Risk Externalities of Financial Innovation: Evidence from Operational Losses at Large U.S. Bank Holding Companies

This study documents adverse operational risk externalities of financial innovation. Using supervisory data on operational losses from large U.S. bank holding companies (BHCs), we show that organizations with more financial patent innovation suffer higher operational losses per dollar of assets and more tail risk events. The association varies significantly by the types of financial patents and operational losses. It is more pronounced for institutions that have weaker risk management. We demonstrate that BHCs that engage in more financial innovation prior to or during the global financial crisis (GFC) have more severe operational losses during the GFC. Our findings have important implications for banking organization risk and supervision in an environment of intense innovation and technology adoption.