For former Federal Reserve Board chairman Paul Volcker, this year’s landmark financial legislation was mildly disappointing. The bright-line separation of traditional banking from riskier trading activities that he had been stumping for — the Volcker rule — got watered down. But if that contribution doesn’t secure for the venerable economist a permanent niche in the bank regulatory pantheon, then his rhetorical flourishes certainly should.
Most memorably and pointedly, Volcker proclaimed the automated teller machine the greatest financial industry innovation of recent decades. Dismissing much of the inventiveness that produced securitizations and derivatives in their many flavors, automated market mechanisms and an explosion of investment choices, Volcker groused in a London speech last December, “I wish someone would give me one shred of neutral evidence that financial innovation has led to economic growth.”
The sitting Fed chairman, Ben Bernanke, concurred during recent congressional testimony, conceding, “Financial innovation is not always a good thing.” The upshot of the recent wave of creativity, he said, was too often “to take unfair advantage rather than to create a more efficient market.”
The climate has turned hostile toward financial innovation. And yet, amid the slow-paced recovery, economists, corporate executives and politicians alike hail innovation — broadly defined — as a job- and wealth-creating engine that should be stoked by tax breaks, capital expenditures and research and development.
Is there no role for the chastened financial industry in this hoped-for revival? Or don’t its would-be innovators have a contribution to make to the greater cause?
The answers, alas, are not as simple as Volcker’s well-aimed but unnuanced zingers. The ATM was an electromechanical invention of engineers, not bankers. Modern financial products are intangible, and although the crash did their image no good, there have been true breakthroughs over the years: financial futures and money market funds, for example, not to mention a long list of quantitative algorithms and business processes that the U.S. government has seen fit to grant patent protection.
It seems no more logical to close off R&D in this or any other industry than it would have been to shut down the U.S. Patent and Trademark Office, as one of its directors supposedly suggested in the 19th century in anticipation of an end to inventions.
What may have ended is anything on the order of the quantum advances in information technology and the Internet that fueled the last boom. “Don’t look for a new wave of IT,” advises Ronald Ruckh, a lead financial services industry consultant with LECG in New York. “It’s hard to see a million new products being developed, and derivatives are out the window. But IT can provide tools to be innovative, which means introducing something new that is repeatable, solves a problem and adds value.”
Charles Wendel, president of New York–based Financial Institutions Consulting, who works closely with business lenders, says the innovation-associated qualities of growth, experimentation and creativity are “not at a premium.” They are most visible at big, profitable banks and in areas where technology investments yield an identifiable payoff, such as corporate cash management services.
What Wendel sums up as “product innovation on the margins” won’t move markets or economies. Steven Spear, senior lecturer at the Massachusetts Institute of Technology’s Sloan School of Management and the author of a new book, The High-Velocity Edge, says two ingredients in tandem have that power: “constant discovery and innovation.” A postrecessionary environment “demands that companies be innovative,” says Spear. “But it’s not just a matter of spinning the wheel faster.” Firms and their customers are emerging into changed circumstances that have to be understood and translated into growth opportunities. One financial player that has had “no letup in the push to constantly innovate” is the International Securities Exchange, says Thomas Ascher, its chief strategy officer. ISE opened ten years ago as the first fully electronic U.S. options market; today it pursues transaction speeds and efficiencies with graphical processing units, a high-performance technology first proved in video games. The name of ISE’s game is market structure innovation, and it has seen no recessionary pause.
Jeffrey Kutler is editor in chief of Risk Professional magazine, published by the Global Association of Risk Professionals.
