Nagaoka Director, Osaka Securities Finance Co., Ltd. and Associate

Fellow, Research Center of Socionetwork Strategies, Kansai University

3-3-35 Yamate-cho, Suita, Osaka, Japan 564-8680

[email protected]

Toshihiko Takemura Research Assistant, Research Center of Socionetwork

Strategies, Kansai University

3-3-35 Yamate-cho, Suita, Osaka, Japan 564-8680

takemuraOrcss.kansai-u. ac.j p

List of Figures

1.1 Enlargement of business and shifting branches to the new

system 7

1.2 General scheme of the shift to the second-generation on-line

system 11

1.3 General figures of banking network systems 13

1.4 The third-generation on-line system and the hub-and-spoke

type system 14

2.1 Sources of risk surrounding the computer system 35

2.2 Hub-and-spoke type branch networks 37

6.1 Changes in the number of banks in Japan based on charging

computer software 114

6.2 Proportion of banks based on the frequency of writing

computer software in the financial statements more than one

times in the 1993-1999 period 115

6.3 Scatter diagram between computer software assets and

computer equipment for Japanese banks 117

9.1 Share of bad debt in loan and bills discounted in Japanese

banks for 1993 and the 1997-1999 period 170

9.2 Number of Japanese banks using on-line systems at the time. . . 171

List of Tables

1.1 Progress of on-line systems in the banking industry 6

1.2 Lessons from Setagaya cable fire 18

1.3 Lessons from the 1992 London explosion 21

1.4 Lessons from the great Hanshin earthquake 22

1.5 Countermeasures to the Y2K problem 24

2.1 A list of main management problems, main themes, and items

facing information systems 31

2.2 Main services of firm banking and home banking 33

2.3 ATMs in main convenience stores 39

3.1 Studies of IT investment efi'ect on the whole economy 58

3.2 Industry-level studies on economic efi"ect of IT investment 64

4.1 Firm-level studies on economic efifects of IT investment 72

6.1 Number of Japanese banks in the 1993-1999 period 114

6.2 Statistics of information system assets in Japanese banks for

each year during 1993-1999 116

6.3 Statistics of computer software in the 1993-1999 period 119

6.4 Statistics of computer equipment in the 1993-1999 period: I. . . . 120

6.5 Statistics of computer equipment in the 1993-1999 period: II . . . 121

6.6 Statistics of the planned budgets concerning information

systems in the 1993-1999 period 123

7.1 Statistics from answers to the first questionnaire 131

7.2 Statistics from answers to the second questionnaire 132

7.3 Statistics from answers to the third questionnaire 133

8.1 Estimated result using unbalanced panel data (Information

System I) 158