EFFECT OF ONLINE LOAN TECHNOLOGY ON INDIVIDUALS
CHAPTER TWO
LITERATURE REVIEW
2.0 Introduction
This section will explore the various theoretical literatures concerning technological innovation and there effect on financial institutions, empirical literature on relevant studies done in this area will be discussed.
2.1 Theoretical Literature
Literature on effect of online loan technology on individuals are scanty and as such much literature will be drawn from other institutions in the same financial sector like banks, microfinance institutions and other financial intermediaries.
2.1.1Financial Intermediation Theory
Financial intermediation is a process which involves surplus units depositing funds with financial institutions who then lend to deficit units. Matthews and Thompson (2008) identify that financial intermediaries can be distinguished by four criteria: first their main categories of liabilities (deposits) are specified for a fixed sum which is not related to the performance of a portfolio.
Second the deposits are typically short-term and of a much shorter term than their assets. Third high proportions of their liabilities are chequeable this implies that it can be withdrawn on demand and fourth their liabilities and assets are largely not transferable. The most important contribution of intermediaries is a steady flow of funds from surplus to deficit units.
In the traditional Arrow-Debreu model of resource allocation, firms and households interact through markets and financial intermediaries play no role. When markets are perfect and complete, the allocation of resources is Pareto efficient and there is no scope for intermediaries to improve welfare. Moreover, the Modigliani-Miller theorem applied in this context asserts that financial structure does not matter: households can construct portfolios which offset any position taken by an intermediary and intermediation cannot create value (Fama, 1980).
Such an extreme view that financial markets allow an efficient allocation and intermediaries have no role to play- is clearly at odds with what is observed in practice. Historically, banks and insurance companies have played a central role. This appears to be true in virtually all economies except emerging economies which are at a very early stage. Even here, however, the development of intermediaries tends to lead the development of financial markets themselves. (McKinnon, 1973).
The understanding of the role or roles played by these intermediaries in the financial sector is found in the many and varied models in the area known as intermediation theory. These theories of intermediation have built on the models of resource allocation based on perfect and complete markets by suggesting that it is frictions such as transaction costs and asymmetric information that are important in understanding intermediation.
Gurley and Shaw (1960) and many subsequent authors have stressed the role of transaction costs. For example, fixed costs of asset evaluation mean that intermediaries have an advantage over individuals because they allow such costs to be shared. Similarly, trading costs mean that intermediaries can more easily be diversified than individuals.
Financial intermediaries exist because they can reduce information and transaction costs that arise from an information asymmetry between borrowers and lenders. Financial intermediaries thus assist the efficient functioning of markets, and any factors that affect the amount of credit channeled through financial intermediaries can have significant macroeconomic effects. (Rothschild&Stiglitz,1976).
HELB acts as a financial intermediary in allocating finances from surplus sources which may include government and other philanthropists in form of loans, bursaries and scholarships to the deficit areas or agents i.e. the universities which need tuition fees to facilitate their programs and the students who need money for upkeep in those institutions of higher learning.
2.1.2Information Asymmetry
The concept of asymmetric information was first introduced in (George, 1970) paper The Market for "Lemons": Quality Uncertainty and the Market Mechanism. In the paper, (George, 1970) develops asymmetric information with the example case of automobile market. His basic argument is that in many markets the buyer uses some market statistics to measure the value of a class of goods. Thus the buyer sees the average of the whole market while the seller has more intimate knowledge of a specific item.
(George, 1970) argues that this information asymmetry gives the seller an incentive to sell goods of less than the average market quality. The average quality of goods in the market will then reduce as will the market size. Such differences in social and private returns can be mitigated by a number of different market institutions.
This theory is based on the notion that the borrower is likely to have more information than the lender about the risks of the project for which they receive funds. This leads to the problems of moral hazard and adverse selection (Matthews & Thompson, 2008). These problems reduce the efficiency of the transfer of funds from surplus to deficit units.
Numerous authors have stressed the role of asymmetric information as an alternative rationalization for the importance of intermediaries. One of the earliest and most cited papers, Leland and Pyle (1977) suggests that an intermediary can signal its informed status by investing its wealth in assets about which it has special knowledge.
