Financial Innovations, Marketability and Stability in Banking

Abstract

A fundamental feature of more recent financial innovations is their focus on augmenting marketability. We point at the potential dark side of marketability. Marketability has possibly led to an excessive proliferation of transaction-oriented banking (trading and financial market activities). The 2007-2009 financial crisis appears to have countered this trend, and possibly reemphasized the importance of relationship banking. In order to focus on these issues in a rigorous way, we will evaluate the key insights from the relationship banking literature, including the potential complementarities and conflicts of interest between intermediated relationship banking activities and financial market (underwriting, securitization, etc.) activities. From here we will point at institutional and regulatory changes that might be needed to improve the stability of the financial sector. One could say that the institutional structure (including regulation) has not kept up with the enhanced marketability and ‘changeability’ of the industry.

Keywords: financial innovation, financial market, relationship banking