Innovation and Complexity

Patrick McConnell

Universal banking is, at the same time, both complex and interconnected. Complex because it encompasses many different types of financial products and services, and interconnected because technology, processes and services are shared not only within, but more importantly across, organisations. This combination is risky, because interconnectedness causes any shocks (both internal and external) to be transmitted and amplified across an organisation and, in extreme circumstances, across the banking system as a whole. Dangerous shocks can be transmitted quickly because the complexity of the interconnections between components (or nodes) in the “network” makes the diagnosis of problems difficult and actions to address them problematic.

This chapter will discuss the underlying reasons why banks and the banking system has become so difficult to manage, in particular because of product, process and technology innovation.

FINANCIAL INNOVATION

Tufano (2003) points out that innovation is ever-present in the financial industry and, while it may ebb and flow over time, that it is a “regular ongoing part of a profit-maximising economy”. Nobel prizewinner Robert Merton (1990) points out