Mumbai: Exotic financial derivatives that masked credit risk contributed to the 2008 meltdown and underlined that financial innovation is a double-edged sword.
Used wisely and honestly, it can promote sustainable market growth, but unscrupulous market participants are capable of wreaking financial and economic havoc in the name of innovation.
Still, experts aren’t ready to give up on financial innovation. Innovation is needed both for products and channels, but strictly under regulatory frameworks that can ensure no excessive and individualistic behaviour prevails in the markets, experts at the India Economic Summit of the World Economic Forum said in Mumbai on Monday.
Middle path: Janalakshmi Financial Services chairman Ramesh Ramanathan (left) and Rich Ricci, co-chief executive of Barclays Capital, during a discussion at the WEF India Economic Summit on Monday
“Innovation is good and we need to encourage it. It needs to be regulated well. One needs to keep track of what is happening in the market and check if excesses happen,” said Rich Ricci, co-chief executive of UK-based Barclays Capital.
Financial innovation is a broad term that is used to describe the creation and marketing of new types of products and services in different financial circumstances.
India’s banking system has seen some major financial innovations in the past decade as well as steps to promote financial inclusion, schemes that aim to take banking services to yet-to-be-banked areas.
These include mobile and Internet banking, introduction of no-frills bank accounts and business correspondents—individuals or institutions acting as agents of banks in far-flung areas.
Experts said there is a negative perception about innovation which needs to be cleared up. Innovation in delivering products and services to customers across segments can do wonders for financial inclusion, particularly in a country like India where more than half the population does not yet have access to banking facilities.
A lack of supervision leads to mismanagement of products, said Rana Kapoor, founder, managing director and chief executive officer of Yes Bank Ltd. “Innovation is not negative. The question is—were the people selling these products doing it in the right manner,” he said.
While effective regulation is paramount for financial innovation, too much of it can also become a challenge.
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“Regulators have upped their vigil after the crisis. If they don’t get it right, banks can get paralysed by over-regulation,” said Ricci.
The failure of an innovation is not a failure of that initiative, it’s a collective failure of innovators, regulators, banks and institutions, said Ramesh Ramanathan, chairman of Janalakshmi Financial Services, an urban microfinance institution.
“Financial innovation is about helping the poor. So many people are unbanked in India, and the opportunity to serve them is huge. Innovation is for the greater good,” he said.
Bankers say no single model works when it comes to financial innovation and its adoption. For example, State Bank of India (SBI) started with a branch model and after the Reserve Bank of India offered commercial banks the option of appointing business correspondents, SBI adopted that as well and has more than 22,000 of them.
“It’s got to be a hybrid model, no single model works,” said Hemant Contractor, managing director and group executive of international banking at SBI.
Innovation is also important because countries such as India need low-cost structures for financial inclusion. Calibrated models, efficiency, technology and lean frameworks are the need of the day.
“It’s not just about opening accounts; how do we ensure that all facilities are given to customers,” said Ramanathan.
With banks increasingly looking for innovations that can increase their reach to customers at the so-called bottom of the pyramid—the largest and poorest socio-economic group—can they serve the segment that’s now served by microfinance institutions (MFIs)?
“Impossible,” said Kapoor, adding that banks cannot replicate the cost structure of MFIs in terms of the use of technology, delivery, collection and disbursement of capital, among others. “Banks are brick and mortar. They don’t get outsourcing. We do not have that mindset and structural alliance.”
Automated teller machines (ATMs) and debit/credit cards are among the innovations that have revolutionized banking. On the next big innovation in financial services, Barclays’ Ricci said it would be the use of smart phones. The first ATM was introduced in June 1967 at Barclays Bank Plc in the UK.