v k sharma : the financial innovations that never were keynote address by mr v k sharma, executive director of the reserve bank of india, at the finnoviti 2012, organised by banking frontiers, mumbai, 8 november 2012. * * * the views expressed are those of the author and not of the reserve bank of india. i deem it an honour and privilege to be addressing this very distinguished and august audience. right at the outset, i would like to impress upon this very learned and discerning audience that responsible financial innovation is not an end in itself, but instead, a means to an end of sub - serving the real sector and in that sense it is consistent with, and a natural fit to, public policy purpose of “ financial sector - real sector balance ”. as this distinguished audience is aware, there is broad consensus and unanimity now among all key stakeholders that it was the unsustainable “ financial sector - real sector imbalance ” due to certain financial innovations that was the real cause of the last global financial crisis. generic financial innovation has typically evolved in the form of both on - balance sheet and off - balance sheet derivative instruments. while collateralized debt obligations ( cdos ), cdo - squared, cdo - cubed, credit linked notes ( clns ) etc., are the typical examples of onbalance sheet financial innovations, currency swaps, interest rate swaps ( irs ), futures, options, credit default swaps ( cds ), etc., are those of off - balance sheet financial innovations. in both the types, the underlying theory and practice has been the so - called law of one price or, what is the same thing as the no - arbitrage argument, involving replication of derivatives cash flows in the cash markets. in other words, a derivative of an underlying cash market asset will be so priced / valued that it is not possible to arbitrage between the cash market and the derivative market, provided the derivative in question is fairly priced / valued. for, if a derivative were priced expensive relative to the underlying asset, an arbitrageur will engage in riskless arbitrage by selling the expensively priced derivative and buying the asset in the cash market by financing it at the going repo rate. in the opposite case, an arbitrageur will engage in riskless arbitrage by shorting the asset in the cash market, investing the proceeds of short sale at the higher going repo rate and

- 12 - 16 - 16 15 ( e ) 16 ( f ) 17 ( f ) ( e ) estimate. ( f ) forecast. ( * ) mining investment in 2015 is estimated using available fecu information up to the third quarter, and codelco's investment plan. housing investment uses information from the chilean chamber of construction and national accounts by institutional sector. other contributions are taken as residues. for 2016 and 2017, forecasting models from the central bank and sectoral sources are used, such as the capital goods corporation's investment plans and surveys. source : central bank of chile. bis central bankers ’ speeches table 2 domestic scenario ( annual change, percent ) 1. 9 gdp 2015 ( e ) dec. 15 report 2. 1 2016 ( f ) dec. 15 report mar. 16 report 2017 ( f ) mar. 16 report mar. 16 report 2. 1 2. 0 - 3. 0 1. 25 - 2. 25 2. 0 - 3. 0 domestic demand 1. 1 2. 0 1. 3 2. 5 1. 5 2. 3 domestic demand ( w / o inventory change ) - 4. 2 0. 7 - 1. 5 1. 7 0. 5 1. 0 gross fixed capital formation 2. 8 2. 4 2. 2 2. 7 1. 8 2. 7 total consumption 1. 1 - 1. 7 - 1. 9 1. 0 0. 6 2. 40 goods and services exports - 5. 7 - 1. 4 - 2. 8 1. 6 - 0. 6 2. 10 goods and services imports - 1. 3 - 1. 7 - 2. 1 - 2. 6 - 2. 5 - 2. 0 current account ( % of gdp ) 20. 9 20. 0 20. 4 19. 1 19. 9 20. 2 gross national savings ( % of gdp ) nominal gross fixed capital formation ( % of gdp ) 23. 0 22. 0 22. 7 21. 9 22. 6 22. 1 23. 0 22. 0 22. 7 21. 9 22. 6 22. 1 ( e ) estimate. ( f ) forecast. source : central bank of chile. figure 4 unemployment rate and annual growth in salaried employment ( percent ) unemployment rate salaried asalariado employment empleo ( a / ( y / y ) source : national statistics institute ( ine ). bis central bankers ’ speeches figure 5 cpi inflation ( * ) cpiefe