financial innovation in afghanistan

8/13/2019 Financial Innovation in Afghanistan

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Source: Economics of Banking by Kent Mathews and John Thompson (2005)

Zachary J. Gubler (2011) believes that financial innovation should be understood first

and foremost as a process of change, a change in the type and variety of available

financial products to be sure, but also a change in financial intermediaries (such as

banks) and in markets, themselves.

The Modern financial innovation process based on Zachary J. Gubler

The figure below indicates that financial products migrate away from financial

intermediaries (located in the lower left- hand corner of the grid) and toward

markets (located in the upper right hand corner of the grid) when they exhibit

increasing information symmetry between intermediaries and investors (as reflected

by the arrow on the Y axis) and increasing standardization of terms (as reflected by

the arrow on the X axis). The migration of CDOs (Collateralized Debt Obligation)

away from banks is represented by its location closer to the market corner of the

grid. Note that CDOs are not located all the way at the upper right hand corner of

the grid, where the terms exchange and CCPs (Centralized Clearing Parties) arefound, because CDOs have not yet migrated to these market institutions. Finally,

note that credit default swaps, particularly those that are tied to CDOs and discussed

above, are still in a nascent, testing stage, embedded in relationships with financial

intermediaries. This diagram thus captures in broad strokes the intuitions regarding

the financial innovation process as developed in this subpart. The next subpart

discusses how the financial innovation process affects products, institutions, and

markets. In short, the process itself may lead to increased complexity in products

and institutions and create certain fragilities within the new markets created by the

market migration process.

Principle Forms of Structured Change in Ba

due to Financial Innovation

According to Goodhart (1984) there are t

principal forms of structural change du

financial innovation. They are in turn:

(1) The switch from asset management to lia

management.

(2) The development of variable rate lending

(3) The introduction of cash manage

technology.

Asset management fitted easily into the pos

world of bank balance sheets swollen with p

sector debt and quantitative controls on

lending. The basic idea behind the conce

asset management is that banks manage

assets regarding duration and type of len

subject to the constraint provided by

holdings of reserve assets. The move to lia

management (namely, their ability to c

liabilities by, for example, borrowing in the bank market) came in the USA by b

borrowing from the offshore euro dollar m

(often from their own overseas branches)

attempt to circumvent the restriction

regulation Q. The ceiling on the rate payab

deposits drove savers to invest in securities

mutual funds. In the UK, liability manage

was given a boost with the Competition

Credit Control Act 1971. With asset managem

the total quantity of bank loans was controll

restriction and deposits were supplied pas

to the banking system.

From the other side volatile inflation and int

rates during the 1970s led to the fu

development of variable rate lending. Blue

customers always had access to over

facilities at variable rates but during the 1

more and more companies switched to var

rate loans (linked to the London Inter-Bank

Rate - LIBOR). Banks were able to len

customers subject to risk, competitive pre

and marginal costs of lending. The total sto

bank loans became determined by the dem

for bank credit (this implies a near-horizsupply of bank loans curve). The developme

liability management and variable rate lendin

to the rapid expansion of bank balance sh

Banks managing their liabilities by alt

interest rates on deposits and borrowing from

inter-bank market satisfied the demand for

loans. Thus, the simplest type of fina

innovation was the development of inte

bearing demand deposits which enabled ban

manage liability.


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The pace of technological innovation in banking has seen the development of new financial products that have also

resulted in a decline in unit costs to their suppliers - the banks. Credit cards, Electronic Fund Transfer (EFT),

Automated Teller Machines (ATMs), Point Of Sale (POS) machines have had the dual effect of improving consumer

cash management techniques and reducing the costs of delivery of cash management services. A good example is

the use of debit cards over cheques. The costs of clearing a cheque are 35p per item compared with 7p per debit

card transaction. (Association of Payment Clearing Services information oce, www.apacs.org.uk)

Financial Innovation in AfghanistanAfghan modern banking industry is still very infant, hence we are still not in the position where we could expect

financial innovations should generate from Afghanistan, but certainly we can rely on extension or imitation of a

financial product that already existed in advanced countries or countries with a full fledge functioning banking

industry . Looking at recent history of Afghan banking industry one can easily finds out that imitation of financial

products have been effective in Afghanistan, though bundled with several challenges. It wont be exaggeration if

we insist to say that the entire modern banking industry of Afghanistan is imitated. When a financial product is to

be imitated one acute concern would be research and analysis about the target market and contextualization of

the product based on findings. Another perilous problem would be the capacity of central bank of Afghanistan

(DAB) to effectively monitor and supervise these innovations, because some of the recent cases in banking sector

of Afghanistan indicate that the afghan regulators and policy makers are still to bring reforms in the system and

improve their own capacity.

Conclusion

Financial innovation is much overused banking terminology. Financial innovation has been used to describe any

change in the scale, scope and delivery of financial services. Many scholars have highlighted the importance of

financial innovation. Three are three interacting forces behind any financial innovations i.e. instability, regulation

and technology. The process of financial innovation is depending on the three interacting forces based or

according to Zachary J. Gubler financial innovation should be understood first and foremost as a process of

change, a change in the type and variety of available financial products to be sure, but also a change in financial

intermediaries (such as banks) and in markets, themselves. Goodhart (1984) identified three principal forms of

structural change in banking due to financial innovations which are (1) the switch from asset management to

liability management (2) the development of variable rate lending (3) the introduction of cash management

technology.

To conclude, financial innovation is indispensable to banking, however we have to be enough vigilant about theseinnovations, because recently some of the innovations were subject to criticism. For example product

development is one of the forms that has been subject to much criticism following the recent global financial crisis.

Structured products, in particular, bear the lions share of suspicious critique with reference to the financial

turmoil that we continue to witness today. This has also led to the term of reference that the bearers and

conducers of financial modernization must embrace in practice not simply financial innovation but responsible

innovation.

References

1. Miller, Merton H., 1986, Financial Innovation: The last twenty years and the next. Journal of Financial andQuantitative Analysis

2. Josh Learner, The New New Things: The origins of Financial Innovations, 20023. Merton, Robert C., 1992, Financial Innovation and Economic Performance. Journal of Applied Corporate

Finance (Winter)

4. Gowland, D. H. (1991). Financial Innovation in Theory and Practice (Surveys in Monetary Economics, Vol. 2, edited byC. J. Green and D. T. Llewellyn). Oxford, UK: Blackwell.

5. Financial Times Lexicon(www.lexicon.ft.com/term?term=financialinnovation , Seen on 20/11/136. Zachary J. Gubler (2011), Financial Innovation Process: Theory and Application, research paper7. Goodhart, C. A. E. (1984). Monetary Theory and Practice: The UK Experience. London: Macmillan.

financial innovation in afghanistan

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