Financial Institutions PDF

**WEEK** ONE These are organizations which deal primarily in money. They constitute the financial framework of an economy. Financial institutions include commercial Banks, Discount houses, Acceptance houses (merchant bank), central banks, savings bank, Development banks, savings bank, Development b...

**WEEK** ONE These are organizations which deal primarily in money. They constitute the financial framework of an economy. Financial institutions include commercial Banks, Discount houses, Acceptance houses (merchant bank), central banks, savings bank, Development banks, savings bank, Development banks, insurance companies, Hire purchase companies etc. **[Traditional financial institutions]** 1\. In some places, a number of persons come together and perform one major banking function such as saving and lending. Such organisations are called **isusu** or **Asusu**. It is common among the rural folk and the low income earners. 2\. Some of these people operate as thrift societies or co-operative societies. The members save money in common pool on a regular basis according to the members' ability. Such money contributed by each member is repaid to him (plus accruing interest) after an agreed period of time. 3\. Another type of traditional banking is the type in which members contribute on agreed sum (or each according to his ability) and the money so contributed is given to the members in turns. This is more common among wage earners. This helps them to raise substantial amount of money at a time that can be channeled into a meaningful project. A commercial bank may be defined as a financial institution which deals in money and credit and which receives deposits from the public and from organizations. Some of which is payable on demand by cheque. Commercial banks are public limited owned by shareholders, they are out to maximize profits by trading in money. Commercial banking arose from the activities of gold smith who had facilities such as safes for the safe-keeping of valuables with the gold-smiths. They issue receipts for various weights or values deposited. The receipts issued by the goldsmiths are usually used by merchants to make purchases (means of payment). The deposits were later lent and interest charged. There are two groups of commercial banks in Nigeria & West Africa. \- Foreign or expatriate banks e.g. First Bank, UBA, Union Bank. Commercial banking started in West Africa in 1894 with the establishment of the first foreign bank- the British bank of West Africa now the first bank. \- Indigenous banks e.g. Wema bank, GTB, Stanbic. They are wholly owned and controlled by West Africans. They were established to neutralize the discrimination by foreign banks against indigenous businessmen in the granting of credits. 1\. Mobilisation of savings or acceptance of deposits. They accept money deposits from people and organizations for safe-keeping. The amount deposited is credited to the customer's account. 2\. Commercial banks act as lending agents by giving loans to borrowers who have the necessary collateral security such as stock and shares certificates, landed properties. 3\. Commercial banks act as agents of payment on behalf of their customers) organizations like KAC can make payment to its workers through a bank. Also, a customer can leave a standing order with the bank to pay its regular bills e.g. school fees, rent, insurance premiums etc. 4\. Commercial banks help in the safe keeping of their customers' valuables such as jewelleries and important documents such as wills, educational certificates etc. 5\. They act as referees as to the integrity and financial standing of their customers. They could recommend their customers to foreign firms who require indigenous business partners for carrying out their business. 6\. They give financial and technical advice to their customers in matters relating to investment. 7\. A commercial bank could assume the responsibility of carrying out the duties of an attorney, executor and trustee. It could look after a dead man's assets and distribute them among his heirs, according to his will. 8\. Commercial banks help in foreign exchange transactions thereby facilitating foreign trade and travel. 9\. Commercial banks help directly in economic development by investing directly in the productive sectors of the economy. 10\. Commercial banks act as agents that purchase stocks and shares for their customers. They can also sell stocks and shares on behalf of the issuing houses. 11\. Commercial banks are important agents for carrying out government monetary policy by helping to contract or expand the monetary supply. 12\. Commercial banks facilities business transactions by making it possible the use of cheques. This reduces the problem of having to carry about large amounts of money. They include: 1\. Cash in the fills of the bank, and deposits with the central bank. 2\. Cheques drawn on other banks, which are paid in by customers and which are in the course of collection. 3\. Money lent for a short term, i.e. money at call and short notice. 4\. Treasury bills, and discounted bills of exchange. 5\. Loans and advances. 6\. Investments 7\. Fixed assets such as buildings 1\. Capital provided by shareholders. 2\. Deposits kept in the bank by customers 3\. Reserves- Undistributed profits. Bank lending increases the quantity of money in circulation. In other words, it increases the total purchasing power. This is because the bank credit the amount borrowed thereby creating new bank deposits. The total purchasing power increases by the amount loaned out. This is why it said that bank lending creates money. 1\. By giving direct loans to people and organisations and charging interest on the loans. 2\. By granting overdrafts to customers with current accounts that is allowing them to draw above the amount in their current accounts up to a certain limit and interest is charged on the overdrafts. (An overdraft is the excess amount which a customer is allowed to draw over the amount he has in his current account). 3\. By purchasing treasury bills from the government and by discounting bills of exchange. The ability to create money by commercial banks depends on the following: 1\. The cash deposit ratio (i.e. the legal reserve requirement which a commercial bank must keep with the central bank. The higher the cash deposit ratio, the lower the amount of money that would be created and vice versa. 2\. Restrictions on individual banks imposed by the bankers clearing house. The credit policy of other banks determine the amount of credit which can be created. 3\. Restrictions imposed on commercial banks by the central bank, such restrictions include Omo (open market operation), bank rates, directives etc. 4\. The amount of collateral securities available to borrowers. 5\. The total amount of cash in existence determines the amount of credit a commercial bank can create. 