Josh Lerner – HBS

Financial Innovation in the 21st Century: Evidence from U.S. Patents

Josh Lerner, Amit Seru, Nicholas Short, & Yuan Sun
December 29, 2021

We explore financial innovation through a dataset of 24 thousand U.S. finance patents granted over last two decades, using machine learning to identify the financial patents and  extensively auditing the results to ensure their reasonableness. Patented financial innovation is substantial and economically important, with the number of annual grants expanding from a few dozen in the 1990s to over 2000 in the 2010s. The subject matter of financial patents has changed, consistent with the industry’s shift towards household investors and borrowers. The surge in financial patenting was driven by information technology firms and others outside of financial sector, with more than threequarters of important financial awards being to such firms. The location of innovation has shifted, with banks moving activity from regions with tight financial regulation to more permissive ones. Concurrently, high-tech regions have attracted financial innovation by payments, IT, and other nonfinancial firms. While academic knowledge remains associated with more valuable patents, citations in finance patents to academic papers, especially in those by banks, fell sharply. An examination of the relative returns to financial and non-financial innovations suggests that firms are incentivized to pursue financial innovations that have high private value, but much less so to develop those with high social value. Our results highlight the limitations of standard measures of productivity in the financial sector.