Financial innovations An Indian perspective

Mr. Ganesh Patare Department of commerce and research center University of Pune Email. ganesh.patare@hotmail.com Mob- 9923607054

Abstract: The relationship between financial innovation new modes of fund raising, liquidity enhancing, risk transferring instruments and economic development is well research and well founded. The Noble Laureate, Dr. Kenneth Arrow has shown that resources within a nation can be allocated better if a greater variety of financial instruments are made available. It has become a customary now to describe financial system as financial services industry marking shift away from intermediation orientation to customer orientation with an accompanying focus on varied service packages for commercial and personal financial needs. Thus, the industry has witnessed an unprecedented boom in the design, test and marketing of innovative financial products. While in the past inflation and consequent interests rate and exchange rate volatility played key role in dictating the innovation agenda before the financial service industry, the principal focus of change today is (i) deregulation, (ii) information technology, (iii) Globalization of markets, (iv) huge and rapidly growing financial transactions and volumes, and (v) increase customer sophistication. Key Words:- Financial innovation, Financial services, Information technology

Introduction: "The primary function of the financial system is to facilitate the allocation and deployment of economic resources, both spatially and across time, in an uncertain environment." This function, in turn,

encompasses a payments system with a medium of exchange; the transfer of resources from savers to investor-users of the resources (and the eventual repayment to the savers); the gathering of savings for the purposes of pure time transformation (i.e., deferral/smoothing of consumption); and the reduction of risk through insurance and diversification. The operation of a financial system involves real resource costs, such as labor, materials, and capital employed by financial intermediaries (e.g., banks, insurance companies, etc.) and by financial facilitators (e.g., stock brokers, market makers, financial advisors, etc.). Further, since multiple time periods are an inherent characteristic of finance, there are also uncertainties about future states of the world that generate risks. For risk-averse individuals, these risks represent costs. The possibility of new financial products/services/instruments that can better satisfy financial system participants' demands is always present. Viewed in this context, a financial innovation represents something new that reduces costs, reduces risks, or provides an improved

product/service/instrument that better satisfies participants' demands.

Review of literature: Financial service is an innovative activity and requires dynamism. It has to be constantly redefined and refined on the basis of economic changes. The economic changes will depend on so many factors such as disposable income, standard of living and educational changes. These institutions while designing new service must visualize in advance about the requirements of markets and wants of customers. A good number of experts have contributed to the theory and practice of financial services. 1. Goldon Natrajan emphasized on Changes has been taken Place after new economic policy in India. 2. B.S.Batra has provided certain basic inputs to the financial services in modern India. 3. Sumeet Gupta in his book Financial Innovations in the Indian Capital Market has express the future of derivatives as risk mitigating instruments. The emergence of liberalization, privatization, and globalization opportunities and natural and manmade catastrophes have brought forth the need to have derivative instruments. Objectives of study: The researcher has drawn some objectives relating to the present study. These are as follows: To examine what are the changes taken place in financial services in India after the globalization & liberalization of Indian economy. To identify the impact of growing competition of international capital markets on financial innovation. To examine the effects of globalization in financial innovation. Research Methodology: The present study is based on the secondary method of data collection. The secondary data provide useful and necessary information and further guided the researcher in defining the variables of the study.

For this purpose, secondary data was collected from all associated sources that include: a). Books on Financial Services. b). Research Journals, Websites.

Impetus for financial innovation: As noted above, historically, especially in 1970s inflation played a major role in stimulating financial innovation. The most direct impact of inflation on financial innovation has been a route to the resultant and the parallel movement of interest rates. Raising interest rates had two major financial impacts Holders of outstanding bonds experienced large capital losses while issuers of such debts had to lock themselves into historically high long term rates to raise fresh long term funds. Both long term borrowers and lenders thus experienced increased risk and uncertainty in the financial market. Indeed, there was talk of the impending demise of the bond market. Although it was no surprise that lenders, given their old locked in interest rates, were hurt by inflation, stock also turned out to be a poor inflation hedge during this period. Indeed one witnessed a paradox of simultaneous occurrence of raising consumer prices and fall in real stock prices. It turned out that during an unanticipated, raid and erratic inflation, business was unable to adjust its prices to its costs fast enough to avoid pre-tax erosion of its profits; the after tax situation was even worse. Thus, at given P/E ratios, stock prices lagged, and the yield competition in the market which required dividend yields to rise although absolute dividends lagged, required that stock prices fell. Thus, during this period returns from stock included no capital gains, dividend yields raced parallel to bond interest rates, with capital losses those who had to liquidate shares. Under

