All about financial innovation: causes, types and examples

Financial innovation refers to the creation and application of new financial instruments, technologies, and processes aimed at improving efficiency, accessibility, and risk management within the financial industry.

Financial innovation is a must in a world run by money. A report states that currently, our world has more than 85 trillion US dollars in various forms. In 2022, the world’s unemployment rate stood at 5.3 percent. However, with a moderate improvement in 2023, the unemployment rate reduced to 5.1 percent. 

People need new ways to generate and handle money that can improve their lives and contribute to the country’s development. Through economic innovation, they can achieve it successfully. 

What is financial innovation?

In general, the term financial innovation refers to the process of crafting new financial instruments and technologies. It also means to create financial markets and institutions. For example, some of the most recent financial innovations are exchange-traded funds, Islamic bonds, multi-family offices, hedge funds, private equity, weather derivatives, retail-structured products, etc. 

Financial innovation also includes risk transfer, risk management, credit and equity generation, etc. With the help of digital technology, economic innovation has reached a bigger stage of evolution. 

Causes of financial innovation

There are various causes that lead to financial innovation. To start with, advancement in the field of technology is one of the most significant causes. Payment system innovation, market competition, financial globalization, and market failures are a few other factors that are responsible for financial innovation. 

Many traditional banks are trying to give their business models a new touch by digitizing their services. The aim is to provide quick and smooth facilities to the customers. A few other causes of economic innovation are the desire for better risk management, the impact of regulations, etc. 

Types of financial innovation

A few different types of financial innovation deal with their respective tasks. The most important types are Process innovations, Financial Institutional innovations, and Product innovations. Let’s discuss them in detail. 

  1. Process innovations: To provide clients with better services and boost the effectiveness of business operations, there is a need for innovative financial business processes. These innovative financial processes often include new company procedures that aim to increase productivity. These procedures also help in opening up new markets. The most simple example one can give is the online banking facility;
  1. Financial Institutional innovations: For good economic growth, the advancement of the financial system is a prerequisite that relies on innovation. The establishment of new potential organizations that would provide innovative practices and services is very necessary. The goal of these organizations will be to teach how to boost financial stability using creative, legal, and unique methods;
  1. Production innovations: The products or instruments of economic innovation like family accounts and weather derivatives are introduced in this type. Product innovations are necessary to better adapt to changing consumer demand and increase efficiency. 

Examples of financial innovation

Currently, there are several examples of financial innovation in the market. Online apps have taken over the traditional format of managing finance and guarding expenditures. People’s lives have become a lot easier than before due to financial innovation. Let’s take a few examples to understand it better. 

  1. Paypal: Paypal is one of the most influential and successful examples of economic innovation. Not only is PayPal recruiting more partners, but it is also aiming at aging financial infrastructures. By doing so, PayPal is making itself a very popular option for businesses that are aiming to spread their online and contactless payment options;
  1. M-Pesa: One of the biggest and most impactful payment systems in Africa is M-Pesa. The people of Kenya who live in villages, whether banked or not banked, can deposit, transfer, and withdraw money through this platform. People can also shop through this mobile app. M-Pesa also provides the facility that one can store his/her money in a special account that he/she can access with a PIN when in need. 

Advantages of financial innovation

There are many advantages to introducing financial innovation to the market. It benefits not only the lives of people but also adds to the country’s growth. 

  • By bundling related financial services, financial intermediaries benefit from economies of scale. This is beneficial to those customers who prefer a convenient suite of products;
  • The increase in the ability to inform and communicate between remote businesses and customers has been possible due to mobile and internet facilities. On top of that, with the help of technology, there is a steady increase in the efficiency of direct delivery channels that offer low-cost and customized financial services. It also improves financial inclusion;
  • There is a cut in transaction costs due to economic innovation. The assistance of digital technology has reduced the cost of data collection, storage, processing, and exchange. 

Disadvantages of financial innovation

Despite a number of advantages, there are a few drawbacks to financial innovation. These are important to keep in mind, and hence, let’s discuss them in detail. 

  • Companies can have a strong hold over some sensitive information about the customers;
  • There are many cybersecurity challenges that many tech companies are facing. With the expansion of interconnectivity, the probability of cyber attacks increases. 

Read more: When to hire a financial professional?

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