Financial innovation in retail and corporate banking pdf

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Bank Risk, Governance and Regulation pp Cite as. Innovation has been a core topic for scholars, because of its important contribution to economic growth and to the stability of financial systems Levine, ; IMF, ; Lerner and Tufano, New financial products, such as the securitisation of assets, were believed to have tremendous potential for the diversification and efficient management of risk Merton, ; Mendoza et al. The financial crisis that started in changed those beliefs, as excessive risk-taking in some specialized innovating products brought down the financial system and produced the deepest and most prolonged economic crisis since the Great Depression. Recent studies now blame excessive growth of the financial economy as detrimental to the growth of the real economy Levine, ; Rajan, ; Piazza, ; Shin, ; Johnson and Kwak,

1 Financial innovation in banking

To browse Academia. Skip to main content. By using our site, you agree to our collection of information through the use of cookies. To learn more, view our Privacy Policy. Log In Sign Up. Download Free PDF. Financial innovation: theoretical issues and empirical evidence in Italy and in the UK International Review of Economics, Francesca Arnaboldi.

Bruno Rossignoli. Download PDF. A short summary of this paper. Financial innovation: theoretical issues and empirical evidence in Italy and in the UK. Financial innovation. Theoretical issues and empirical evidence in Europe F. Nowadays, also due to the present financial systems situation, it comes to further relevance. In the first part of the paper, we try to clearly identify the phenomenon and draw a general framework.

Despite the relevance of financial innovation, a unique definition is hard to find. We then provide empirical evidence of such innovations on a sample of European listed banks Euronext, London Stock Exchange and Borsa Italiana over the period using annual reports information.

First the absence of mentions of a specific organizational unit in charge of research and development is highlighted. Second, innovation seems to be mainly concentrated in the product area, in all stock exchanges considered.

Third, larger banks seem more innovative. E-mail: farnaboldi unimi. Introduction Banking systems in industrialized countries are subject to ongoing change and questions about the main drivers of such change would promptly receive the following answers: trends in financial service demand; technological innovation; deregulation and subsequent regulation, known as regulatory dialectic; mergers, acquisitions and strategic agreements; competition; globalization; supply diversification; economic volatility.

These eight drivers of change had been predicted just less than three decades ago, at the beginning of financial system deregulation Freeman, This process has been pursued with varying intensities according to the different institutional contexts. In relatively more recent times the Bank for International Settlements focuses on two significant factors for transformation of financial systems — namely technological innovation and persisting deregulation — and examined their benefits and risks in the light of the experience developed in the last decade of the past century.

The deregulation of banking systems, in particular, promotes economic growth through improved allocation efficiency and a reduction of financial service costs. On the other hand, increasing attention has be devoted to the instability as a result from stronger competitive pressures and from the subsequent erosion of revenue margins, but particularly from the potential incentive to banks to restore these margins through bad policies, or even bad banking.

In a large number of industrial and emerging market economies, taxpayers have in recent years paid out a significant share of GDP to support and recapitalise failed banking systems. All too frequently, the subsequent macroeconomic effects in terms of lost output and rising unemployment have been considerably more costly.

Under the ongoing pressure of the eight drivers of change, banks have pursued strategies aimed at achieving a competitive advantage, in order to create more value than their competitors. In relation to the company size and to market features, such strategies combine diversification of activities with cost leadership in a variety of ways, attributing a primary role to financial product and process innovation.

This phenomenon has always characterized the evolution of financial activities to a varying extent, but becomes more and more evident in the past fifteen years, particularly as a consequence of technological innovation and deregulation. Acceleration of speed and of formats can be envisaged, with changes — sometimes radical — in the processes and organizational structures of financial firms, with the creation of more and more complicated financial instruments and of secondary markets for trading, and with the development of engineering aimed at the transfer and subsequent allocation of specific risk types.

This paper includes multiple sections. It first provides the main definitions of financial innovation section 2.

Then it considers Italian banks as an example to discuss on certain profiles of technological innovation section 3. Finally, after a few necessary preliminary statements section 4. A total of 46 banks are reviewed, covering most of the respective markets in terms of total assets. Section 5 contains the conclusions and a few hints for discussion. Solow highlights that just a small fraction of per-capita growth is due to an increase in the capital-labour ratio, thus drawing attention on the role that technological advances play in welfare improvement.

