Types of financial innovation
Financial innovation can be divided into three broad categories.
• New financial products and services
These include new types of deposits that can combine the advantages of liquidity with the advantages of high interest income, new types of credit (for example, subprime loans by borrowers that did not previously fall into the relevant sphere of banks), new types of securities (securitization of bad or strange loans , indexed to inflation, currency and interest rate swaps).
• New financial processes
Financial operations such as e-commerce, ATMs, electronic money, mobile and online banking have been developed, "smart" credit and debit cards.
• New Financial Institutions
There are new types of banks - virtual organizations without offices and physical presence. An extensive network of non-bank monetary intermediation appeared in the form of mutual investment funds, financial conglomerates, microfinance, savings and loan associations, financial boutiques, mortgage houses, hedge funds, etc.
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Impact on the economy
Financial innovations have had a significant impact on the modern economy. First of all, these results touched the monetary sphere. There was a stronger division of the functions of money than before. Different financial instruments can now perform different functions of money completely independently. New economic agents - non-banks - take part in the process of creating money. The number of assets - substitutes of money, assets-quasi money, is increasing, which reduces the demand for traditional forms of money, especially for cash.
The supply of money is increasingly an endogenous process. Control over liquidity in the economy eludes the hands of the central bank. Traditional monetary policy and control over M0 and Ml are becoming ineffective, central banks are moving to controlling the M2 indicator, which is much more difficult and problematic.
As a large number of financial products with interest income appear, the sensitivity of firms and households to the interest rate increases. This, in turn, leads to an increase in the monetary and credit multiplier. Therefore, although the Central Bank is less able to control financial processes, the impact of monetary policy on economic indicators is stronger. Consequently, the price of error in monetary actions increases.
Under the influence of financial innovations, the structure of the mechanism of monetary transmission changes and the significance of the channels of influence of monetary processes.
As a result, the financial system of modern economies becomes internally less stable, more prone to turbulence, more uncertain and risky, and control over its activity is deteriorating. The economy is more vulnerable to self-justifying panic, the source of which for the most part is the financial sphere.
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