A Proposal for a Standard With Innovation Management System

Claudia Gabriela Baicu, Olimpia State and Mariana Iatagan
1980s, with deregulation and financial liberalization, the strict rules governing banking activity were
gradually removed and replaced by other rules, less stringent.
Howells and Bain (2008) suggest that the process of regulation, the development of technology and
increased volatility are the most cited factors that contributed to financial innovation. All these factors
led to creating of several financial innovations, which had different monetary and economic
implications (table 1).
Table 1: Financial innovation
Causes Results Implications
Regulation and
deregulation
Eurodollar markets Money substitutes
Money market mutual funds New monetary instruments
CDs Evade quantity controls
“Bill leak” Securitization
Off-balance-sheet activity Rise in money’s own rate
Increased competition Money’s own rate market related
Liability management
Volatility Swaps Risk reduction
Options Loan demand less interest elastic
Futures
Variable rate lending
Technology Globalization Economies in cash holding
24hr markets Larger debit and credit positions
Programme trading (fall in velocity)
Derivatives Liability management
ATMs Credit derivatives
EFTPOS
Credit checking
Cheaper intermediation
Cheaper entry
(contestable markets)
Sources: Howells and Bain (2008), p. 530.
Regulation was a key-factor of financial innovation beginning with the creation and developments of
Eurodollars markets, which were an answer to the Regulation Q in the U.S. According to this rule, the
U.S. banks were not allowed to pay interest on deposits that exceeded a certain level. Therefore, in
order to circumvent this rule, the U.S. banks transferred part of their deposits in Europe. Money
market mutual funds were another response to this limitation. In order to increase the profitability of
their savings, the investors transferred their funds from banking deposits to money markets mutual
funds that were not submitted to Regulation Q and other constraints. In the U.K. a similar response
was the “bill-leak”. Circumvention gave birth to off-balance sheet activity; banks begun providing
guarantee to commercial bills issued by large corporations. Subsequently, off-balance sheet activity
diversified, becoming an important source of income for many banks. Securitization – a form of offbalance
sheet activity – was also developed in order to circumvent the capital regulatory
requirements. Increasing financial volatility led to developments of products to manage the new risks:
swaps, options, futures, variable rate lending. Like in other areas, technology allowed the decrease of
production costs, by developing of communications networks, ATMs, EFTPOS etc. (see Howells and
Bain, 2008, p. 530-532).
According to Lumpkin (2009) financial innovation is a result of a competitive economy. Frame and
White (2002) point out that charging differential tax on different streams of income or on different
categories of assets stimulate financial innovations, by finding new ways to reduce taxes. The
increased preference of investors towards financial instruments in the detriment of the traditional
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