Financial innovation, technology, regulation and public policy

As the recent financial crisis starts to disappear, we are beginning to see the world's financial innovations and revert to old methods and practices. Is that good? Maybe …

However, the misunderstanding of financial innovations such as securities trading, which led to the financial crisis through the US leadership, is always at risk for the financial system. Surveillance authorities and mentors everywhere, as guardians of the various components of the global financial system, still do not clearly understand the consequences of financial innovation. Often it is clouded by public policies that are the basis of such surveillance, suspected of which "public" they are intended for good. This applies especially to the use of technology in the provision of financial services.

The word "innovation" means coming in or editing. Financial innovation covers this simple definition of the financial area. However, simplicity concludes with a plethora of products, processes and methods that have been applied in the spectrum of the financial area – some good and bad.

What drives financial innovation? Simply put – self-growth, which finds expression through Adam Smith Smith "invisible hand". Financial institutions seek, through the innovation process, the most cost-effective way to maximize their profits, either on existing products or potentially new ones.

There are two fundamental teachers of financial innovation arising from the obstacles the bank faces in achieving its financial goals – competition and rules. To beat these obstacles banks participate in two types – competitive or negligible. First, it is quite obvious as all banks try to maximize their profits and they do this by competing with other players in the market.

Another, negligible, is a little more obscure. In all jurisdictions, financial institutions face excessive rules and regulations imposed by banking and supervisory authorities on how they conduct their business. These are rules that prevent banks. These barriers can often be curbed by innovation – hence the term "innovative innovation".

A classic example of this is the development of the humble ATM, which was first introduced to the United States as a controversial innovation, to pass invasions to branches. The idea was quickly taken up, first in Europe and then globally as a competitive innovation. European banks had no limits on the number of branches that could have, but labor regulations created restrictions on, for example, working hours among many other issues. At the ATM, European banks found a new "employee" who (1) was cheaper than a person, (2) could work all day and night, (3) was accurate, (4) did not have a physical branch to support it. There were many other plusses well, not to mention the ability to expand a wide range of products and services that could be offered.

Basically, one type of innovation (controversial) morphed into another (competition). This communication is ongoing and is a key factor in the functioning of a stable financial system. And technology has been the leading driver of this process. We see this happening all the time in many ways.

Recently, I came across a news suggesting that Citibank had participated in projects to make a deep invasion of consumer banking in India – a huge market. In spite of the size of India's market, which is in touch with China, someone who tries to establish or expand their business in the world's largest democracy, with a great barrier to overcome. For banks, one of these obstacles is very tight rules and restrictions placed on banks to grow a branch network.

The Central Bank of India, which is the central bank of the country, closely monitors the number of new branch licenses granted to foreign banks. This has a very restrictive effect on the ability of these banks to grow their distribution systems.

In order to overcome these limits on physical presence, Citibank has started targeting India for nearly six hundred million mobile phone users. Now, this is the "controversial innovation" I spoke about.

Citibank, one of the leading foreign banks in India with 42 branches and more than 450 ATMs – a recently completed six-month plan in Bangalore to test customer benefits to do business by phone. The program was called the "Tap and Pay" airplane.

In the project, the bank sold more than 3,000 phones, which are specifically able to do business over the mobile network. Customers made Rs26m (US $ 585,000) from purchases from 250 merchants. Citibank is currently considering expanding such services to its vast clients.

This issue is a classic example of how to utilize financial innovations to meet other needs.

So what is the message to bank regulators, supervisors and their policy makers? Well just put "financial innovation or its consequences are not always well understood". These facts are important for banking supervisors and regulators because new actions on behalf of the financial sector are not always benign or made to the public. At the same time, public policy needs to understand why some financial institutions take place and revise their policies in the light of this. Very often, restrictive methods are created for the wrong reasons – protection from genuine competition is often veiled as consumer protection.


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