StudentShare
Contact Us
Sign In / Sign Up for FREE
Search
Go to advanced search...
Free

Pros and Cons of Financial Innovation - Essay Example

Cite this document
Summary
This essay "Pros and Cons of Financial Innovation" discusses the advantages and disadvantages of financial innovation. Advantages include; the creation of new securities, the creation of new markets and financial institutions, and economic growth…
Download full paper File format: .doc, available for editing
GRAB THE BEST PAPER95% of users find it useful
Pros and Cons of Financial Innovation
Read Text Preview

Extract of sample "Pros and Cons of Financial Innovation"

?Financial s & Market – Financial Innovation Financial innovation hasbeen a topic for debate recently and its pros and cons have been widely discussed. A number of financial experts and economists are of the view that financial innovation should be encouraged as it leads towards new avenues for investment and economic growth, while other experts believe that unmonitored financial innovation is the leading cause behind the financial crises. Financial innovation has been blamed for leading firms and individuals towards high risk investments and in numerous cases, firms and individuals have suffered significant losses due to the unforeseen consequences of such investments. The paper discusses the advantages and disadvantages of the financial innovation. Advantages include; the creation of new securities, creation of new markets and financial institutions and the economic growth. The creation of new securities provides the investors with new avenues to invest in and it injects fresh capital which in turn leads towards increased employment opportunities. The disadvantages include; use of financial innovation for deceptive purposes such as off balance sheet financing and the creation of special purpose vehicles. The paper discusses two cases related to off balance sheet that shed light over the detrimental impacts of financial innovation over the economy as a whole. Financial Institutions & Market – Financial Innovation There has been significant debate regarding the validity of financial innovation. It has been suggested that financial innovation plays a vital role in the economic growth and prosperity and that, resultantly, financial system regulators should resist over-regulation that might create hindrances in the way of innovation. As a counter argument, it has been brought to foreground that certain financial innovations have been blamed for creating enormous economic crises in the recent past. As a result of such financial crises, governments all over the globe are taking extraordinary measures in order to avert more of such crises and they are imposing new financial regulations in this regard. The question that would be discussed in the following paper is whether the potential benefits of the financial system innovation should deter regulators from imposing restrictions on the activities of financial institutions. ADVANTAGES OF FINANCIAL INNOVATION Even though financial innovation has been blamed as the main reason behind financial crises, it has also been said that financial innovation is very important for economic growth. The economic crises that have been said to be due to financial innovation are actually due to the improper use of financial innovation. Innovation, if used properly and constructively, can lead towards growth and prosperity in the economy of a country. Following are some of the benefits of financial innovation: Creation of New Securities Financial innovation is the leading reason behind the creation of new securities. Any creation of securities leads towards new capital which is used for economic growth. By creating of new securities, investors invest in the securities and earn returns while the institutions that create such securities invest the capital for the purpose of economic growth (Kimmel, 2010). The resultant growth creates new job opportunities and adds new revenue to the overall economic system of the country. In this way, financial innovation leads towards new investment and financial growth. Creation of New Markets and Institutions Financial innovation is the reason behind the creation of new markets and financial institutions. For example; the concept of ‘Collective Investment Schemes (CIS)’ came to foreground due to financial innovation and this method is being widely used by investors all around the world to create and invest in investment schemes with different investment portfolios (Boot & Thakor, 1997). The investment schemes are managed by ‘Asset Management Companies’ which have been created specifically for this purpose. The investment schemes are defined by the type of securities they will be allowed to invest in and the investor is given the choice to invest in any scheme. Thus, the returns earned from the investment schemes are distributed among the investors or as they are called in case of CIS, unit holders. Thus, it can be inferred that financial innovation leads towards creation of new financial institutions and new markets. Economic Growth Financial innovation adds to economic growth in a number of ways. By creation of new securities, new capital is introduced into the economic system of the country and this investment results in new employment opportunities and revenue generation. Financial innovation also results in new markets and financial institutions that add to the economic development of the country (Mitchell et al., 2006). Thus, it can be said that financial innovation is one of the factors that help in the economic growth of a country. DISADVANTAGES OF FINANCIAL INNOVATION There is no doubt in the fact that financial innovation has some advantages but its disadvantages seem to be more immense. Experts who do not support financial innovation argue that a good financial system should minimize the extent