Financial innovations carry risk, some prove to be beneficial on net, but some others result in adverse outcomes. Authorities must ensure the infrastructure needed to support innovative activities in finance is in place and functioning properly.
Some financial developments have been efforts at liberalisation, which allowed for increased competition across sectors and borders. This has created the need for greater resilience. Financial innovations raise a number of policy issues, so it might be advised that innovations be treated on a case-by-case basis.
Banks often create entirely new products and trading strategies to deal with financial innovation. This can create a more optimal distribution of risks throughout the system so that risks are shifted to parties with the ability to bear them.
There are periodic episodes of instability which tend to occur in the wake of innovations. Failures of discipline across all participants in the latest financial crisis was caused by insufficient concerns about credit risk, the mis-pricing of risk and complex policies that were not understood.
Not all innovations are necessary for growth and development of the economy. Policy makers should not walk away and admit defeat, as innovations touch on issues that are of considerable public interest.
Regulatory measures should balance preserving safety and soundness of the system whilst allowing financial institutions and markets to perform their intended risk management functions. This requires a proper structure for reviewing financial innovations. The first step in the process is surveillance, then careful analysis before allowing a product to continue unchanged. A given product or activity may not raise particular concerns for some objectives, but may be a serious issue for others. All objectives must be considered and some authority must take a system-wide view.