financial innovation


According to Tofano (2002, p.2) financial innovation is an ongoing process that involves the development of new products and services or modification of existing products and introducing them as new products. Innovation in the banking industry is as important as it is in other industries as argued in Lerner (2003, p.2).

The innovation capabilities of a bank is influenced by its market and structural features of the bank according to Frame and White (2004, p.116). These features also influence the type and level of financial innovation adopted by the bank. Such features include the banks position in the market, the size of the bank, ability of the bank to access technological resources, ability of the bank to adopt new ideas in the market and the demand for the banks product in the market.

Types of innovation can be based on the product, processes, services and organization forms as put in Lerner (2003, p.6).


There is a high correlation between the company’s characteristics and its ability to innovate as put in Leiner (2003, p.6). Some of the characteristics that influence a company’s ability to innovate include;

The Market Position of the Company

The company’s market position influences its competitive ability in the market. It is determined by the company age as put in White and Frame (2004, p.119) and Leiner (2003, p.6). They argue that new firms in the market are likely to introduce new products for example new forms of mortgages into the market so as to gain competitive advantage over the already established companies in the market.

Frame and White(2004, p.119) questions the ability of small new firms to sustain innovation in the long-term due to constraints arising from insufficient funds required carry out research and development. Leiner (2008, p.6) says that large firms with already established markets in the financial industry are more likely to engage in research and development due to the finances at their disposal hence are more likely to innovate their products, services for example internet banking and mobile banking, processes and organization forms for instance by introducing internet only banks, Muslim banks.

Size of the Company and financial capability

Leiner (2003, p.7-8) argues that the size of the firm determines the resources at their disposal and financial capability which in turn influence the company’s innovate capabilities. Large companies have well established research and development departments in charge of developing and implementing new products and services into the market. They are therefore more likely to engage in unprecedented innovation products and processes, services, new forms of organization for example Muslim banks due to their ability to spread the cost related to the innovations as put in Frame and white (2004, p.118).

Small firms on the hand due financial constraints as put in Tofano (2002, p.12) are less likely to engage in uncertain innovation that have not been tried in the market before due to their inability to absorb the costs that would arise from failure of such innovation. Their level of innovation is restricted to product and services.


As put in Leiner (2003, p.10) and Tofano (2002, p.14) ability of the company to incorporate new ideas in the market into the companies already existing products, services and processes influences its innovation capabilities.

White and Frame (2002, p.119) says that new ideas and processes that have not been copyrighted or patented by the company that came up with the idea are likely to be adopted by competing firms as improved versions of the original idea.

A company that has the ability to take advantage of idea spill over’s does not incur the initial cost of research and development associated with unprecedented ideas. Such firms are able to improve on their products and services regularly.

The level of innovation is restricted to product and service due to the technicalities associated with copying complex ideas without carrying out market research.

Product Demand

Frame and White (2004, p.119-120) says that if the market demand for the companies product is high this will translate to high returns which in turn help to facilitate the innovation process by ensuring that there are sufficient fund for research add development.

Companies with high market demand are likely to engage in complex innovation processes for their products, processes, organization forms and services because they are not constrained by finances. This also helps them to efficiently serve their large market with different product needs. They are therefore likely to engage in all kinds of innovation types such new product for example new mortgage forms, new organization types for example internet only banks for their technologically advanced consumers and new services for example use credit cards.


Financial innovation is very crucial component for a banks ability to gain competitive edge and survival in the industry. It is influenced by the banks market and structural features such as the banks position in the market, the size of the bank, ability of the bank to access technological resources, ability of the bank to adopt new ideas in the market and the demand for the banks product in the market. This features influence the level and type of innovation that the bank adopts.













Frame, S. and. White, L. J. (2004), ‘Empirical Studies of Financial Innovation: Lots of Talk, Little Action?’, Journal of Economic Literature

Lerner, J. (2004). ‘The New New Financial Thing: The Sources of Innovation before and After State Street’, Harvard NOM Research Paper No. 04-20

Tufano, P. (2003), ‘Financial Innovation’, in Handbook of the Economics of Finance, Ed. G. Constantinides, R.M. Stulz, and M. Harris, North Holland


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