How can financial innovation lead to financial crisis?
The innovation-fragility view, by contrast, has identified financial innovations as the root cause of the recent Global Financial Crisis, by leading to an unprecedented credit expansion fueling a boom-bust cycle in housing prices, by engineering securities perceived to be safe but exposed to neglected risks, and by ...
Among these literatures the three most important issues that would make financial innovation directly responsible for the financial crisis are: excessive risk taking by 'highly bonus-driven' business cultures at investment banks (Crotty, 2009 ) and hidden bonus systems created by lax corporate governance systems at ...
According to a report released by the World Economic Forum (2012), financial innovation has a broader impact on economic growth and significantly influences the global economic order. A good amount of literature is available on this topic, still less than in other finance areas.
For example, most analysts would agree that financial innovation helped cause the recent terrible financial crisis, but its culpability ranges from secondary to severe, depending on one's theory of why the crisis happened and how it evolved.
Under such circ*mstances, financial innovation plays a key role since it helps banks and other financial institutions to not only reach new niches in the economy, but also to bypass some restrictions imposed by regulators.
Businesses can gain long-term advantages by understanding such shifts and the opportunities they present. In past crises, companies that invested in innovation delivered superior growth and performance postcrisis.
Reasons Behind Financial Innovation
Notable among them are the quest for increased efficiency, a desire for improved risk management, the advancement in technology, and the impact of regulations.
Innovation can lead to a reduction in production costs. Process innovations, for example, can sustainably and significantly increase a company's effectiveness and efficiency. By using new methods and processes, resources can be used more effectively, which leads to a reduction in costs.
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.
As an example, due to e-banking, people spend lesser time within the banks. As a result, they will use this time to either earn more money or for leisure activities. On the opposite hand, non-technical innovations have to be scrutinized more. a number of these innovations do benefit society.
Do you believe financial innovation can lead to greater risks in financial stability?
With rational expectations, financial innovation allows gains from trade to be realized and is strictly beneficial. Although this effect of financial innovation shows up in the case of local thinking as well, in that world it can lead to excessive innovation and financial fragility.
Everybody involved with the 2007–2008 financial crisis is partly to blame for the Great Recession: the government, for a lack of oversight; consumers, for reckless borrowing; and financial institutions, for predatory lending and unscrupulous bundling and selling of mortgage-‐backed securities.
The Biggest Culprit: The Lenders
Most of the blame is on the mortgage originators or the lenders. That's because they were responsible for creating these problems. After all, the lenders were the ones who advanced loans to people with poor credit and a high risk of default. 7 Here's why that happened.
Financial innovation in derivatives and securitization, fuelled by a lax monetary policy, created a bubble in the housing and credit-supply markets which burst when the subprime mortgage crisis hit in 2007.
US house prices fell, borrowers missed repayments
The catalysts for the GFC were falling US house prices and a rising number of borrowers unable to repay their loans.
The NARDL test examined the asymmetry between financial innovation and economic growth. The limits tests report long-run cointegration between financial innovation and economic development. NARDL also demonstrated that significant advances in financial innovation are tied to long-term economic growth.
Economic crises cause companies to reduce their investment, including investment in innovation where returns are uncertain and long-term. This has been confirmed by the 2008 financial crisis, which has substantially reduced the willingness of firms to invest in innovation.
Crisis-driven innovation has a long history. Atypical circ*mstances such as wars and economic downturns create new needs, which in turn lead to new solutions — the radio, stainless steel, and Toyota's lean manufacturing process are just a few stand-out examples.
Innovative problem-solving is not just about finding quick fixes to immediate challenges; it's about devising novel approaches to tackle problems that have never been encountered before. It requires thinking outside the box, breaking free from traditional thought patterns, and exploring unconventional solutions.
- improved productivity.
- reduced costs.
- increased competitiveness.
- improved brand recognition and value.
- new partnerships and relationships.
- increased turnover and improved profitability.
What are the barriers to financial innovation?
According to managers, the most important are exogenous barriers, including: (1) Unclear tax and accounting regulations, (2) complex construction of financial innovations, and (3) transaction costs related to their application.
High costs and risks: Innovation often involves significant investments in research, development, and implementation. Because not all new ideas succeed in the market, there is a danger of failure. To get a satisfactory return on investment, businesses must carefully manage these expenses and risks.
While innovation can increase productivity and business success, it means change, and people naturally resist change. Managers need to encourage innovation and manage the change that comes with it.
- Increasing Production. ...
- Easily Accessible. ...
- Increasing Job Opportunities. ...
- Better Communication. ...
- Different Learning Methods. ...
- Disadvantages of Innovative Technology. ...
- A Social Divide. ...
- Making People Lazy.
Examples include cardless ATM services, weather derivatives, central bank digital currency, QR code payment, hedge funds, and exchange-traded funds. There are different types of financial innovations: product, process, and institutional.
