DEFINITION of 'Financial Innovation'

Financial innovation has come through advances over time in financial instruments and payment systems used in the lending and borrowing of funds. These changes – which include updates in technology, risk transfer, and credit and equity generation – have increased available credit for borrowers and given banks new and less costly ways to raise equity capital.

BREAKING DOWN '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 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 has 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 crowdfunded debt financing. 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.

Remittances are another area that financial innovation is transforming. Remittances are funds that expatriates send back to his or her country of origin via wire, mail, or online transfer. Given the volume of these transfers worldwide, remittances are economically significant for many of the countries that receive them. In the early 2000s, the World Bank established a database, where people could compare 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.

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’s still important for customers to establish a secure connection before logging into a mobile banking app in order to avoid his or her personal information being compromised.

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