In another important paper, (Diamond, 1984) has argued that intermediaries overcome asymmetric information problems by acting as "delegated monitors." Many others followed, expanding on these two contributions and advancing the literature in substantive ways Gale and Hellwig,(1985).
The banks overcome these problems in three respects: First by providing commitment to long term relationships with customers, Secondly through information sharing and thirdly through delegated monitoring of borrowers. Under direct financing, it is necessary for a lender to collect information to try to redress the information asymmetry. HELB is directly affected by this theory as many investors may want to shy away from investing in the scheme despite heavy investments in terms of modernization of technology and use of current debt management principles. The issue of asymmetric information can also be a reason that HELB has continued to function since loanees may fear to default with the fear of being penalized or prosecuted as specified in the HELB Act (1995) without trying to investigate how many of such kind of individuals have been prosecuted and what was the outcome of that case.
2.2 Theories of technological innovation
The introduction of a new information system or the upgrading of an existing system can be seen as an innovation as, in each case, the result will be something that is seen as new by those involved in its use. The most widely accepted theory of how technological innovation take place is provided by Innovation Diffusion.
Another approach however, that of Innovation Translation which draws on the sociology of translations, more commonly known as actor network theory (ANT), also has much to offer. This is according to (Arthur 2...) in his working paper Information Systems Innovation – two Different Models. Innovation diffusion is based on the notion that adoption of an innovation involves the spontaneous or planned spread of new ideas and Rogers defines an innovation as:
―an idea, practice, or object that is perceived as new.‖ (Rogers, 1995).
2.2.1 The Theory of Innovation Diffusion
In diffusion theory the existence of an innovation is seen to cause uncertainty in the minds of potential adopters (Berlyne,1962) uncertainty implies a lack of predictability and of information. Diffusion is considered to be an information exchange process amongst members of a communicating social network driven by the need to reduce uncertainty (Rogers, 1995).
Uncertainty can be considered as the degree to which a number of alternatives are perceived in relation to the occurrence of some event, along with the relative probabilities of each of these alternatives occurring. Those involved in considering adoption of the innovation are motivated to seek information to reduce this uncertainty (Rogers, 1995).
Diffusion theory contends that a technological innovation embodies information, and so its adoption acts to reduce uncertainty. In illustration of this Rogers cites the innovation of solar panels as reducing uncertainty over future energy costs and reliability of energy supply. The new ideas upon which an innovation is based are communicated over time, through various types of communication channels, among the members of a social system. There are thus four main elements of any theory of innovation diffusion: characteristic of the innovation itself, the nature of the communication channels, the passage of time, and the social system through which the innovation diffuses (Rogers, 1995).
Rogers‘s argues that the attributes and characteristics of the innovation itself are important in determining the manner of its diffusion and the rate of its adoption. Borrowing from the work of Thomas and Znaniecki (1927) he notes that it is what potential adopters perceive to be the attributes of an innovation that is the important thing.
Rogers‘s outlines five important characteristics of an innovation which, he argues, affect its diffusion: Relative advantage, this is the degree to which an innovation is perceived as better than the idea it supersedes. Relative advantage is often expressed in terms of economic profitability, social prestige, or other similar benefits. Rogers contends that an innovation‘s relative advantage is positively correlated with its rate of adoption.
Compatibility or the degree to which an innovation is perceived by potential adopters as being consistent with their existing values and past experiences. Compatibility with what is already in place makes the new idea seem less uncertain, more familiar, and helps to give it meaning. This is important because―the rate ofadoption of anew idea isaffected by theold idea thatit supersedes‖ (Rogers, 1995).(Rogers, 1995) claims that the perceived compatibility of an innovation is positively related to its rate of adoption.
Complexity or the degree to which an innovation is perceived as difficult to understand and use. Rogers claims that the more complex the innovation, the less likely it is to be quickly adopted. In support of this conjecture Rogers and Daley (1980) point out that in the late 1970s, a period of six to eight weeks of extreme frustration characterized the adoption of a new home computer. Trainability is the degree to which a particular innovation may be subjected to limited experimentation. Rogers‘ research suggests that if a potential adopter is able to ‗play‘ with the innovation before being faced with an adoption decision, then adoption is more likely.
