Financial Innovation: The Bright and the Dark Sides

HKIMR Working Paper No.05/2012

52 Pages Posted: 6 Mar 2012 Last revised: 15 Jun 2014

See all articles by Thorsten Beck

Thorsten Beck

City University London - Sir John Cass Business School; Tilburg University - European Banking Center, CentER

Tao Chen

Nanyang Technological University (NTU) - Division of Banking & Finance

Chen Lin

The University of Hong Kong - Faculty of Business and Economics

Frank M. Song

The University of Hong Kong - School of Economics and Finance

Multiple version iconThere are 2 versions of this paper

Date Written: February 29, 2012

Abstract

“Everybody talks about financial innovation, but (almost) nobody empirically tests hypotheses about it” Frame and White (2004).

The financial turmoil from 2007 onwards has spurred renewed debates on the “bright” and “dark” sides of financial innovation. Using bank-, industry- and country-level data for 32, mostly high-income, countries between 1996 and 2006, this paper is the first to explicitly assess the relationship between financial innovation in the banking sector and (i) real sector growth, (ii) real sector volatility, and (iii) bank fragility. We find evidence for both bright and dark sides of financial innovation. On the one hand, we find that a higher level of financial innovation is associated with a stronger relationship between a country’s growth opportunities and capital and GDP per capita growth and with higher growth rates in industries that rely more on external financing and depend more on innovation. On the other hand, we find that financial innovation is associated with higher growth volatility among industries more dependent on external financing and on innovation and with higher idiosyncratic bank fragility, higher bank profit volatility and higher bank losses during the recent crisis.

Keywords: Financial Innovation, Financial R&D Intensity, Bank Risk Taking, Financial Crisis, Industrial Growth, Finance and Growth

JEL Classification: G2, G15, G28, G01, O3

Suggested Citation

Beck, Thorsten and Chen, Tao and Lin, Chen and Song, Frank M., Financial Innovation: The Bright and the Dark Sides (February 29, 2012). HKIMR Working Paper No.05/2012. Available at SSRN: https://ssrn.com/abstract=2015884 or http://dx.doi.org/10.2139/ssrn.2015884

Thorsten Beck (Contact Author)

City University London - Sir John Cass Business School ( email )

106 Bunhill Row
London, EC1Y 8TZ
United Kingdom

Tilburg University - European Banking Center, CentER ( email )

PO Box 90153
Tilburg, 5000 LE
Netherlands

Tao Chen

Nanyang Technological University (NTU) - Division of Banking & Finance ( email )

S3-B1A-08, Nanyang Avenue
Singapore, 639798
Singapore

Chen Lin

The University of Hong Kong - Faculty of Business and Economics ( email )

Pokfulam Road
Hong Kong
China

Frank M. Song

The University of Hong Kong - School of Economics and Finance ( email )

8th Floor Kennedy Town Centre
23 Belcher's Street
Kennedy Town
Hong Kong

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