of risk faced by firms and individuals rather than maximizing it by creating new financial avenues with unclear consequences (Eichengreen, 2010). Financial innovation poses numerous risks to the firms, individuals and economy as a whole. Financial innovation is the reason behind off-balance sheet financing and the creation of ‘special purpose vehicles’. Off-balance sheet financing and use of special purpose vehicles for this purpose have enabled firms to conduct fraudulent financial reporting (Gennaioli et al, 2010). Due to the creation of special purpose vehicles, firms and individuals have suffered significant unforeseen losses (Bernanke, 2009). Some of the cases regarding the use of special purpose vehicles by firms for deceptive purposes have brought the economy to the brink of crises (Haan & Sterk, 2011). Following are the brief details regarding the incidences of deceptive use of special purpose vehicles that caused a stir in the economy: The Enron Case Enron Corporation was the first that brought the use of deceptive off balance sheet transactions to the attention of the general public. The accounting principle that was used by Enron to carry out the off balance sheet financing is ‘mark-to-market’. According to this accounting principle, assets held by an entity, specifically securities, can be held by the entity at their market value. This accounting principle is normally used for securities that are traded in the stock markets but for any other assets, this accounting principle may have detrimental impacts. This principle was used by Enron Corporation in such a manner that the entity would book the profit from its non-current assets such as a power plant even before it starts operating using the discounted market value of the asset. The company used Special Purpose Entities (SPEs) for the purpose of concealing its non-performing assets. Thus, the company showed its financial position to be in a much better form that it actually was. Ultimately the company collapsed and it caused a stir in the Wall Street (Needles, 2010) The Wall Street Meltdown The Wall Street Meltdown of 2008 has also been blamed upon the financial innovation in some ways. The accounting principles that were applied in the real estate investments by the investment banks and lending institutions were the complex principles related to leasing and included innovative financial procedures. The financial institutions used Structured Investment Vehicles (SIVs) for the purpose of keeping the real estate investments off the balance sheet (Pozen, 2009). The value of real estate in the United States peaked in the year 2006 due to the use of complex transactions by the financial institutions and their use of SIVs. Right after reaching its peak in 2006, the real estate market began to collapse in 2007 and due to the significance of the investment by the financial institutions in the real estate market these institutions were unable to remain solvent without the intervention of the government. This caused the Wall Street meltdown in 2008. Before the meltdown, the financial institutions used SIVs to conceal their investments in the real estate and to inflate the real estate value. The system soon collapsed and resulted into a financial crisis. CONCLUSION From the analysis of the advantages and disadvantages of financial innovation, it can be inferred that the disadvantages of financial innovation have led the economy towards the brink of disaster and loosening the regulatory pressure over the financial system may heighten the risk of other crises led by financial innovation. Therefore, it can be concluded that regulators should not ease the regulation of the financial system and the financial innovation should be monitored. REFERENCES Alfaro, L. & Chen, M., 2011. Surviving the Global Financial Crisis. World Trade, 5(11), p.26-31. Bernanke, B.S., 2009. Financial Innovation and Consumer Protection. In Federal Reserve Systems Sixth Biennial Community Affairs Research Conference. Boot, A.W.A. & Thakor, A.V., 1997. Banking scope and financial innovation. Review of Financial Studies, 10(4), p.1099-1131. Available at: http://www.jstor.org/stable/2962340. Eichengreen, B., 2010. The Crisis in Financial Innovation. Depression, 36(January), p.2-7. Gennaioli, N., Shleifer, A. & Vishny, R.W., 2010. Financial Innovation and Financial Fragility. Journal of Economic Issues, 23(3), p.779-793. Available at: http://journals.cambridge.org/abstract_S0022109000012333. Haan, W. D.; Sterk, V. 2011. The Myth of Financial Innovation and the Great Moderation. Economic Journal, June Issue. Kimmel, P. D.; Kieso, D. E.; Weygandt, J. J. (2010) Financial Accounting, Tools for Business Decision Making. 6th Edition. Hoboken, New Jersey: John Wiley Publishers. Mitchell, O.S. et al., 2006. Financial Innovation for an Aging World. National Bureau of Economic Research Working Paper Series, No. 12444. Available at: http://ssrn.com/paper=921041. Needles, B. E. & Powers, M. (2010). Financial Accounting. 11th Edition. Cengage Learning. Pozen, R. C. (2009). Too big to save: how to fix the U.S. financial system. Hoboken, New Jersey: Wiley Publishers. Read More
Cite this document
  • APA
  • MLA
  • CHICAGO
(“Financial Institutions and Market - Financial Innovation Essay”, n.d.)
Financial Institutions and Market - Financial Innovation Essay. Retrieved from https://studentshare.org/finance-accounting/1448364-financial-institutions-market-financial-innovation
(Financial Institutions and Market - Financial Innovation Essay)
Financial Institutions and Market - Financial Innovation Essay. https://studentshare.org/finance-accounting/1448364-financial-institutions-market-financial-innovation.
“Financial Institutions and Market - Financial Innovation Essay”, n.d. https://studentshare.org/finance-accounting/1448364-financial-institutions-market-financial-innovation.
  • Cited: 0 times

