How To Promote Responsible Financial Innovation

How To Promote Responsible Financial Innovation Image source: Intelligenthq

For the past decade amazing innovations happened in the finance sector, particularly in Fintech and alternative finance. Those innovations had a quite dramatic impact in the world of finance, but not all have been beneficial to society in general. This has lead  to a decrease in public trust and confidence in the finance system. How to address the important issue of promoting responsible innovation in the finance sector ?

During 2012 the World Economic Forum secured support form consultancy firm Oliver Wyman to gain an understanding of how financial services can better deliver society’s needs. As a result of this undertaking, the participants published a report: The Role of Financial Services in Society. This focused on ways to manage financial innovations to make sure that risks are minimised and that they lead to growth and development.

This was carried out given the background of some very rapid advances in financial innovations such as mobile banking, foreign exchange swaps and others, while trying to avoid some of the more negative innovations that have occurred, some of which were implicated in the financial crisis.

The research aimed to understand a number of areas. These included being able to show the benefits of financial innovation in society, based on the societal needs that they have historically fulfilled. It also included defining the ways in which innovations can sometimes have negative ramifications for society. Thirdly it sought to look at the ways in which society can avoid the negative ramifications that can sometimes occur with a view to promoting responsible financial innovation. While not all financial innovations were found to support societal needs, there were plenty that did do exactly that. One example is the promotion of financial and economic resilience, and an example of a financial innovation in this area is safety nets like deposit insurance and state insurance guaranty funds. Another risk the provision of access to financial products and services to a broad range of people, as this is particularly challenging in some countries. Examples like mobile banking and online banking as well as microfinance were seen to help in these areas. Enabling payments included financial innovations such as point of sale terminals and wire transfer services.

How To Define The Risks Of Innovation

Defining the risks of innovation in this sector is argued by the report to be challenging, and particularly in this sector due to the impact that such products can potentially have on society. This is explained by the report to be due to a number of reasons. One is that people use financial services widely and the items that they use are often “big ticket” items like mortgages. The financial services used may be long term in nature, such as pensions. The understanding of such products can also be a problem and some people are more vulnerable in this regard. Additionally financial innovations can be interconnected so failure can have a more dramatic impact. It is for these reasons that the report by the World Economic Forum suggests that innovations in this industry should be more carefully managed.

Important Recommendations

All of this led to a number of important recommendations being made in the report. The first is that there should be review and adaptation of enterprise risk management and new product approval processes to address risks and uncertainties of incremental innovations arising from changes to existing products. This recommendation is based on the problem identified which is that a financial innovation can get adapted for broader use without proper risk and benefit understanding. A second recommendation is to redesign incentive systems so that they incorporate the uncertainties associated with innovation. This means improving performance metrics, among others. The third is to ensure a proper framework to provide adequate protection for different client segments. This is based on the idea that the risks of innovations of the future will be different than those of the past, and many investors are simply not equipped to identify or understand those risks. This places the responsibility firmly in the court of the financial institution rather than on the consumer’s shoulders. It also includes testing out new innovations on small groups of early adopters ahead of a broader marketing to a wider audience, so that the innovation can be better understood. A fourth recommendation is developing and maintaining infrastructure to support innovations. Ensuring systemic stability is tied to this recommendation.

Recommendations for financial iinnovation

It is hoped by the World Economic Forum that if such recommendations are taken on board then financial institutions will manage the risks not only of new products but also of those products throughout their lifecycle. This will benefit the end user to ensure that risks are properly assessed. It is hoped that the recommendations are taken on board and implemented.