Observability the more the results of an innovation are visible to others, the more likely the innovation is to be adopted. Rogers cites their high observability in public places and in the media as an explanation for the rapid take-up of video games such as Nintendo, and of cellular telephones.
Attributes of the potential adopter are also seen as an important consideration in the adoption of an innovation. Rogers maintains that these attributes include social status, level of education, degree of cosmopolitanism and amount of innovativeness. A slightly different slant on adoption is offered by Abrahamson and Rosenkopf (1993) who describe what they call the ‗bandwagon effect‘. They argue that there are times when people or organizations adopt innovations, not because of their technical properties, but because of the sheer number of others that have already made the adoption.
The bandwagon effect can be one of the reason for adoption of technology, for a very long time the board was hesitant to employ new technology despite its peers like banks absorbing new technologies very fast, the sluggish pace could be attributed to a perception about government entities but a time came when the pressure to finance new students became overwhelming amidst dwindling rate of recoveries. In this regard ways of increasing recoveries and HELB s operations arose and technology became inevitable.
2.2.2 The Theory of Innovation Translation
An alternative view of innovation is that of innovation translation proposed in actor-network Theory (ANT). The core of the actor-network approach is translation (Law, 1992) which can be defined as: ―The means by which one entity gives a role to others.‖ (Singleton &Michael, 1993)
A common approach to researching innovation in Information Systems is to focus on the technical aspects of an innovation, and to treat ‗the social‘ as the context in which its development and adoption take place. Approaches of this type which contend that only the ‗most appropriate‘ innovations are adopted, and that only those ‗sensible people‘ who make these adoptions go on to prosper, assume that all outcomes of technological change are attributable to the ‗technological‘ rather than the ‗social‘ (Grint&Woolgar, 1997).
At the other extreme social determinism holds that relatively stable social categories can be used to explain technological change (Law &Callon, 1988) concentrates on the investigation of social interactions, relegating the technology to context; to something that can be bundled up and forgotten. This bundling means that fixed and unproblematic properties or ‗essences‘ can then be assigned to the technology and used in any explanation of change.
Innovation diffusion asserts that a technological innovation embodies ‗information‘: some essential capacity or ‗essence‘ that is largely responsible for determining its rate of adoption (Rogers, 1995).The rate of adoption may be fast or slower depending on the causal factors, at Higher education loans board, increase in the number of students accessing higher education placed much pressure on its operations and technology was necessary to solve this issue otherwise the whole programme could be in a mess, management of good records is essential for the success of any credit institution and technological innovations help in maintaining a good database
2.5 Empirical Literature
Agboola (2001) studied the impact of computer automation on the banking services in Lagos and discovered that Electronic Banking has tremendously improved the services of some banks to their customers in Lagos. The study was however restricted to the commercial nerve center of Nigeria and concentrated on only six banks. He made a comparative analysis between the old and new generation banks and discovered variation in the rate of adoption of the automated devices.
Aragba (1998) wrote on the application of information technology in Nigerian banks and pointed out that IT is becoming the backbone of banks‘ services regeneration in Nigeria. He cited the Diamond Integrated Banking Services (DIBS) of Diamond Bank Limited and Electronic Smart Card Account (ESCA) of All States Bank Limited as efforts geared towards creating sophistication in the banking sector.
Ovia (2000) discovered that banking in Nigeria has increasingly depended on the deployment of Information Technology and that the IT budget for banking is by far larger than that of any other industry in Nigeria. He contended that On-line system has facilitated Internet banking in Nigeria as evidenced in some of them launching websites. He found also that banks now offer customers the flexibility of operating an account in any branch irrespective of which branch the account is domiciled. Cashless transactions were made possible in our society of today.
There is a multiplicity of different actual and measured effects of new technologies on productivity growth and industry structure. Some new technologies – such as ATMs in the early 1980s and possibly Internet banking currently or in the near future – may increase productivity significantly in terms of the quality of the service to the consumer, but these benefits may not be easily measured.
Firms may provide the higher quality without charging the full costs due to competitive pressures. In contrast, some new technologies – such as the innovations in processing electronic payments may have very significant and easily observable effects in terms of productivity gains and increased scale economies. Some new technologies – such as innovations in information exchanges may alternatively have significant benefits that can only be measured with nontraditional methods, such as examining the composition of the loan portfolio (Berger, (2002).
