Financial Innovation in Retail and Corporate Banking

Financial Innovation in Retail and Corporate Banking

New Horizons in Money and Finance series

Edited by Luisa Anderloni, David T. Llewellyn and Reinhard H. Schmidt

This valuable book discusses in detail, through a blend of theory and empirical research, the processes of innovation and the diffusion of new financial instruments.

Chapter 1: Financial Innovation and the Economics of Banking and the Financial System

David T. Llewellyn

Subjects: business and management, corporate governance, economics and finance, corporate governance, financial economics and regulation, money and banking


1. Financial innovation and the economics of banking and the financial system David T. Llewellyn Derivatives are financial weapons of mass destruction, carrying dangers that, while now latent, are potentially lethal to the financial system. (Warren Buffett, Financial Times, 4 March 2003, p. 16) If risk is properly dispersed, shocks to the overall economic system will be better absorbed and less likely to . . . threaten financial stability. (Greenspan, 2002, p. 6) Not everything that counts can be counted, and not everything that can be counted counts. (Albert Einstein, 1936, sign in Einstein’s office, Princeton University) 1 THE CONTEXT In many respects, financial innovation has become a defining characteristic of national financial systems. Two particular characteristics of the recent evolution of financial systems have been increased globalisation of financial markets, and the rapid growth of financial innovation, and in particular the development of structured instruments and credit derivatives. One of the features of the globalisation of financial markets is that financial innovation generated in one market can be easily and quickly transferred to others. Notwithstanding recent interest in the topic, financial innovation is not a new phenomenon. What is new is the acceleration since the mid1990s in the pace and range of financial innovation, and the emergence of several secondary markets in which new instruments are traded, and the emergence of credit derivatives that enable credit risk to be shifted and traded (see Partnoy and Skeel, 2007, for a survey). In most developed 1 2 Financial innovation in retail...

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