Category: financial innovation process

Innovation for Financial Services Summit – Luxembourg, 19th – 21st September, 2012

The Luxembourg conference, to me was very worthwhile. The sessions mainly focused on innovations in retail banking. There were very small groups in most sessions and this made discussions very interactive and interesting. In terms of networking, I would say there were lots of opportunities. All the participants were open and willing to talk.

The following are key points that I find interesting and important to my research:

  • Financial innovation specifically, over decades, has brought many benefits to society, however some have brought negative outcomes and this is due to the lack of adequate supervision.
  • Findings from a self -assessment research show that
    • Only half of sampled banks have an innovation strategy
    • Only 43% of the banks he evaluated had a clear innovation metrics
    •  More banks are aiming to be innovation followers rather than leaders
    • In terms of performance, banks rate themselves higher in channels and lower in processes.
  • Innovation exists on a sliding scale from radical to incremental
  • Is there a trade-off between regulation and financial innovation? It depends on a lot of factors; however, there are three possibilities where regulation will encourage, discourage or not cause any impact to financial innovation.
  • The ability for regulation to identify innovations that aid bubbles and panics will always be a challenge; and it is not possible to have a right model for regulating financial innovations. Thus regulation should focus mainly on increasing transparency and decreasing regulatory uncertainty in order to maximize benefits and limit negative impacts.
    • Complexity (e.g. CDO, CDO squared, CDO cubed) is not innovation
    • Leverage is not innovation – it is people taking a huge amount of risk
    • Transparency usually helps innovation
    • Basel III as a regulation helps reduce leverage based innovations, but it could lead to more innovations that are not necessarily good.

 

What is financial innovation?

mortgage-backed-securities

According to the Oxford Dictionary, the term finance can be used as both a noun and a verb in slightly different ways. While it refers to the monetary resources of a state, organization or person when used as a noun, it can also mean, not only providing funding for a person or an enterprise, but also managing effectively large sums of money when used as a verb.  Despite the slight variations in what the concept of finance means, it is evident that money is a key factor in finance; thus it can be said that the history of finance, spans thousands of years into history, starting from when the concept of money was introduced. To this end, it can be argued that financial innovation has been since the existence of man; and the advance of civilization has played a great role in its development overtime.

Although we mostly tend to think about financial instruments for investments (such as bonds, stocks, options, swaps, futures and other structured financial products) when the term is used, it actually encompasses a lot more to include process management products and services such as point of sale terminals, debit and credit cards, credit scoring, electronic trading and on-line, mobile and telephone banking among others. In general innovation theory, most researchers have highlighted the element of “newness” as key in defining innovation. However, in practical terms, it can be said that nothing is entirely new in itself. Thus experts in financial innovation explain that financial innovation involves not only the creation and popularization of new financial products, processes, markets and institutions, but the unbundling and reassembling of the characteristics and risks of already existing instruments to form different combinations. It is interesting to note that financial innovations are largely incremental but very complex and globalized. Therefore the riskiness of financial innovations do not derive from the creation of radical innovations, but from the development of several incremental improvements to already existing products in a very complex and globalized context.

Surprisingly, research undertaken so far suggest that the financial innovation landscape is poorly characterised and no model of financial innovation exists. This is quite alarming as we cannot attempt to address the negative concerns of financial innovation without understanding the process within which it is developed. Probably, we can take clues from the new products/service development process in financial institutions as a way of developing a model for financial innovation as a whole. To this end, it can be inferred that the financial innovation process has similarities with the traditional stage-gate model, comprising four or five stages (e.g. problem recognition, concept development, market research and assessment, concept testing and implementation). Nevertheless, financial innovation differs slightly as it involves what is known as the “innovation spiral”; a process where one financial innovation begets another. Further, financial innovations normally have a short lead time, with development and commercialization taking place within months and days respectively. These suggest that the financial innovation process is a complex one; and this is probably a justification for why a model of financial innovation, does not seem to exist at the moment.

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