The finding that large banks tend to adopt innovations earlier also holds for other banking technologies including the adoption of ATMs (e.g., Hannan and McDowell 1984), securitization and off-balance sheet financial activities and the new portfolio risk models for dealing with proposed Basle international capital standards ( Berger &Udell, 1993).
Similarly, small banks can gain access to other large-scale technologies. For example, small banks in the U.S take advantage of scale-efficient processing of paper payments provided by large institutions and are able to tap into nationwide and worldwide ATM networks without each bank setting up its own expansive network. Even some of the benefits of new complex risk management technologies may filter to banks too small to create their own systems through outsourcing, e.g., by purchasing portfolio risk models such as Credit Metrics or Credit Risk (Gordy, 2000).
However, access to these technologies does not necessarily mean that small banks can use these technologies at the same unit cost as large banks – the parties providing the back-office services may charge a relatively high fixed cost or offer significant volume discounts that put small banks at a disadvantage, which may help explain why small banks may be slower to adopt new technologies.
Research suggests that the effects of a new technology may differ very significantly with the way in which it is implemented. The research on front-office technologies suggests that combining new technologies with existing technologies to offer more consumer choice may often be the most effective implementation strategy.
In the 1980s, banks generally combined the new ATM networks with traditional physical offices and today, the large banks that serve most customers are adding transactional Internet sites to their physical offices and ATM networks. For back-office technologies, the implementation strategy also appears to matter. The Federal Reserve appeared to achieve dramatically lower unit costs in processing electronic payments in part by consolidating operations to take advantage of scale economies. The effects of small business credit scoring on lending also appear to vary considerably with whether the bank follows ―rules ―versus exercises more ―discretion‖ and other factors (Allen, 2005).
Zheng and Zhong (2005) examined the trend in the internet revolutions that have set the Chinese banking sector in motion and the factors which have influenced the adoption of information technology in China. It was revealed that internet availability, awareness, attitude towards change, computer and internet access, cost, trust in one bank, security concerns, ease of use and convenience were the major factors affecting the adoption.
Al-Hajri (2008) examined various factors that might act to determine whether a given technology is likely to be adopted by the banking industry in developing country such as Oman by comparing it with a developed country such as Australia. The result indicated that relative advantage, organizational performance, Customer organizational relationship and ease of use, can shed light on the reasons for adoption of Internet technology.
An exploration done by Singhal and Padhmabhan (2008) revealed that utility request, security, utility transaction, ticket booking and funds transfer were major factors contributing to internet banking adoption examined predictors of intention among users of internet banking to continue using IB services. It was revealed that trust was the strongest predictor followed by compatibility and ease of use.
Mirzal(2009) revealed a significant difference between demographic and attitude of users and non-user groups. The majority of customers were very comfortable and willing to use IB services. Security concerns, lack of technological knowledge and awareness stood out as being obstacles to the adoption of Internet Banking.
Yuttapong (2009) investigated the factors impacting the adoption of internet banking and found that complexity had a negative relationship with intention to adopt the internet banking in Thailand. Further, it was indicated that compatibility had a high positive relationship with intention to adopt IB.
Al-ghamdi and King (2009) explored how IB affects the relationship between customers‘ trust and their loyalty. The study also examined how factors may affecting IB usage can be different in UK and Saudi Arabia. The study considered privacy aspects, communication, customer experience, usefulness, self-efficacy and ease of use as major factors trust and customer loyalty.
Shirley and Sushanta (2006) studied the impact of information technology on the banking industry and analyzed both theoretically and empirically how information technology (IT related products are internet banking, electronic payments, security investments, information exchanges.
(Berger, 2003) related how spending can affect bank profits via competition in financial services that are offered by the banks. Using a panel of 68 US banks for a period of over 20 years to estimate the impact of IT on profitability of banks, they found out that though IT might lead to cost saving, higher IT spending can create network effects lowering bank profits.
They further contend that the relationship between IT expenditures and bank‘s financial performance is conditional to the extent of network effect. They say that if network effect is too low, IT expenditures are likely to; reduce payroll expenses, increase market share, and increase revenue and profit. The survey of literature indicates that many researchers have examined factors affecting IB adoption, trends in different countries but not in Kenya. (Nyangosi, 2009)