CHECK THESE SAMPLES OF Pros and Cons of Financial Innovation

Pros and Cons of Bank Regulation and Deregulation

This research paper "pros and cons of Bank Regulation and Deregulation" addresses how deregulation relates to global economics.... Each of these moves has its pros and cons.... The government agencies concerned with the regulation of banks supervise the operations of financial institutions preventing them from abusing taxpayers.... Therefore, a safety net help to safeguard banks from bank runs reduces systemic risk in addition to reducing the cost of evaluating the health of financial institutions (Pellerin, Walter and Wescott 11-13)....
13 Pages (3250 words) Research Paper

The Financial System Innovation

The list of positive innovations includes Automated Teller Machine (ATM), debit cards, money market funds, exchange-traded funds, indexed mutual funds, currency and interest rate swaps (The Brookings Institution, 'The Pros and Cons of Financial Innovation').... This paper ''The Financial System Innovation'' tells us that the process of financial innovation has been viewed to be beneficial even by economists due to two main reasons.... The introduction of sophisticated derivative contracts, new types of 'pooled investment products' and new forms of corporate securities exemplifies the financial innovation achieved in modern financial markets....
10 Pages (2500 words) Essay

Financial and Strategic Management

What are their pros and cons?... What are their pros and cons?... Debt Financing – pros and cons.... One of the cons of debt financing is the payment of interest.... A lot of projects lead to the creation of innovation in a company.... innovation deals with bringing new products into the market (Princeton).... The Nature and Importance of innovation.... 5) Do project financial results affect financial health of the entire organization or a department or a private company?...
2 Pages (500 words) Essay

How Modern Day Technology Has Changed Our Lives

Satellite TV: The innovation in the field of telecommunication changed the context of multimedia.... How modern day technology has changed our lives Modern day technology is able to transform human life by flooding the market with innovative gadgets.... To be specific, earlier, time/distance was considered as the most important hindrance in front of human beings to communicate with each other....
5 Pages (1250 words) Essay

What changes are to be introduced in the Ruritiania central bank law with a new currency law

Therefore, the Ruritiania new currency law should include measures that tend to weigh properly the pros and cons of dollarization before adopting it.... Full Dollarization; the pros and cons.... Central banks have generally had the objectives of maintaining price stability, maintaining financial stability and fostering financial development more broadly and to support the state's financing need in times of crisis (Goodhart)....
2 Pages (500 words) Essay

Pros and Cons of Bitcoin Digital Currency

In the paper “pros and cons of Bitcoin digital currency” the author analyzes the advantages of using Bitcoin digital currency.... He thinks that there is a need for advancements in the digital currency that will prevent the risk of increased crime, giving clear guidelines for addressing this issue....
4 Pages (1000 words) Research Paper

Human Resource Management and Hospitality Institution

The lists the pros and cons of innovation and sound human resource practices that facilitate innovation.... This paper presents innovation which is at the center of the success enjoyed by hospitality organization.... As the report stresses human resource management has a crucial role to the growth of innovation.... From this discussion it is clear that innovation allows hospitality organizations to meet the dynamic needs of the customer....
3 Pages (750 words) Essay

Improving Sales, Marketability, and Profitability of the Brannigan Company

The paper 'Improving Sales, Marketability, and Profitability of the Brannigan Company' is a great example of a management case study.... Bert Clark, the vice-president of Brannigan Food Soup's Division faces the most challenging task of his life to decide upon the four different alternatives which his team members have proposed to be implemented to ensure the decline of industry growth....
7 Pages (1750 words) Case Study
sponsored ads
We use cookies to create the best experience for you. Keep on browsing if you are OK with that, or find out how to manage cookies.
Contact Us