Financial innovation in the banking sector of the US and the UK

Abstract

Financial innovation is the subject of this thesis. The purpose of this thesis is to build up the first comprehensive theoretical framework able to analyze the causes, nature and process of financial innovation, in other words the first holistic and integrated approach to the phenomenon of financial innovation. Initially, we review a significant part of the available literature on innovation. Then we discuss the financial innovation-related literature, and incorporate some features from the general innovation literature. We introduce an analytical framework and model that accounts for the process of financial innovation. The novelty of the model is that it takes into account the integral process of financial innovation and for the first time combines elements from both standard and financial-innovation theory. Initially we present a set of factors that cause financial innovative activity. Furthermore, we highlight the fact that very often, more than one cause contributes to the initiation of innovative activity. In contrast with the existing literature, Silber (1975), Kane (1981), Miler (1986) and Tufano (1989), we elaborate further on the phenomenon of financial innovation by taking into account the factors that shape the innovative firm, mostly internal to the financial institution and very often related with the innovation-originated concepts. Then, we classify financial innovation according to five criteria, two of them commonly found in the innovation literature, one novel and the other two derived from the BIS (1986) classification. Finally, we present seven criteria that a financial innovation fulfils in order to be successful and "survive". A further contribution of our model is its dynamic approach. We highlight this dynamic process, by citing examples of financial innovations that were created in order to address the shortcomings of existing innovations. In order to provide the supporting evidence for the above model, we discuss in great detail four clusters of financial innovation: special bank liabilties, derivative products, securitization and plastic cards. During our research we encountered many financial innovations that took place in different places and times and under different circumstances. Our model provided us a unique analytical framework able to analyze each and every financial innovation in relation to its causes of emergence, factors that shaped the innovative output, classify in a detailed way this output and understand the reasons that enabled the survival of this innovation. Our analytical framework is not a single dimensional linear model but a dynamic, multi-level framework subject to evolution, able to provide a holistic, integrated and ageless approach.