| As the recent financial crisis begins to fade from | | | | it. There were many other plusses a well, not to |
| memory we are starting to see behaviors in the world | | | | mention the ability to widely expand the range of |
| of financial innovation reverting to old methods and | | | | products and services that could be offered. |
| practices. Is it a good thing? Perhaps… | | | | In essence, one type of innovation (circumventive) |
| However, misunderstood financial innovations such as | | | | morphed into another (competitive). This interaction |
| securitization, which led to the financial crisis through | | | | goes on constantly and is a key feature of the |
| the sub-prime debacle in the United States, pose an | | | | dynamics of a constantly evolving financial system. |
| ever present danger to the financial industry. | | | | And technology has been a leading driver of this |
| Regulators and supervisors everywhere, as guardians | | | | process. We see this in action all the time in many |
| of the various components of the world's financial | | | | different ways. |
| system, do still not clearly understand the implications | | | | Recently I came across a news item that indicated |
| of financial innovation. Often too this is clouded by | | | | that Citibank had embarked on a project to make |
| public policies which as the basis for such oversight | | | | deep inroads to consumer banking in India – a vast |
| are suspect as to which "public" they are intended to | | | | market. Notwithstanding the size of the market in India, |
| benefit. This is especially the case in the uses of | | | | which is on a par with that of China, anyone trying to |
| technology in the provision of financial services. | | | | establish or expand their business in the worlds largest |
| The word "innovate" means to bring in novelties or to | | | | democracy has a massive hurdle to overcome. For a |
| make changes. Financial innovation extends this simple | | | | bank one of these hurdles is very tight regulation and |
| definition to the financial world. However, here the | | | | the restrictions placed on banks in growing their branch |
| simplicity ends with a plethora of products, processes | | | | networks. |
| and methods that have been applied to the spectrum | | | | The Reserve Bank of India, which is the country's |
| of the financial world – some good and some bad. | | | | central bank, tightly controls the number of new branch |
| What drives financial innovation? Simply put – self | | | | licenses that are granted to foreign banks. This has a |
| interest, which finds expression through Adam Smith's | | | | massive restrictive affect on the ability of such banks |
| "invisible hand". Financial institutions seek out, through | | | | to grow their distribution networks. |
| the innovative process, the most efficient cost | | | | To get past this limit on its physical presence Citibank |
| effective way to maximise their profits either on | | | | has begun targeting India's almost six hundred million |
| existing products or potential new ones. | | | | mobile users. Now this is the "circumventive innovation" |
| There are two basic drivers of financial innovation | | | | that I spoke of. |
| which result from the barriers that a bank faces in | | | | Citibank, who is one of the leading foreign banks in |
| reaching its financial goals – competition and | | | | India with 42 branches and more than 450 ATMs – |
| regulation. To beat these barriers banks engage in | | | | recently completed a six-month program in Bangalore |
| completion of two sorts – competitive or | | | | to test the appetite of customers to make |
| circumventive. The first is pretty obvious as all banks | | | | transactions through phones. The program was called |
| seek to maximise their profits and they do this by | | | | the "Tap and Pay" pilot project. |
| competing with other players in the market. | | | | During the project, the bank sold more than 3,000 |
| The second, circumventive, is a little bit more obscure. | | | | phones especially enabled to make transactions over |
| In all jurisdictions financial firms are faced by a plethora | | | | the mobile network. Customers made Rs26m |
| of rules and regulations, imposed by the banking and | | | | (US$585,000) of purchases from 250 merchants. |
| regulatory authorities on how they conduct their | | | | Citibank is now considering rolling out such services to |
| business. These are the regulatory barriers that a bank | | | | its wider client base. |
| faces. These barriers may often be overcome by | | | | This case is a classic illustration of how financial |
| innovation – hence the term "circumventive | | | | innovations can be used an adapted to achieve other |
| innovation". | | | | needs. |
| The classic illustration of this is the development of the | | | | So, what is the message to bank regulators, |
| humble Automated Telling Machine (ATM) which was | | | | supervisors and their policy makers? Well put simply |
| introduced first in the United States as a circumventive | | | | "financial innovation or its implications are not always |
| innovation, to get past retractions on branch banking. | | | | clearly understood". These facts are critical to bank |
| The idea was quickly picked up, first in Europe, and | | | | supervisors and regulators because innovative actions |
| then globally as a competitive innovation. European | | | | on behalf of the financial industry are not always |
| banks had no restrictions on the number of branches | | | | benign or made for the general good. Equally so, public |
| they could have but labour policies created limitations | | | | policy makers need to understand why some financial |
| on for example working hours among many other | | | | innovations take place and review their policies in the |
| issues. In the ATM the European banks found a new | | | | light of this. Very often restrictive practices are |
| "staff member" who (1) was cheaper than a human | | | | created for the wrong reasons – protection against |
| teller, (2) could work all day and night, (3) was | | | | genuine competition is often disguised as consumer |
| accurate, (4) did not need a physical branch to support | | | | protection. |