Academic journal article Academy of Accounting and Financial Studies Journal

A Literature Review on the Effects of Liquidity Constraints on New Financial Product Development

Academic journal article Academy of Accounting and Financial Studies Journal

A Literature Review on the Effects of Liquidity Constraints on New Financial Product Development

Article excerpt


The rising significance of the banking industry as well as its new financial product developments in the liquidity constrained economy of a developing country has led to a research concern in financial innovation. Effective product development is vital for the survival, expansion and profitability of most financial institutions. The financial market is now encompassed with many difficulties, drawbacks, obstacles, uncertainties and risks due to the dynamic landscape of demanding clients and technological advancement. Consequently, this brings the necessity of introducing new products that enable effective risk management, boost liquidity and portfolio diversification. The objective of this study is to review the literature on the impacts of liquidity constraints on new financial product development, the benefits derived from new product development, the various challenges encountered in developing new financial products and the techniques that can be articulated in the context of developing successful new product in commercial banks. This paper seeks to bring to light the existence and the impact of financial frictions on the propensity of commercials banks to innovate.

Liquidity Constraints and New Financial Product Development

New financial product development is defined by Dewati (2015) as the introduction of new financial instruments in more radical and sophisticated financial markets. Dewati (2015) further suggests that the presence of new financial products can rally allocation of resources, reduce growth instability, enable firms to have a financial structure that is quite stable and household consumption is smoothened. However, in the context of the presence of financial constraints, firms are highly incapacitated to carry out their new product innovations (Segarra et al., 2013). Bowen et al. (2010) define financial constraints as the incapacity of a firm to obtain the necessary financial resources to enable them to fund their investment and growth. In support Aas et al. (2011) suggest that a firm is said to be financially unconstrained if it has the ability to implement its innovation projects at optimal scale and is financially constrained if it is not capable to do so owing to a shortage in funding.

Impact of Liquidity Constraints on New Financial Product Development

Financial constraints may represent a severe hindrance to firms' innovativeness (Bowen et al., 2014, Segarra et al., 2013). Segarra et al. (2013) is of the view that financial frictions, to innovation, are an important constraint hampering firms from upgrading and implementing innovations to decrease the gap between these firms and the technological frontier. There is a solid impeding effect of financial constraints on research and development (Almeida and Campello, 2002). Due to lack of access to funds, some innovation projects are prone to not being started, may have to be deferred or are abandoned. In a supporting view Mancusi and Vezuli (2010) are of the view that there is a significantly negative impact on the probability to implement research and development activities due to the existence of financing constraints. The impact of research and development on productivity at the firm level curtails from the execution of newly acquired knowledge and technological innovations into new products, reductions in cost of producing existing products or services, enhancement of existing products and production processes or (Imeson and Pugh, 2012).

However, tighter liquidity constraints improve firms' innovation efficiency (Segarra et al., 2013; Almeida et al., 2002). Almeida et al. (2002) argue that organisations with extra free cash flow are likely to invest their excess funds in negative innovative projects due to agency complications. Firms that are more financially constrained have lesser free cash flow hence there more likely to take optimal investment decisions. This disciplinary benefit of liquidity constraints is principally important to innovation related investment such as research and development (Balaceanu, 2011). …

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