Work Package 8 explores 'technological trajectories' in banking and their relation to regulation. It aims to improve understanding of how shifts from the current trajectory based around re-engineering the risk of default, to one that takes more account of liquidity risks will take place. This analysis will integrate research on financial technology within an evolutionary framework to inform public and academic debate and the effective generation and regulation of financial innovations within Europe.
Description of work
This Work Package will review and analyse financial service innovation in the light of current policy concerns about the financial crisis. The work will be undertaken at SPRU, led by Paul Nightingale.
Exploring innovation in financial services
Work Package 8 will generate a working paper exploring innovation in financial services using a novel evolutionary framework. The analysis will explore the influence of regulation and industrial structure on innovation trajectories as financial services have moved from the national to European level. Dr. Nightingale will work with a post-doc to explore the influence of regulations such as Basel I and II on risk management, and post-ENRON regulations and corporate governance 'soft-law' on innovation and the social distribution of risk. For example, addressing questions about the extent to which a focus on Capital Adequacy Requirements drives innovation towards riskier services to increase returns.
Changing technological trajectories in finance
The second deliverable will be a working paper on changing technological trajectories in finance that will explore the emergence of the existing technological trajectory over the last 30 years and its focus on securitisation and re-engineering of financial obligations. It will explore how the development of increasingly sophisticated methods for engineering, pooling and insuring risks have focused on the risk of default.
Technological convergence, financial technologies and regulation
A central focus will be technological convergence between different financial technologies (i.e. between the derivatives and insurance markets), and how differences in the regulation of functionally equivalent products influence s the rate and direction of technical change. For example, many options are now functionally equivalent to sophisticated insurance contracts that for historical reasons have been regulated at the state level in the United States. This may have been appropriate for insuring local factories against fires, but raises concern when insurance contracts underwrite the national debt of the Netherlands and are used to re-pool and in some instances obscure the risks of default of pooled securities (for example, insuring the risk of default of subprime lending). Since there is no central clearing house for these contracts, they have contributed towards the increased opaque nature of the credit markets, where the leverage generated by new financial instruments makes the relationship between the credit worthiness of institutions and their ratings by financial ratings organisations less transparent. This has led to an increased concern about liquidity risk, suggesting that the current technological trajectory will have to change.
Work Package leader: Paul Nightingale, University of Sussex