dr rozita chong

8/14/2019 DR ROZITA CHONG

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CURRENT ISSUES SEMINAR 1

TO BE IN A

COMPETITIVE EDGE:

PERILS OF INNOVATION

Rosita Chong


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1.0 INTRODUCTION

Rapid process of globalisation rapid pace

of innovation devastating disruption in the

financial system Current financial

turmoil.

However, in a highly globalise financial

market, innovation themain

differentiating factorin orderto beCOMPETITIVE and to ensure SURVIVAL-

ABILITY.


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What Does Competitiveness Mean?

According to the definition by Porter,

competitiveness focussed on the prosperityderived from economic activity that create

values by providing products and services at

prices above their cost of production.


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What does innovation mean?

The act of introducing new or relatively new

product or process.

Important in the study of economics,business, technology, sociology and

engineering.

It is considered it as the engine of growth by

many economists.


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Like in any other industries, innovation is part

of the dynamic process of what Schumpeter

called creative destruction.

It has driven forward and raised the living

standard of people in the market economies.

However, if innovative activities are stretched

too far out brings more harm thanbenefits

Innovation in the Financial Industry


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2.0 FINANCIAL INNOVATION

Innovation is considered as a common toolwith which a financial organisation could

ensure comparative advantage in itsbusiness activities over others. One form of innovation related to business

is financial innovation.


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What is financial innovation? Jacque (1999) refers financial innovation to any

new development in a national financial system orthe international financial system that

(i) enhances the allocation efficiency of thefinancial intermediation process, and(ii) improves the operational efficiency of

the financial system by

reducing the costs and/or risk oftransactions in the primary and secondarymarkets in which financial instruments are

traded.



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It refers to the various activities related tofinancial products, which banks created in orderto mitigate or manage risks.

It has allowed firms of all industries to raisecapital in large amounts and at a lower cost thanthey would otherwise.

an ongoingprocess whereby private parties

experiment to try to differentiate their productsand services, responding to both sudden andgradual changes in the economy



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Tufano (2002) classified financial innovation as

(i) new financial intermediaries such as venture

capital funds,

(ii) new financial instruments such as collateralised

mortgage obligation or credit derivatives,(iii) new financial markets such as

insurance

derivatives,(iv) new financial services such as e-trading or e-

banking and(v) new financial techniques such as Leverage Buy

Outs.


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2.1 Drivers of

Financial Innovation

According to Poole (2008), financial markets are alwaysinnovative and there are various drivers of innovation, namely;(i) Technological advances : In the 1950s credit

card was introduced because of advancement ofcomputer and communication technology has enable ahigh- speed processing of credit card transactions

feasible, (ii) Profit motive,(iii) Response to

regulation and government policy.

(iv) Opportunity to earn a market rate of interest ontransaction balances when interest rate on bank and thrift

deposits were capped by law.(v) Lower cost of producing the existing financial services,

(vi) Response to risks due to globalisation such asexchange rate, interest and political risk ,

(vii) Lower mortgage rate charged to borrowers.


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2.2 Perils of Innovation

History is full of examples of innovation that led toinstability (Poole, 2008).

Example of such is the innovation in the mortgageindustry

It has enabled loans to be made available to manypeople including those who have poor credit rating the recent sub-prime lending crisis

The crisis has proven that it may be good to provide

loans to as many poor as possible in order to enablethem to buy houses, however, if such innovativeactivities are undertaken excessively, there will beperilous consequences to the economy.


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Sub-prime crisis is a phenomena wherebymortgages are offered to low-income high-risk borrowers,

Sub-prime lending is new innovation It enables lenders with high risk profile to take

up loan, and banks and other lenders transfer

the risk off their balance-sheets by shiftingand dicing the principal and income streamsinto securiticised tranches to suit investorsseeking yields (Wignall (2007).

What is Sub-prime Crisis?


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What happened that led to the crisis?

It was that financial innovative activities have

further developed through the process ofsecuritizations.

According to Check (2008), financial

innovation through securitisation has allowed

banks to sell the mortgages to investmentfirms on Wall Street.



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The investment firms then bundled the top-grade

mortgages with the low quality mortgages.

This was later sold as mortgage-backed securities

to investors providing relatively high returns, but atthe same time they appeared safe because they

were backed semi government entity such as by

Fannie Mae and Freddie Mac.

The innovative breakthrough has made it possible toconvert the bad mortgages into triple-A, investment

grade, mortgage-backed securities.



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Illustration on Securitisation of MBS

3 0 INNOVATION


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3.0 INNOVATION:

THE MALAYSIAN

EXPERIENCE

Most of the innovation in the financial markets inMalaysia has been derived from the innovation onIslamic financial product.

The word financial innovation in Malaysia takes itsmeaning particularly with reference to innovation inthe Islamic banking industry.

It relates to the effort of Islamic banking to createShariah-compliant new ideas and possibilities inorder to meet their increasing concerns aboutproduct development as well as liquidity and riskmanagement.

