Loopholes And Financial Innovation

Abstract

The loophole phenomenon occurs in financial services, bureaucratically controlled marketplaces, as well as in our everyday lives.  Whenever an entity writes a rule, that entity simultaneously creates many loopholes (Kane, 1977).  Loopholes provide a way to pervert regulations and may even stimulate innovation. Different parties search out loopholes to adapt to changes as processes evolve over time. We discuss how various parties have reacted to specific loopholes. Our discussion seeks to provide a better understanding of the evolutionary interplay between financial innovation and regulation as well as to provide instruction on how to identify and exploit loopholes.