Posts tagged: history of financial innovation

What is financial innovation?

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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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