Should the potential benefits of financial system innovation deter Essay

Should the potential benefits of financial system innovation deter regulators from imposing restrictions on the activities of fi - Essay Example Firstly, it spurs economic growth by facilitating the easy flow of funds from the agents who have less or limited productive projects to agents with higher productive avenues. Secondly, the level of risk taken by an investor is reduced on account of a broader availability of assets resulting in greater diversification benefits and risk sharing. However, the above views have come under tremendous criticism with the predication that financial innovation reduces the risk exposure of the investors. The financial innovation was essentially introduced from a positive perspective but it has been seen that these innovations had a negative impact on the overall economy. Though the main purpose of this innovation was to aid the growing external debt market in U.S., it is now blamed to be the pivotal cause of the recent credit turmoil. To avoid such recurrences in the future, the regulatory bodies need to exercise a greater control over the financial markets. (Piazza, â€Å"Financial Innovatio n and Risk, The Role of Information†). Financial innovation: bane or boon Innovation is a ‘double-edged sword’. ... This blend of good and bad means the views on financial innovation is likely to be very subjective. As in the case of automobile inventions, while some view it as a gain for the economy and society; there are others, though very few in number, who believe that pollution and accidental deaths arising from this invention outweigh the societal and economic benefits. According to analysts, ‘financial innovation’ caused the recent financial crisis with the extent of culpability ranging from secondary to extreme. According to some, financial innovation has led to some very effective inventions such as the ATM machine whereas the other financial inventions like Structured Investment Vehicles (SIV’s) are a bane. The list of positive innovations includes Automated Teller Machine (ATM), debit cards, money market funds, exchanged traded funds, indexed mutual funds, currency and interest rate swaps (The Brookings Institution, â€Å"The Pros and Cons of Financial Innovationâ € ). The use of debit cards has enhanced the attractiveness of accounts as people no longer have to stand in queues to withdraw money. The introduction of financial swaps has empowered the businesses to hedge against any unforeseen circumstances. So, if a business with a huge export base is wary of depreciation of the receivables then it can take a suitable position in the currency swap. By this way, the value of its receivables remains intact. Similarly, a prospective borrower afraid of rise in interest rates, can buy forward rate agreements (FRAs) that will safeguard his position in the event of any unfavorable movement in interest rates. Financial innovation has empowered the domestic companies to raise the necessary funds or invest surpluses in the foreign capital markets.