Financial Innovation – Key to Growth
There are many versions of the expression “financial innovation”. In broad-spectrum, it denotes to the development and promotion of different types of securities. Financial innovation can be termed as the transformation of a thought process into products and services with financial worth.
Innovation can be categorized as the following:
• Launch of a new product or modification to the existing product.
• Process improvement.
• Access to new markets.
• Establishment of new supply channels.
• Transformation in the organizational structure.
Thereby, financial innovation is a vital factor in an era of globalization.
Financial systems play a key role in the economy. Banks have significant socio-economic importance. According to some experts, financial mediums are needed to identify the correct investment. It would be prudent to provide cash to a prominent financial institution.
Key roles played by the financial system:
• Connect the lenders of funds and the users of funds.
• Arrange a dynamic spot and futures market for critical commodities and financial instruments.
• Organize payment services to various stakeholders in the economy.
• Deliver insurance services-life, property and liability.
Banks combine the risks on their balance sheet. These ensures the depositors are not impacted by a discrete risk, but instead are exposed to the complete portfolio. Thus, the financial institution decreases the distinctive risk.
Financial institutions deliver “maturity transformation” by using short-term deposits from the domestic savings to fund long-term loans to enterprises.
Financial institutions maintain a gamut of assets (various loans to the companies) along with using a distinct combination of equity and debt related to the liability. Banks provide investment opportunities to the investors.
Investors can choose between a safe debt instrument or an extremely risky, but possibly high-yielding equity. This expands investment options to the probable investors.
Financial institutions provide cost advantage to the economy due to following reasons:
• They have the capability to filter and assess the borrowers.
• They can decipher some refined indicators, which enables them to conduct the specified functions efficiently.
In recent years, technology has played a huge role in transforming the financial system. Financial intermediaries are enhancing their prominence year-on-year. The word “financialization” has become prominent and is being used on a daily basis.
In the last three decades, the growth of the financial system has been reflected in two critical progresses: enhanced leverage and increased transaction volumes covering various types of financial instruments. Such trends can also be witnessed in the commodities future markets.
According to some experts, the profitability of lending has come down in the last two decades. A critical measure of effectiveness of lending is the Net Interest Margin. It is elucidated as the variance between interest rate the borrowers have to pay and interest rate the lenders receive.
If financial institutions must maintain a robust revenue development and enhance the shareholders rates of return, they must compensate for the reducing profitability in the critical lending function by expanding into alternate services and products.
It is not easy to ascertain the correlation between profitability and financial products. However, according to available evidence, it can be concluded that highly pioneering products are more profitable than traditional products.
Financial innovation has both merits and demerits. Any innovation based on technology along with advancement in Mutual funds, Index funds, ETFs makes it cost effective for the investor to invest in a varied portfolio of equity securities.
On the other hand, though private equity provides funds for new ventures, they are controversial in nature. It is difficult to measure their risk because they function in confidentiality. Futures products, credit default swaps have been related to extreme speculation.
The financial innovations of the 1980s such as Adjustable Rate Mortgages, Asset-Backed Securities, CDOs, SIVs and Credit Default Swaps have concurred with the series of deregulation in the developed economies. Again, the duration of deregulation matched termination of the normal investment banking business.
The process of deregulation along with the modified legal structure enhanced opportunities for the financial institutions, but also significantly enlarged competition among various players in the financial sector.
Financial products have become very complex in nature over a period of time. The complexity has led to an increase in product fees. The high fees are justified because the products provide value to the clients and contribute to effective capital distribution.
Often, customized intricate products are traded over the counter. It becomes difficult for financial stakeholders to measure the risk. At the same time, complex products contribute immensely to enhancing market effectiveness.
Financial innovation has to some extent contributed to the global meltdown in 2008. According to Joseph Stiglitz, Professor of Economics at Columbia University and recipient of the Nobel Memorial Prize in Economic Sciences (2001), “The worst elements of the US financial system, such as toxic mortgages, were exported around the world, in the name of innovation, and any regulatory initiative was fought away with claims that it would suppress that innovation. They were innovating, all right, but not in ways that made the economy stronger. The innovators were mainly devoting their talents to getting around standards and regulations designed to ensure the safety of the banking system.”
However, some experts believe, innovation along with macroeconomic disparities, low-cost capital, too much leverage and regulatory failings led to the financial crisis.
Financial innovation plays a vital role in boosting the intentional economy and would create opportunities for economic development. It would assist in resolving economic issues in developed and emerging economies.
