Impact of financial innovation on money demand & deposit mobilization

Abstract

The objective of this thesis is to take the case of Pakistan and assess whether financial innovation has any significant impact on its financial system. In particular the study examines how the retail payments system influence the demand for cash money as well as the demand deposits of the banks. Retail payments system in Pakistan is classified into two main categories i.e the paper based payments and the electronic bank based payments. It is found that despite increase in bank branches majority of these payments are paper based that involve cash, checks, bank drafts etc. The electronic transactions although small are gradually increasing specifically those made through automatic teller machines (ATMs) and the real time online banking (RTOB). Regression results of cash money demand suggest that of the two main sources of electronic transactions, the increase in ATM network has led to increase in demand for cash with drawls. Where as the increase in RTOB branches has a negative effect on money demand. To examine the influence of financial innovation on demand deposits of banks, regression results indicate that ATMs transactions do not increase bank deposits. As expected RTOB has a positive effect on deposits. The demand deposits of banks are found to be insensitive to the rate of return on deposits. Main conclusions drawn from these results are that financial innovations influences cash money demand and bank deposits in a limited manner. Key facts about the financial system are that bank branches, bank accounts and bank deposits have increased side by side with increase in currency in circulation. These conflicting set of results are explained by the fact that only 12 to IV 15 percent of the population hold a bank account and majority of the people are unbanked. Preference for cash transactions may either reflect the presence of a large informal sector where people are self employed and retail transactions are often made in cash, or tax avoidance and corrupt illegal practices involve cash transactions that cannot be traced easily.