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Robert M. Hunt *

Innovation in Financial Services and Payments May 16-17, 2002 Session on Information, IT and Property Rights. Robert M. Hunt *. *: The views expressed here are my own and not necessarily those of the Federal Reserve Bank of Philadelphia or the Federal Reserve System. Overview.

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Robert M. Hunt *

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  1. Innovation in Financial Services and Payments May 16-17, 2002 Session onInformation, IT and Property Rights Robert M. Hunt* *: The views expressed here are my own and not necessarily those of the Federal Reserve Bank of Philadelphia or the Federal Reserve System.

  2. Overview • Hauswald-Marquez show us how innovations, and their spillovers affect lending markets • There are tantalizing hints of the implications for the incentive to innovate • Highlights the role of appropriability • Thomas shows us that FIRE has obtained a new tool to enhance appropriability--patents on methods of doing business. • What can we conclude about effects on the industry?

  3. Financial Services as a High Technology Industry • IT investments are very large • Mid 1990s, US banks spend 15% of non-interest expense on IT, the largest consumers of IT. • Used/developed $23 billion in software in 1998, the largest of any U.S. industry. • Significant investments in R&D (NSF) • $1.6 billion 1998, 2x 1995 level • 17,000 scientists and engineers, 3x 1995 level • Un-measured R&D is likely much higher. • In Canadian data, most R&D in FIRE is software.

  4. Key Insights from Hauswald-Marquez • Innovations may increase/decrease information asymmetries between lenders • These determine the primary beneficiaries of innovation: incumbent lenders or consumers • Implications for industry structure and competition • Results are less stark when we generalize the model • Access to technology is important • Spillovers • Technology vendors • Implications are tentative • Would like a model of dynamic innovation

  5. Insights from Hauswald-Marquez (cont.) • Screening effort is increasing in the quality of IT, but decreasing in the extent of spillovers • It is possible that some limitation on spillovers is welfare improving, even though it is costly • efficient monitoring • incentives to innovate • Effort expended preventing spillovers is increasing in the value of IT. • But this effort is not a monotonic function of the propensity for information to leak out.

  6. Insights from Hauswald-Marquez (cont.)

  7. Insights from Thomas • Financial Institutions have a new means of regulating spillovers - patents on computer software and business methods. • Software was an evolution • Business methods occurred rapidly • Financial institutions are exercising this option. • A surge in these patents • Participation by banks and vendors

  8. Insights from Thomas (cont.) • There are concerns about patent quality • PTO has to learn about new things • In general, is PTO examination good enough? • Patent standards have also been relaxed • Less significant inventions qualify for protection • Concerns about hold-up, defensive patenting • Examples of litigation (automated underwriting, online banking) • Examples of substantial licensing fees (call center patents)

  9. Endogenous Screening • Now the same screening technology is available to both lenders • In a mixed strategy equilibrium, improved IT increases expected price competition among lenders • But the authors argue the mixing equilibrium is less plausible for established markets • Couldn't better IT decrease the significance of established relationships? • What about effort expended to inhibit innovations? • choosing a rival that screens or not.

  10. Implications for Innovation • We'd like to use a dynamic model • Racing and sequential innovation • There is an optimal level of appropriability • Imitation cost or lead time • Patent Standards - Nonobviousness • The optimal standard is more strict for rapidly innovating industries • Too many patents dissipate more rents than they create • The effect is most pronounced when innovation is rapid • This holds even in the absence of transactions costs

  11. Policy Implications • Patents will play a more important role in this industry than in the past • But in the US, patent standards have been relaxed • There are also issues about the quality of patents granted • It is not at all clear the patent system is calibrated to maximize innovation in financial services • We should think about the significance of access to technology on industry structure and competition

  12. Information, IT and Property Rights

  13. Source: CHI Research and author's calculations

  14. A Few Interesting Financial Patents

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