3 0 INNOVATION:


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There has been an increasing interest in the

demand for alternative financial instruments

in the country and around the world.

The interest in particularly the Islamic

financial instruments has been evident

especially after the Asian financial crisis of

the late 1990s and the recent Global financialcrisis.

3.0 INNOVATION:THE MALAYSIAN

EXPERIENCE


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A major trend has been the growing integration ofIslamic investments and financing into the globaleconomy.

As a consequence ofuniversal changes, a more

diverse innovative vibrant Islamic financialinstitution is beginning to take hold. A rapid expansion of Islamic products that are

being offered by conventional banks whose

clientele are both the Muslim and non-Muslim. As Islamic financial institutions now operate in

over75 countries with assets in excess of USD230 billion.

.THE MALAYSIAN

EXPERIENCE

3 0 INNOVATION:


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The Malaysian government has rigorouslyembarked on development of more Shariah-compliant to come up with such instruments.

However, it is important for financial innovation inIslamic finance to have clearShariah objectives andadhere to the requisite principles ofShariah.

This is to ensure that the Shariah -based innovationwould contribute towards Islamic financial productsthat have distinct value propositions with in-builtstrategies arising from the essential features ofShariah.

3.0 INNOVATION:THE MALAYSIAN

EXPERIENCE

THE MALAYSIAN


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INNOVATION is pertinent in order to increase the efficiency and

competitiveness of the Islamic financial institutions,

hence, there is a constant need for product

development. applies to (i) the creation of new products, and to

(ii) enhancing existing products.

encompasses developments ofShariah -complaint

products, derivatives and the more complex

structured products that involve financial products

engineering and executive produce.

THE MALAYSIAN

EXPERIENCE


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3.1 Financial innovation in

Islamic Finance

The emergence of interest-free Islamic bankingduring the last three decades considered asafinancial innovation.

Reasonto consider it as an innovation is that itoffers the services of a financial intermediarywithout paying and receiving interest, the keyplayer of the existing financial system.

As a resultIslamic banks have been able tomobilise large amount of deposits that wereotherwise untapped in the Muslim countries(Noman, 2006).

3 2 Perils of Innovation


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3.2 Perils of Innovationfrom the Islamic

Perspective

It is imperatives that in orderto be

competitive, there is a need to innovate.

However, such efforts should not result ina diffusion of the Shariah authenticityor

classification of the Islamic financial

products.


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Financial innovation often brings with it changes inthe perception of risk.

Merton (1995) makes the point that less apparentunderstanding of the new environment can create a

sense of greater risk even if the objective level ofrisk in the system is unchanged or reduced.

Islamic finance is not immune to such perceptions. The emergence of Islamic finance on the world

financial landscape presents challenges similar tothat of the conventional finance. Hence, Islamic financial engineering has designed

differently from the conventional ones.

.from the Islamic

Perspective


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If financial instruments are mere copy-cats of

the current instruments, then an Islamic sub-

prime crisis might emerge.

This is because, in line with Mertons

observation, it is generating concerns on the

inherent risks it presents and theirpossible

spillover on the rest of the financial system asit is less well understood than conventional

finance.

3.2 Perils of Innovation

from the Islamic Perspective


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With financial innovation, including both through theIslamic Financial Institutions as well as theconventional counterpart, various instruments andstructures are emerging to meet the demand forspecific services.

As a result, the functions of financial institutions areevolving continuously and becoming more complex.

Hence there is a need forenhancement in the roleand skills on the part of the regulatorto frequentlyassess the adequacy and strength of the regulationsthat are currently in place.

.from the Islamic

Perspective


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Too often innovation has been achieved by

putting the business and/or misusing fatwa by

taking them out of context.

There should also be an effort to avoid mereimitation, for instance, from just mere purification

of current financial transactions from haram (the

prohibited) to designing financial ways and means

that would serve the maqasid al- Shariah(objectives of Islam).

.from the Islamic

Perspective


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Once Islamic finance is in the correct direction, then it will finditself in good company. There has been a relative decline in bonds and a rise in equity as

means of investment at the international as well as domesticlevels.

The financial community is now aware of the environmental andethical considerations that must attend its choices.

People want to invest their money in order to have more money inthe future.

This has provided a window of opportunity for Islamic financeseeking to serve the Islamic goals of balanced growth, equitable

distribution and mutuality. These goals are universally acclaimed by contemporary humanity.

4.0 CONCLUSION


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With respect to Islamic Finance, the ownership and rights to theassets in the investment exist at all times as it is a requirementunderShariah.

Investors can feel and identify the assets in which they invested,

unlike sub-prime products where investors found themselves nolonger having the ability to sell their invested assets becausethey were no longer there.

Sub-prime type transactions whereby the sub-prime asset aresecuritised over and over again cannot occur under Shariahbecause it is seen as unproductive and without value to society.

Irrespective of whether transaction are conducted in local orglobal markets, the Islamic financial industry exists in the samemarket as the conventional financial industry and look for thesame client base.

4.0 CONCLUSION

dr rozita chong

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