Tirole points out to three subsequent steps in research: basic research, aimed at developing basic knowledge, and mainly carried out in universities and government agencies; applied research, associated with engineering; development, which allows to use products and processes commercially. In the industrial economy, a distinction is made between product innovation and process innovation. The former outlines new products and services, while the latter reduces the cost for the production of existing goods.

Indeed, this distinction is not always clear because, for example, product innovation for one company can turn into process innovation for another. Each innovation creates information that can be used by other companies at lower or no cost.

While all companies are ready to use this information, none is willing to make the investments required, without a reasonable expectation to obtain an appropriate profit. This is generally achieved through the mechanism of patents, which allows a company to work as in a monopoly for some time, thus ensuring full return on its investment.

It should be noted that a non-patented innovation can also be a source of profit if a monopoly is temporary created, for example because such innovation includes traits unknown to competitors or because too much time is required to imitate it.

A description of the models of innovation may be added to this first proposed definition of financial innovation. Early models in industrial economy can hardly be applied to the financial system. This has specificities that differ from some other economic sectors.

First, the intangible character of services does not allow to store and transport them and, in particular, makes it more difficult to identify the distinctive features of each service. Moreover, the service supply chain shows a close interaction between the provider and the end user. For example, the client, who subscribed a deposit account, interacts with the bank in various situations, also with the goal of using the acquired service in the best possible way.

In addition, the skills and know-how of those providing the service and confronting directly with clients have a significant impact on the quality of service itself. For example, in the case of factoring, services could have widely different and hardly comparable prices. Finally, as mentioned in the next section, the products offered by financial firms can be protected only in part through patents.

This group includes companies that only manage to provide a minor contribution to innovations, and actually draw them from the outside, particularly at technological level. This is the case, for example, of a bank that, thanks to new processors developed by software houses, implements an internet platform for distribution of online services.

With a closer focus on the above-mentioned peculiarities of financial brokers, Llewellyn suggests three different factors to identify financial innovation: the type, the cause, and the function. In the first case, the phenomenon is identified according to three dimensions: product innovation, which consists in creating new financial instruments, techniques, and markets; innovation that allows risk transfer, separating its different components and re-assembling them into different combinations; process innovation, tied to an improvement of, for example, financial instrument distribution, of the pricing of transactions, or of their performance.

The basic features of financial innovation are thus highlighted: these include increasing the number and variety of financial instruments; combining the features of existing instruments in a greater variety of ways; expanding the possible combinations, thus reducing the number and size of discontinuities in the financial instrument range; and, finally, mitigate differences among brokerage forms.

CDSs represent one financial innovation allowing to achieve the above goal: maintain the assets while, however, transferring the credit risk to a counterpart. Derivative instruments usually allow exploiting comparative advantages on different markets, with an impact on the risk and yielding profiles of financial asset portfolios.

This analysis refers to the approach of Silber , , who defines financial innovation as a response of the companies to the economic forces acting on them. With reference to the above-mentioned categories, changes in the regulation and supervision of financial firms can result into forms of innovation. Actually, there are some innovations that do not involve one firm, but rather the system at large, as is the case of innovations in the payment system.

For Llewellyn, the critical point of this definition is the identification of relevant functions. This is one case of innovation, because the new system is generally adopted by the financial firms, thus reducing the costs and risks involved in cross-border payments and turning, in time, into a new standard.

It includes risk transfer, the improvement of liquidity and credit generation e. Finnerty identifies a set of functions that partly refer to the ones suggested by Merton, combining fund transfer and pooling into a single cash management function. Similar considerations can be found in Tufano In general, he defines financial innovation as the act of creating new financial instruments, technologies, institutions, and markets, and of drawing profit from these.

Moreover, he mentions once again the distinction between product and process innovation, however stressing its ambiguity. Products and processes are often tied together and the former can be hardly separated from the latter. In an effort to overcome this impasse, several authors, including Finnerty , , have tried to develop a taxonomy or list of innovations from which the main functions can be drawn using a bottom-up approach. The challenge of drafting a full list of financial innovations — or even just of innovations in the issuing of securities — reflects the challenge of classifying the new products.

Lists can be organized based on product names, but these would not be satisfactory, because banks often use different names for products with similar contents. Similarly, lists based on other criteria would not allow to provide a full description of the phenomenon.

