Future Trend of Financial Innovation

1
Future Trend of Financial Innovation

• ??? Edward H. Chow
• ??????????????? Professor of Finance
• ??? ??
• Dean of College of Commerce
• 2008/5

2
Outline

• Definition of innovation
• Functional taxonomy of financial innovation
• Financial innovation originates from market
  imperfections
• A local financial innovation
• Conclusion

3
Definition of innovation

• Websters Collegiate Dictionary to introduce as
  or as if new
• Most innovations are about improving existing
  products and process

4
Definition of innovation

• Miller (1992) argued that true innovations should
  have lasting impactsfutures contracts and cash
  settlement

5
Financial innovation originates from market
imperfections

• incomplete markets
• tax
• regulatory constraints
• information asymmetry induces agency problem

6
Financial innovation originates from market
imperfections

• transaction cost
• moral hazard
• globalization
• risk
• NO ONE explanation works

7
Ironically, sometimes financial innovation would
aggravate the very causes for innovation

• Financial innovations related to the subprime
  problem
• Financial institutions wanted to reduce risk
• SIV and securitization
• Financial institutions wanted to make money
• The subprime crisis spread at a global scale
• The subprime products were much riskier than
  people had expected
• The subprime crisis resulted from moral hazard
• Financial institutions bought products based on
  credit ratings and did not bother to worry about
  liquidity risk and valuation

8
Ironically, sometimes financial innovation would
aggravate the very causes for innovation

• Structured products sold to retail clients
• Clients (probably financial advisors too) do not
  understand the complicated structure of the
  products
• Financial institutions wanted to make money
• The structured products were much riskier than
  people had expected
• The dispute between sellers and clients resulted
  from agency problem

9
The future trend of financial innovation

• Transparency will be crucial
• More likely products will be designed based on
  liquid underlying assets
• US and European financial institutions will be
  scrutinized more for their financial
  productsRegulators will focus on
• Transparency
• Liquidity
• Valuation
• Governance of Institutions designing products
  will be stressed
• Product designer will be look to behavioral
  finance more and more
• Financial e-commerce

10
A local Taiwanese financial innovationInternet
Huei

• Shacom.com created the Internet Huei
• It is a kind of traditional Huei without Huei
  Shou
• There is bidding on the first allocation date
• Participants are guaranteed by the bank
• The Bank is responsible for clearing and
  settlement
• Borrowers and Lenders determine their own
  interest rate
• Participants who bid early are likely borrowers
• Participants who bid later are likely lenders
• Borrowers and lenders share the traditional
  loan-deposit interest spread

11
A local Taiwanese financial innovationInternet
Huei

• The Internet Huei is a type of e-commerce
• The innovation is protected by many patents
• The innovation is in the process of bidding to
  determine interest rate and the clearing and
  settlement mechanism
• The innovation overcomes the shortcomings of
  traditional Huei
• Default risk
• Liquidity
• interest rate references
• Huei Shou advantage

12
Conclusion

• Thank you for your attention