Financial Innovation and Transparency in Turbulent Times

Abstract

The stunning failure of a number of banks during the recent crisis has put regulatory intervention high on the agenda of governments. Adequate risk monitoring, including by credit rating agencies, measurement, and management have proven to be a daunting task, whereas regulation of innovative financial instruments has not brought about adequate disclosure and transparency. After critically reviewing the virtues and pitfalls of financial innovation, this paper offers an analysis of the main transparency initiatives undertaken in the E.U. and the U.S. in the wake of the crisis to harness various financial innovations that have marked the history of financial markets in the last three decades. The paper argues for better managed regulatory cooperation at the international level and warns against institutional deficiencies of the new regulatory frameworks in the E.U. and the U.S. One key message of the paper is that more regulation may hamper financial innovation; yet better regulation may direct entrepreneurial talents to financial innovations that enhance societal wellbeing and still yield reasonable returns.