Financial Innovation: Definition, Role, Categories, and Examples

What Is Financial Innovation?

Financial innovation is the process of creating new financial products, services, or processes. Financial innovation has come via advances in financial instruments, technology, and payment systems. Digital technology has helped to transform the financial services industry, changing how we save, borrow, invest, and pay for goods.

While large banks continue to invest in mobile banking, FinTech companies, like Stripe, help small businesses conduct online payments, and investment broker Robinhood seeks to democratize investing and finance. These innovations have increased the number of financial providers available to consumers, borrowers, and businesses.

Understanding Financial Innovation

Financial innovation is a general term and can be broken down into specific categories based on updates to various spheres of the financial system. While the following is not an exhaustive list, major financial innovations have come in the raising of equity capital, remittances, and mobile banking.

Investment Crowdfunding

Investment crowdfunding has begun to open up and make the process of raising equity capital more democratic. While investing in early and growth-stage companies used to be reserved for a privileged few (generally institutional investors), new infrastructure and regulations have allowed individual retail investors to invest in projects they are passionate about and/or have other connections to for a small sum. Individuals receive shares of the new company commensurate with the amount they have invested.

Two popular platforms for equity crowdfunding are SeedInvest and FundersClub. In addition, micro-lending platforms such as LendingClub and Prosper allow for debt financing similar to crowdfunding. In this asset class, instead of owning part of the company, individuals become creditors and receive regular interest payments until the loan is eventually paid back in full. Also, P2P lending marketplaces enable both people and companies to buy whole or fractional loans.

Remittances

Remittances are another area that financial innovation is transforming. Remittances are funds that expatriates send back to their country of origin via wire, mail, or online transfer. Given the volume of these transfers worldwide, remittances are economically significant for many countries that receive them.

In the early 2000s, the World Bank established a database where people could compare the prices of different transfer services. The Gates Foundation subsequently began tracking remittances in 2011. Western Union and Moneygram once monopolized remittances; however, in recent years, startups such as Transferwise and Wave have competed with their lower-cost apps.

Given the onset of Bitcoin, Ethereum, Stablecoins, and Blockchain technology, remittances are becoming more affordable. The lower costs are in line with the Sustainable Development Goals (SDG) of the World Bank to reduce the cost of remittances from 7% to 3% by 2030.

Mobile Banking

Finally, mobile banking has made major innovations for retail customers. Today, many banks like T.D. Bank offer comprehensive apps with options to deposit checks, pay for merchandise, transfer money to a friend, or find an ATM instantly. It is still important for customers to establish a secure connection before logging into a mobile banking app in order to avoid their personal information being compromised.