Technological change, financial innovation, and diffusion in international banking

Published on November 30, 2015   21 min
0:00
My name is Lawrence J. White. I'm a professor of economics at the Stern School of Business, New York University and I want to talk about technological change, financial innovation and diffusion in international banking.
0:22
I'd like to start my talk with three quotations. The first is by a Nobel prize winning economist, Merton Miller, who back in 1986 wrote that, "The word 'revolution' is entirely appropriate for describing the changes in financial institutions and instruments that have occurred in the past 20 years." So here's Merton Miller, this Nobel prize winning economist as of 1986, looking back over 20 years saying, "Look at all the things that have happened. Look at all the changes. It's a revolution." And he was right. The problem is that even though everybody knows he's right, it's very hard actually to document this and it was true back in 1986, it turns out to be still true almost 30 years later. And so, to remind us of this phenomenon, my next quotation attributed to Mark Twain. "Everybody talks about the weather, but nobody does anything about it." And little over a decade ago, a co-author of mine, W. Scott Frame and I wrote the phrase, "Everybody talks about financial innovation, but almost nobody empirically tests hypotheses about it." We know it's there but it's real hard to document what's going on.
2:01
So the overview of my talk: First, I'm going to provide a lot of background. I think to understand these issues, one really has to understand the background. Then I will talk about innovation in three broad categories, first, products and services, then processes, and finally, briefly, organizational form, and, of course, I will provide a conclusion.
2:30
It used to be the case almost 30 years ago when Merton Miller was writing but even more recently, financial innovation used to be seen as unequivocally a good thing. It's innovation, it's allowing more types of services. It allows things to be done that couldn't be done before. This was all seen as a good thing but since the financial crisis of 2008, there's been a lot of questioning, a lot of new products, mortgage-backed securities, collateralized debt obligations, credit default swaps, derivatives, other innovations of the past few decades are often described as responsible for the financial crisis. Now, there's some truth, only a small amount but some truth in this claim. I think it's overblown, but still. I'm sure most of the listeners will have heard some kind of attribution of the financial crisis to various kinds of derivatives. So derivatives no longer have the good name, the unequivocal good thing or concept that they did before the financial crisis. Paul Krugman, an economist, columnist for the New York Times, and a widely read author, in 2009, wrote, "It's hard to think of any major recent financial innovations that actually aided society, as opposed to being new, improved ways to blow bubbles, evade regulations and implement de facto Ponzi schemes." That sums up the tarnished image that we have nowadays. I still think that net financial innovation is a good thing but I have to acknowledge that there are the Krugman-like beliefs that are widespread.
4:38
As I mentioned at the beginning, financial innovation has been pervasive, especially for capital markets, all those new instruments but it's also been pervasive in banking. But there are some fundamental questions that one would like to know about financial innovation. Why does it occur? When does it occur? How does it occur? And in order to answer these questions, we need good data and good hypotheses or as an economist might term it "good theory to help organize the data." If we don't have those things, then all we have are stories and anecdotes. Now theory is not the problem. Economists are really good at coming up with theory but it's the empirical testing of the hypotheses to really help us understand what's been going on that's been relatively sparse. Further within that sparse testing, most of the empirical work has focused on characterizing who adopts the financial innovations and when. For example, diffusion studies are an important form of this empirical characterization, the testing of hypotheses, but the testing of hypotheses about structural conditions that encourage or discourage financial innovation in the first place, that has been especially sparse.
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Technological change, financial innovation, and diffusion in international banking

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