Turning back to the problem of defining financial innovation, Tufano tries to group together the different aspects of the functional approach based on a few key concepts: 1 innovation exists to complete incomplete markets; 2 innovation persists to overcome agency problems and information asymmetries; 3 innovation exists in order for the counterparts to minimize transaction, research, or marketing costs; 4 innovation starts in response to taxation and regulation; 5 globalization and risks produce innovation; 6 technological shocks stimulate innovation.

While each of these six descriptions, taken individually, is hardly exhaustive, innovation can be accounted for by a combination of two or more of the above-mentioned factors. For example, in the case of index funds, Black and Scholes describe the efforts that Wells Fargo had to make to introduce the product on the market.

On one hand, the new funds completed the market concept 1 and, on the other, allowed to make up for the high transaction costs that prevented investors from buying a set of securities replicating the market trend concept 3. Moreover, they provided an answer to tax and regulation factors concept 4 and to information asymmetries that made it poorly economic to buy the securities separately concept 2.

The key concepts introduced by Tufano thus allow defining the phenomenon of financial innovation in a more comprehensive way. In particular, the baseline distinction, typical of the industrial economy, between product innovation and process innovation can be further analyzed, in the case of banks, through the identification of different domains.

First, the definition of product or service innovation refers to the improvement or launch of new product types. In the case of banks, innovation may be originated from the introduction and dissemination of services not strictly of a banking kind, including the distribution of insurance policies or investment funds.

On the other hand, process innovation, as mentioned above, consists in new ways to carry out production activities. Innovation of delivery channels can be referred both to process and to product innovation tout court: it is represented, for example, by the internet or by mobile banking, which started gaining popularity at the end of the s DeYoung, , Filotto After defining the phenomenon, focus is now made on any benefits an innovating bank can reap versus its competitors.

Patents would allow drawing an economic benefit from the output produced through research and development. An alternative way to maintain the economic value of innovation, as well as its benefits, is confidentiality, as in the case of industrial secrets. Moreover, both either innovation protection method can hardly be applied. Secrecy cannot be used for innovations in financial products, because the investors and the supervising authority request transparency to decide to invest and to allow product trading, respectively.

For example, the provisions contained in the MiFID directive call for more transparency and data disclosure within the system. Secrecy could be more effectively applied to process innovations, such as to a new credit risk management model. The regulating authority, however, requests a continuous flow of information in order to validate the model and thus allow its adoption.

Financial innovation in retail banking in South Africa

Financial innovation is the act of creating new financial instruments as well as new financial technologies , institutions , and markets. Recent financial innovations include hedge funds , private equity , weather derivatives , retail-structured products , exchange-traded funds , multi-family offices , and Islamic bonds Sukuk. The shadow banking system has spawned an array of financial innovations including mortgage-backed securities products and collateralized debt obligations CDOs. There are 3 categories of innovation: institutional, product, and process. Institutional innovations relate to the creation of new types of financial firms such as specialist credit card firms like Capital One , electronic trading platforms such as Charles Schwab Corporation , and direct banks.

Financial Innovation in Retail and Corporate Banking

Research Articles. In the existing literature on innovation, financial services firms are attributed with a dependence on external knowledge inputs. Meanwhile, relative importance of sources of knowledge for innovation, modes of knowledge inflow, cooperation partners, advantages and disadvantages of cooperation for innovation remain underexplored. This study has unveiled that the most important internal sources of knowledge for innovation in financial services are frontline employees, new service development teams, bank executives, and backstage staff. Highly valuable modes of knowledge inflow for innovation are human resource development, purchase of equipment, and informal personal interactions.

Emergent innovative financial technologies are profoundly changing the way in which we spend, move and manage our money, unlike ever before, and traditional retail banks are facing stiff competition. The global financial crisis in — led to large losses, and even the collapse of a significant number of established banks shaking the trust of financial customers worldwide. The Digital Banking Revolution is an insightful look at how financial technology and the rapid rise of financial technology companies have brought welcome changes offering flexibility to the banking industry. The book offers a unique perspective on the consumerization of retail banking services.

Download Printable Version of this page. The banking industry is confronted with greater challenges than ever as it tries to keep up with demand for more efficient ways to do banking and ways to make the lives of consumers easier. Many organizations are beginning to embrace the process of digital transformation, aligning products and processes to the realities of a changing marketplace.

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