Financial innovation and social welfare

Abstract

PurposeThe purpose of this paper is to consider the case for regulating financial innovation in light of the recent global financial crisis.Design/methodology/approachResponsibility for assuring the bank customers are “treated fairly” in the UK currents belongs to the Financial Services Authority (FSA), whilst the Office of Fair Trading (OFT) oversees the Consumer Credit Act. The paper argues for the regulation of retail banking and financial service provision as a utility, leaving the FSA to concentrate on prudential supervision and the OFT to concentrate on its other responsibilities. Financial innovation in wholesale and investment banking should be regulated by the prudential authorities.FindingsNew financial instruments are frequently underpriced, which may be in part to encourage rapid and widespread adoption.Practical implicationsGood, transactions cost and risk reducing, retail financial innovation should be encouraged. New wholesale financial products should be thoroughly “stress tested” prior to being licensed, analogous to the testing of new medical “drugs” by the pharmaceutical industry.Originality/valueThe global banking crisis led to calls for banks to maintain lending to small‐ and medium‐sized enterprises and households (especially mortgages). This implies that access to finance, like access to water and electricity, should be assured and that customers should be protected against the “monopoly” powers of large suppliers. Hence, retail banks are utilities and should be regulated as such.