Innovations in modern finance

The world of finance is always moving forward even in – and sometimes because of – times of crisis and challenge. Innovations in finance come from the development of new financial services and products. These developments can be a reaction to consumer trends or can inspire changes in consumer behaviour. Financial innovations often involve risk management, updated technology, and credit and equity generation.

It’s generally thought that there are six major factors that initiate financial innovation:

• Volatility in interest rates, inflation, equity pricing, and exchange rates.
• Advances in digital and financial technology.
• More sophisticated training amongst professional market participants.
• Competition amongst financial institutions.
• Incentives to work around tax laws.
• A change in the pattern of wealth globally.   

In the wake of the financial crisis of 2008, the financial system got shaken up and the way was cleared for more innovation amongst leading banks and financial services providers. However it has been the technological innovations of start-ups that have really forced the pace of change. 

The proliferation of start-ups that were applying technology to both old and new financial products in that time, and which continue to do so, led to the naming of a new sector – fintech. 

What are financial innovations?

In today’s fast-paced world, technology drives innovation. Financial innovations which have been highly successful and which now feel like a normal part of our everyday lives include mobile banking and banking apps, contactless payments, and chatbots. Innovations that offer more future potential include blockchain and artificial intelligence (AI).

Although blockchain famously provides the basis for cryptocurrencies, it offers other advantages including greater securitisation and the technology to implement smart contracts. Using blockchain can facilitate real-time processing of transactions and the automation of payments, enforce business rules and transparency, and reduce costs by eliminating intermediaries and simplifying infrastructure. This can be hugely beneficial in supporting supply chains especially those which span across the world, in different time zones, and with different currencies.

A lot of financial innovations and technological advancements were precipitated by the global pandemic or became more popular due to restrictions during lockdowns. Contactless inevitably became appealing to many as from a hygiene perspective, many retailers stopped taking cash. In July 2021, Visa confirmed it processed one billion contactless transactions across Europe in 12 months. Mastercard also observed a leap in contactless use and announced in August 2021 that it was phasing out its magnetic stripe cards over the next decade.

Paying by using smartphones with digital wallets such as Apple Pay also became more relevant for many, and Mastercard’s pioneering Cloud Tap on Phone tool has inspired Apple to further develop its payment capabilities with Tap to Pay on iPhone. The innovation of tap-to-pay transactions is facilitated through integration with payments systems such as Stripe.

Some of the main areas within the financial sector that offer examples of innovation include:

Mobile banking

Most if not all major banks have their own apps and offer mobile banking but they were inspired by the features offered by online-only banks (sometimes known as challenger banks) such as Monzo and Starling Bank. Apps allow customers to check their balance instantly, make sure deposits have been received, transfer money, or even find their nearest ATM should they need cash.

Digital-first financial services were pioneers in offering more interactive functions via their apps, for example financial planning to help people reach their long-term and short-term savings goals using payment pots and spending caps. They also built innovative features such as spare change investing which rounds up transaction amounts and places the extra into savings or invests it.

Remittances

Remittances usually refers to money that expatriates send back to friends and family in their country of origin. This used to be a potentially lengthy process with various charges involved predominantly carried out via mail, wire (e.g. Western Union, Moneygram), or bank transfer. In the early 2000s, the World Bank even established a database to help people compare the prices of the various transfer services.

Remittances represent the largest source of external finance for many developing countries, ahead of Official Development Assistance (ODA) and Foreign Direct Investment (FDI). They are important to global economic development and particularly to poorer countries where they can represent over a third of Gross Domestic Product (GDP). 

TransferWise (now known as Wise) became the first fintech group to gain direct access to the Bank of England’s interbank payments system. This was a result of a regulatory strategy to encourage competition in the UK’s financial sector. It meant that TransferWise could process payments coming into the UK without the payment first having to hit an account in a commercial bank. It was a major move in financial regulation to create a level playing field for fintech start-ups to compete with banks. The competition has also helped lower transfer rates.

Investment crowdfunding

The opening up of investment crowdfunding platforms and apps has led to a more democratic space for raising equity capital. New infrastructure and regulations made it possible for members of the public to invest in projects that they feel passionately about for even a small sum of money. 

Platforms such as Seedrs and Crowdcube provide accessibility to investment opportunities that anyone can support.

What are innovative financial instruments?

According to the Financial Reporting Council (FRC) “a financial instrument is a contract that gives rise to a financial asset of one entity and a financial liability or equity instrument of another entity. It includes cash, trade receivables and payables, equity investments, borrowings and derivatives.”

Essentially, financial instruments are assets that can be traded. They are either cash instruments or derivatives instruments and can be classed according to asset, so either debt-based or equity-based. Foreign exchange instruments are the third type of financial instrument.

A hybrid is a new instrument created through a combination of debt, equity, and, possibly, other derivatives. There are many hybrids, but contingent debt (or structured notes) and swaps are probably the most popular.

Cash instruments that may be considered innovative include green bonds to finance climate action. Philanthropy towards social development and gender equality also benefit from innovative financial instruments such as equity investments and guarantees to local banks which lend to large numbers of small businesses, for instance.

Contribute to future innovation with an MBA Finance

With consumer spending habits changing, people retiring at an older age, and purchasing homes later in life, financial services such as savings and mortgages need to change. Major banks as well as start-ups need to innovate to keep financial markets buoyant and to reflect changing demographics and lifestyles. 

Learn more about the financial industry and the different types of innovation that are re-shaping the industry with a 100% online, part-time MBA Finance from Keele University.