Financial Innovation : An Concept Grounded

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Financial innovation is an underlying concept grounded in theoretical science. To put it bluntly, it is in some circumstances viewed as a visionary breakthrough and in others a combination of existing elements that inevitably leads to a breakthrough of equal proportion. Innovation is the driving force behind many financial instruments and institutions, allowing them a means of generating returns for each respective innovation. I will discuss how such ‘innovation’ can act as a means of generating revenue for firms, how they are ‘created’ and their implications to the firm. Silber (1975) provides the beginning framework for discussing financial innovation as a way of reducing the costs imposed by regulation. While he recognizes regulation…show more content…
If the cost of adhering to an internal constraint increases, the firm may revaluate the policy, relaxing or removing that constraint. However, if the costs are imposed by a binding external constraint, there is an incentive for the firm to innovate to reduce these costs. Silber refers to this type of innovation as constraint - induced innovation. The features or characterizations (as stated by Miller, 1986 and Merton, 1992) of Financial innovation is the ability to generate additional sources of funds and act as an “engine of economic growth” (Josh, L. Peter, T. 2011). It is indeed true that these breakthroughs generate additional sources of funds for the firm but it also has the potential to affect the entire economic system. Perhaps even leading to far reaching changes (as further firms down the line can adopt the changes that came as a result of the financial innovation) e.g. FI enable firms to raise capital in larger amounts at a lower cost than they could otherwise, by developing a more (say) cost efficient form of production. The next firm down the line can then benefit from the lower cost production (as they would be able to access or learn this new form of cost saving from the previous firm). This is an example of FI’s influence on economic systems and being a driving force for growth. Another feature of financial innovation is in its ability to transfer risk and systematically address asymmetric information issues. The way in which it allows this to
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