The Concept of Financial Innovation

Financial intermediaries have to perform the task of financial innovation to meet the ever-changing requirements of the economy and to help the investors cope with the increasingly volatile market. Because of this reason there is a necessity for the financial intermediaries to innovate unique financial instruments.

The following are the major reasons for financial innovation:

  1. Low Profitability: Profitability refers to the ability of a financial institution to maximize profits. The profitability of the major financial institutions have been declining in the recent times. So, the institutions are compelled to seek new products, which fetches high returns.
  2. Competition: The entry foreign and private players in the financial services sector have led to severe competition in the industry. This has compelled the institutions to innovate the financial instruments.
  3. Economic Liberalization: Economic liberalization such as, deregulation of exchange controls and interest rate ceilings etc, have made the industry more innovative.
  4. Customer service: To cater to the needs of various customers, financial institutions must be innovative. Customers desire for newer products at lower cost or lower credit risk to replace the existing ones. To meet the increased customer sophistication the financial intermediaries are constantly undertaking research to invent a new product, which suit to the requirement of investing public.
  5. Global impact: The changes happening in the global scenario is affecting the financial service sector to a larger extent. Financial intermediaries have come out of their traditional approach and they are ready to assume more credit risks. As a consequence many innovations have taken place in the global financial sector, which have its own impact on the domestic sector also.
  6. Investor awareness: There is degree of awareness amongst the investing public; there has been a distinct shift from investing the savings in physical assets like gold, silver, land etc. to financial assets like shares, debentures, mutual funds etc. Within the financial assets, they go from risk free bank deposits to risky investments in shares. To meet the growing awareness of the public, financial innovation has become the need of the hour.

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