Financial innovation and financing of the economy: relational schema

Abstract

Since the end of the 1970s, repressed financing, based on excessive regulation, has remained the only system for financing the economy. To escape this regulation, new financial instruments have emerged, hence the emergence of financial innovation. On the other hand, this financing system has had harmful monetary, financial, and real consequences on both economic and financial development. The conjunction of these consequences was the basis for its replacement by a new system based on market mechanisms. In contrast to the old system, which was based on excessive regulation, the new financing system is based on a range of liberal measures. These, in turn, have allowed financial innovation to flourish. The objective of this article is therefore to establish a relational diagram that shows that the emergence and development of financial innovation in its various forms is closely linked to the evolution of the financing system from a repressed system based on financial repression to a liberalized or market-based system and that this innovation only experienced a remarkable boom after the establishment of the foundations of financial liberalization, notably deregulation, decompartmentalization, and disintermediation.