these circumstances options and futures become a substitute or complement for buying stocks or funds themselves. The eighties saw an accelerated pace of innovation assisted with the liberalization of several major financial systems and the transformation of the international financial markets. International credit flows started moving away from loans through banks towards direct credit and security markets, reflecting a move towards international disintermediation and involving a change in the role of banks. Financial markets became more closely integrated world- wide. Cross border capital mobility also increases considerably. All these changes led to financial innovations. Effects of Liberalization on Financial Innovation: 1. Several major financial markets resulting from abolition of exchange controls and interest rate regulations, opening of domestic financial markets to foreign financial institutions, and lessening of market fragmentation. 2. Supervisory authorities becoming more concerned about the soundness of other financial institutions; in particular, they started questioning the quality of some international assets. This resulted in concern for pressure for better capital adequacy ratios. Both these developments led to a search for new techniques and instruments to adjust to the changed environment and the new supervisory requirements. Other stimulating factors were:

Growing Competition Impact: Growing competition in international capital markets was also responsible for these innovations. The causes which were responsible for the growing competition in the financial markets (i) New technologies which fostered competition sought to exploit their comparative advantage in as many markets as possible (ii) Shifting pattern of saving and investment brought out pressure on financial institution particularly in those situation where market were shrinking to innovate and there was a keen desire to maintain or expand their shares in the market. Global Integration of Financial Markets: Global integration of financial market resulted from macroeconomic developments, deregulatory measures, technological changes and financial innovations and one could clearly see through the fading of three demarcation line (i) between market elements; (ii) between different kinds of financial assets in domestic and international markets; (iii) between financial institutions; and (iv) between financial innovation and security markets. Despite the fact that there are a variety of new instruments their prices are determined and regulated by three basic formulas, namely (a) fixed rates; (b) fluctuation rates; and (c) convertibility. In facts, price comparisons and intermediation across the market spectrum has led to a unified price structure. This has in turn converted Euro Bonds, Euro Security markets which were initially fragmented,

widened and today they are increasingly homogenous with standardized practices. Swaps have also contributed significantly to market integration by reducing market fragmentation both domestically and internationally by allowing access to portfolios in financial markets independently of the currency or interest rate preference of those involved in the operation. Globalization of markets: The globalization of markets and the international involvement of firms and their customers have been influenced by the factors such as: deregulation that opens doors to foreign competitors; information technology that permits instantaneous linkage of foreign markets and 24 hours trading; the growth of international business with accompanying needs for financial services around the world; and the appetites for expansion that has caused firms to look aboard.

Conclusion: Innovation in financial market is a response to dynamic nature of the market and therefore is a continuous process. However, during the last decade the pace of financial innovation acquired a great momentum and caused widespread changes in structure of market and the interrelationship among economic agents, market segments, etc.

Although the process of innovation has been widespread all over the world, it impact is not uniformed in all countries. While financial markets in developed countries have been influenced to a very large extent, sheltered market, like ours, are affected to lesser extent. Even within

developed countries maximum change can be notices in the US market. Therefore, it is difficult to draw general conclusions regarding its implication for stability of financial system. However, an examination of process of innovation, the forces shaping them and the changes brought by them in the risks borne by various parts of financial systems as well as by the system as a whole can enable us to gain valuable insight into the whole process. Such knowledge will be very useful for us as with the progress of liberalization and globalization of our financial system will also be exposed to the process of innovation. Bibliography: 1. Indian Financial System, Emerging Trends- Pramod Rao, Preeti Phuskete. 2. Financial Markets and Services- Gordon Natarajan. 3. The global Financial Markets and Institutions- Vasant Desai 4. Financial Services- G.S.Batra.