6\. The amount of leakages or cash drain from the banking system. It is not all the money borrowed from one bank is deposited in another bank. 7\. The willingness of people to take loans and advances. **[Types of Account kept with Commercial Banks]** **1. [Current Account (Demand or Cheque Account)]:** Money deposited in this account is called Demand deposit. Money is withdrawable from this account on demand by cheque. The current account customer could withdraw money at any time during normal banking hours without prior notice. It does not earn interest rather; the customer pays some commission to the bank. Anyone who wishes to open up a current account is introduced to the bank by a referee(s) who have current account with the bank. **2. [Savings Account:]** This is an account operated with a pass-book. The withdrawals and deposits of the customer are recorded in this book by the banker. Someone else could pay in money into the account but withdrawal is made personally by the customers. The savings deposits of the customer earn him interest. **3. [Time or fixed Account]:** Money deposited in this account cannot be withdrawn on demand. There is usually a fixed period which sometimes may be up to six months or one year before money can be withdrawn from the account, and when money is to be withdrawn, after the agreed date, notice (usually about seven days) must be given to the bank. A time deposit yield a very high interest. **[Definition of Central Bank]** A central bank is the apex of all the banking institutions in a country. It was established by an act of parliament (by law). It is a government owned bank which helps to control and supervise the entire monetary and financial system of a country. The central bank of Nigeria was established in 1959. **[Brief History of Central Banking In West Africa]** The West African currency Board (WACB) was established by the British Colonial government in 1912 to serve four British territories of Nigeria, Ghana, Sierra Leone and Gambia. It performed some of the functions of the central bank. Its major functions was to issue and operate a uniform currency in British West Africa. However, the dawn of independence in West Africa led to most West African countries to establish their own central banks to help in managing their economies. **[Reasons for establishing Central Banks]** 1\. Central banks were established as a complement to the independent status of the various West Africa countries. 2\. To direct and control the activities of commercial banks and other financial institutions. 3\. To help formulate and implement the monetary and financial policies of the government. 4\. To foster the development and operations of the financial system of the various countries to speed up economic development. **[Functions of Central Bank]** **1. Issuance of currency:** The central bank is the only authority empowered by the law to issue paper money and coins in any country. They also withdraw mutilated notes from circulation. **2.** **Acts as banker to the government**: The central bank is the government's bank, it keeps all revenues from taxation, and makes all payments out of its, on behalf of the government. It also advises the government on financial matters. **3. It acts as bankers bank**: The central bank serves as bank to commercial banks. The commercial banks keep accounts with the central bank. It makes it possible for commercial banks to settle their indebtedness to one another by providing clearing facilities. Thus, it's a clearing house for settlement of inter-bank cheque. **4. It acts as the lender of last resort**: The central bank lends money to commercial banks in serious needs. There are times when a commercial bank may run short of funds to meet the withdrawals and demand for loans by its customers. When this happens, the central bank grants loans to the commercial bank or have its bill re-discounted in order to avoid monetary crises in the economy. **5. It promotes Economic development**: This is achieved by developing the monetary and capital markets to finance various development projects. It also promotes price stability and makes money available to entrepreneurs for productive purposes. These it does by controlling the achievement of commercial banks and promoting the establishment and development of institutions essential for rapid economic growth. **6. It maintains monetary stability**: The central bank controls, supervises, assists and co-ordinates the activities of commercial banks and other financial institutions so that they fulfill the requirements of government monetary policy. **7. It carries out external business for a country**: It deals with the central banks of other countries and with word financial institutions such as IMF and World Bank. Loans are raised from these institutions by the central bank. It therefore manages the external assets and liabilities of a country. It tries to ensure that the country maintains a favourable balance of payment. 1. **Use of Open Market Operation (OMO)** : OMO refers to the buying and selling of government securities such as Treasury bills and bonds ,from and to the public and business organisations. If the amount of money in circulation is too high and the central bank wants to reduce it, It will sell securities to the public and financial institution. When they buy, they pay cheques to the Central Bank. When the cheques are cleared, the amount of money left with the commercial bank will fall. Thereby reducing their lending capacity and the amount of money in circulation. 2. **Cash deposit ratio( Reserve Ratio):** This refers to the prescribed percentage of a commercial bank's deposit that must be kept with the central bank. 3. **Use of bank rate**: This refers to the rate at which central bank discount or re-discount bills for commercial banks and other financial institution. That is, The rate at which central bank lends out money to the financial institutions. The bank rate influences the other interest rate in the economy. A higher bank rates leads to a higher interest rates. If there is inflation, the central bank increase the bank rate and this will force the commercial banks to increase their own interest rates thereby discouraging borrowing by people and organizations. On the other hand, If the volume of money in circulation is too small and the central bank want to increase it, It will reduce the bank rate ,this encourage borrowing as the interest rates will be low. 4. **Use of Directives**: A directive is an instrument or guideline from the central bank to commercial banks regarding the size of loans to give and the areas to which to direct bank lending. It can give specific instructions to commercial banks to increase the proportion of their lending to a particular area of economic activities such as agriculture to reduce lending to a particular sector of the economy. 5. **Moral Suasion :** This is an appeal or suggestion by the central bank to the commercial banks to pursue certain lending policies. The commercial banks could be persuaded by the central bank to behave in a particular way. e.g restrict lending habit or to adopt a more liberal loan policy. 6. **Use of Special Deposits:** These are additional deposits (other than the one required by law) which the central bank may required commercial banks to keep with it. This is used when the use of cash deposit ratio is not adequate to keep down the rate of inflation. The effect of this is to reduce the basic lending activities. However, If it wants to stimulates bank lending, It can release such special deposits. 7. **Funding:** This refers to the conversion of short term government securities. For example, Treasury bills (Short term securities) could be converted to long term securities (such as bonds ) If the central bank feels that the conditions of the economy has not yet improved for the short --term loans to repaid.