Innovation In Finance, As In Other Fields, Involves Responses To... Essay - 946 words

Innovation in finance, as in other fields, involves responses to particular problems. Nevertheless, discussion frequently focuses on various more general forces, giving an impetus to innovation such as the incentives resulting from regulation, improvements in communications and computer technology, increased financial volatility, greater competition in the financial sector, advances in academic financial research, and so on [Marshall and Bansal 1992, chap. 2; BIS 1986]. My remarks are not intended to cast doubt on the importance of these broad forces, but rather to point to certain relations between them which, I hope, will illuminate parts of what follows. Consider regulation. For financial innovation, regulation has a Janus-like quality: particular regulations do often provide incentives for financial innovation, but regulatory assent is also necessary for the actual introduction of innovations, and an accommodating regulatory framework is part and parcel of their feasibility and success. Consider an example outside the field of derivatives, the Eurocurrency market. Regulatory restrictions on U.S.


banks did contribute to the growth of this market [e.g., Sarver 1988, chap. 23]. But Eurocurrency operations also require the permission or acquiescence of the regulatory authorities both of the country where they take place and of the countries whose currencies are used. More specifically, Eurocurrency operations are performed only in countries that permit banks to bid for foreign currency deposits and to make foreign currency loans both to each other and to non-residents, and only in the currencies of countries that allow foreign banks to keep and transfer deposits with their domestic banks and that permit external convertibility of these currencies [Graaf 1991, 3]. Similar remarks apply by and large to regulatory assent in the case of derivatives. Approval of exchange-traded derivatives involves the exchange itself and the regulatory body responsible for it. Over-the-counter (OTC) derivatives, customized instruments issued to particular clients, are subject to the jurisdiction of the body regulating the issuing institution.


This is likely to leave certain end-users of derivatives, such as non-financial corporations, largely or completely outside the regulatory framework. But although lacunae of this kind are of concern to policymakers [see U.S. GAO 1994, chaps. 5 and 7], the resulting unregulated spaces are unlikely to be the location of much innovation in derivative instruments. (These observations should not be taken to imply that regulatory frameworks for derivatives are uniformly effective. My sequel indeed will illustrate that this is far from being true.) With respect to financial innovation generally, and that affecting derivatives more particularly, the enabling impact of improvements in communications and computer technology is always stressed.


But rather less attention is paid to the institutions and knowledge on which these improvements impinge. The financial sector has historically been a repository of vast knowledge of te ...................................................................................................................................................................................................................................................................................................................................................................

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Essay Tags: derivative, derivatives, foreign exchange, regulatory framework, innovation

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