Digital transformation, income diversification, and bank stability: Evidence from an emerging economy

Abstract

This study examines the impact of digital transformation on the financial stability of commercial banks, with a particular focus on the moderating role of income diversification in this relationship. Using a panel dataset of 22 Vietnamese commercial banks over the period 2010–2023, this study applies the System Generalized Method of Moments estimator to account for endogeneity, dynamic effects, and unobserved heterogeneity. Digital transformation is measured through a text-mining approach based on data extracted from annual reports, while financial stability is assessed using the Z-score. Income diversification is proxied by the share of non-interest income in total revenue. The results indicate that digital transformation and income diversification independently and significantly enhance financial stability. Furthermore, the interaction between the two is statistically significant, suggesting that the stability gains from digital initiatives are amplified when banks maintain a more diversified income structure. Component-level analysis further reveals that investments in data analytics and payment infrastructure are key contributors to resilience, while fintech adoption and cybersecurity disclosures do not show significant effects. These findings highlight the importance of aligning digital transformation with income diversification to strengthen bank stability. The study offers practical insights for bank managers and policymakers, emphasizing the need for targeted digital investments and supportive regulatory frameworks to ensure sustainable innovation in the banking sector.