Financial stakeholders must come up with methods to leverage the positive effects of financial innovation while reducing the negative effects. Several contingencies essential to the growth of global economy need a certain proportion of financial innovation.
Innovation can be categorized as the following:
• Launch of a new product or modification to the existing product.
• Process improvement.
• Access to new markets.
• Establishment of new supply channels.
• Transformation in the organizational structure.
Thereby, financial innovation is a vital factor in an era of globalization.
Financial systems play a key role in the economy. Banks have significant socio-economic importance. According to some experts, financial mediums are needed to identify the correct investment. It would be prudent to provide cash to a prominent financial institution.
Key roles played by the financial system:
• Connect the lenders of funds and the users of funds.
• Arrange a dynamic spot and futures market for critical commodities and financial instruments.
• Organize payment services to various stakeholders in the economy.
• Deliver insurance services-life, property and liability.
Banks combine the risks on their balance sheet. These ensures the depositors are not impacted by a discrete risk, but instead are exposed to the complete portfolio. Thus, the financial institution decreases the distinctive risk.
Financial institutions deliver “maturity transformation” by using short-term deposits from the domestic savings to fund long-term loans to enterprises.
Financial institutions maintain a gamut of assets (various loans to the companies) along with using a distinct combination of equity and debt related to the liability. Banks provide investment opportunities to the investors.
Investors can choose between a safe debt instrument or an extremely risky, but possibly high-yielding equity. This expands investment options to the probable investors.
Financial institutions provide cost advantage to the economy due to following reasons:
• They have the capability to filter and assess the borrowers.
• They can decipher some refined indicators, which enables them to conduct the specified functions efficiently.
In recent years, technology has played a huge role in transforming the financial system. Financial intermediaries are enhancing their prominence year-on-year. The word “financialization” has become prominent and is being used on a daily basis.
In the last three decades, the growth of the financial system has been reflected in two critical progresses: enhanced leverage and increased transaction volumes covering various types of financial instruments. Such trends can also be witnessed in the commodities future markets.
According to some experts, the profitability of lending has come down in the last two decades. A critical measure of effectiveness of lending is the Net Interest Margin. It is elucidated as the variance between interest rate the borrowers have to pay and interest rate the lenders receive.
If financial institutions must maintain a robust revenue development and enhance the shareholders rates of return, they must compensate for the reducing profitability in the critical lending function by expanding into alternate services and products.
It is not easy to ascertain the correlation between profitability and financial products. However, according to available evidence, it can be concluded that highly pioneering products are more profitable than traditional products.
Financial innovation has both merits and demerits. Any innovation based on technology along with advancement in Mutual funds, Index funds, ETFs makes it cost effective for the investor to invest in a varied portfolio of equity securities.
On the other hand, though private equity provides funds for new ventures, they are controversial in nature. It is difficult to measure their risk because they function in confidentiality. Futures products, credit default swaps have been related to extreme speculation.
The financial innovations of the 1980s such as Adjustable Rate Mortgages, Asset-Backed Securities, CDOs, SIVs and Credit Default Swaps have concurred with the series of deregulation in the developed economies. Again, the duration of deregulation matched termination of the normal investment banking business.
The process of deregulation along with the modified legal structure enhanced opportunities for the financial institutions, but also significantly enlarged competition among various players in the financial sector.
Financial products have become very complex in nature over a period of time. The complexity has led to an increase in product fees. The high fees are justified because the products provide value to the clients and contribute to effective capital distribution.
Often, customized intricate products are traded over the counter. It becomes difficult for financial stakeholders to measure the risk. At the same time, complex products contribute immensely to enhancing market effectiveness.
Financial innovation has to some extent contributed to the global meltdown in 2008. According to Joseph Stiglitz, Professor of Economics at Columbia University and recipient of the Nobel Memorial Prize in Economic Sciences (2001), “The worst elements of the US financial system, such as toxic mortgages, were exported around the world, in the name of innovation, and any regulatory initiative was fought away with claims that it would suppress that innovation. They were innovating, all right, but not in ways that made the economy stronger. The innovators were mainly devoting their talents to getting around standards and regulations designed to ensure the safety of the banking system.”
However, some experts believe, innovation along with macroeconomic disparities, low-cost capital, too much leverage and regulatory failings led to the financial crisis.
Financial innovation plays a vital role in boosting the intentional economy and would create opportunities for economic development. It would assist in resolving economic issues in developed and emerging economies.
Financial stakeholders must come up with methods to leverage the positive effects of financial innovation while reducing the negative effects. Several contingencies essential to the growth of global economy need a certain proportion of financial innovation.
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