UNIVERSITY OF NAIROBI
SCHOOL OF BUSINESS – KISUMU CAMPUS
COLLEGE OF HUMANITIES AND SOCIAL STUDIES
DEPARTMENT OF BUSINESS ADMINISTRATION
COURSE: FINANCIAL INSTITUTIONS AND MARKETS
COURSE CODE: DFI 503
LECTURER: MR OMORO
NGOME GIDEON BETI
MUOKI SHADRACK KIALA
TSISAGA MERCY ALEYO
OWIDI GABRIEL ODONGO
SEMESTER: MAY TO AUGUST 2014.
TASK: FINANCIAL MARKETS AND MACROECONOMIC POLICY II
FINANCIAL INNOVATION AND MONETARY POLICY
Innovation is the introduction of a new product to a market or the production of an existing one in a new manner. Financial innovations occur because market participants are constantly searching for new ways to make greater profits. The process of financial innovation includes changes in financial instrument institutions, practices and markets. In broad sense financial innovation affects the nature and composition of monetary aggregates through new financial instruments or changes in old instruments as well as the term and conditions of debt or credit arrangements Innovations can be grouped by a functional basis aggressive or defensive. Aggressive innovation is the introduction of a new product or process in response to perceived demand. A very large part of innovation since at least the late 1970’s is aggressive innovation in the literature. Defensive innovation is response to changed environment or transaction cost. Financial innovations lower the transaction cost of transferring funds from lower yielding money balances to higher yielding alternatives. Therefore with financial innovation market participants attempt to minimize risk and to maximize return. As financial innovation is a continuous process, it is difficult, in practice, to grasp all of its contours; and even more difficult to predict its consequences. Therefore, financial innovation adds an element of uncertainty to the economic environment in which central banks operate. Therefore, regulatory bodies should be keen on protecting the targeted users of these innovations, by analyzing various monetary and non-monetary indicators, and constituting a "full-information" framework, that allows information derived from different sources and using different approaches to be cross-checked.
Financial innovations are mainly as the result of four interrelated factors: High, variable and unpredictable inflation, interest rates and exchange rates increase in government deficits and their effects on interest rates and financial markets floating exchange rate. Many financial innovations offer protection against changes in the financial environment especially changes in exchange and interest rates Technology-the development of new technology can stimulate financial innovation by lowering the cost of providing new financial services and instruments by using computers and telecommunication. The rapid development of technology in the financial sector the introduction of new communication and transmission systems also speeds up information flows Changes in the regulatory environment-the relationship between regulation and innovation are the most debated in the literature. It is clear that each can cause the other but it is not clear how significant such effects have actually been Changes in perceived market conditions-financial innovation are fundamentally market driven. Firms offer new products because its profitable. The existing structure of the financial industry, the degree of concentration and competition in the banking sector, ease of entry, profitability, extent of development and of specialization among different types of financial instrument, available choice of portfolio assets, interaction of market forces with regulations effects financial innovations. Changes in the international financial environment and the increasing...
References: 1. Alesina, A. and Ardagna, S. (1998), “Tales of Fiscal Adjustment,” Economic Policy, 27, 487–545.
2. United Nations (2010). World Economic Situation and Prospects 2010. New York: United Nations.
3. UNCTAD (2009). Economic Development in Africa 2009: Strengthening regional economic integration for Africa’s development. United Nations publication. Sales No. E-96.II.D.3. New York and Geneva.
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