Definition of financial institutions

 

         FINANCIAL INSTITUTIONS

       Financial Institutions can be defined as the business organizations that deal in money, though some may deal in other financial assets such as shares, letters of credit, bills of exchange, etc. Except for the Central Bank, they make profits by trading in money; that is, through the process of accepting deposits in several ways e.g. offering technical advice, etc. Banks and other financial institutions are providers of liquidity and payment services and therefore represent an important nerve center of the economy that facilitates the intermediation of financial resources through the promotion of the saving and investment process. They also constitute the institutional framework
for the conduct of sound monetary policy and
transmission mechanism.

       Traditional Financial Institutions

   Before the advent of modern financial institutions,
existing side-by-side with them in modern times,
some traditional institutions perform the basic banking functions.

(a) In the traditional setting, there are money
lenders’ who make profits by charging interest
on money lent to people. Moneylenders have
surplus funds for lending and they usually
charge very high-interest rates.

(b) There is a traditional banking system (Local Bank’) which is called various names such as ‘esusu’, ‘etioutu’ and ‘etibe’ in Nigeria, ‘susu’ in Ghana, and ‘osusu’ in Sierra Leone. In some cases, the members contribute an agreed sum of money into a Fund regularly such as on Sundays, the market day of the area, or month-end. The contributions can be on a daily, weekly, or monthly basis. From the fund, money can be lent to members or other persons, and interest is charged. 

At an agreed period (say during festivals, end of the year, etc) the members are re-paid their money together with their share of the interest or profit. On the other hand, the members may pay various sums of money into the fund, each according to his ability.

(c) There is another variation of the “esusu”  in
which members of the organization contribute
agreed sums of money which are given to the members in turns. The order is arrived at by various means e.g. balloting, consensus, etc. This type is
common among workers (especially the low-Income earners) in various organizations. It is a means of raising relatively large sums of money that could be channeled into meaningful projects.

           Modern Financial Institutions

Central Bank;
A Central Bank is a Federal Government owned apex a financial institution that controls and supervises the entire monetary system of a country. It assists, directs, and regulates the activities of other financial institutions to make them comply with government monetary and economic policies.

           Functions of the Central Bank

Central Bank performs certain roles in an economy.
These include:
(i) Serves as the government’s bank and financial
adviser: The Central Bank collects all revenues
accruing to the government from taxation and
other sources. It makes payments on the
the government’s behalf and advises the
the government on monetary matters.

(ii) Banker to other banks: The commercial banks
and other financial institutions keep a
percentage of their deposits with the Central
Bank as legal reserves or special deposits.
also offers clearing house facilities for settling
interbank indebtedness.

(iii) A lender of last resort: It makes loans to
commercial banks and other financial
institutions to enable them to meet usual cash demands by customers. This helps to prevent a monetary crisis.

(iv) Issuing of currency: The Central Bank is the sole
authority permitted by law to issue currency
(coins and banknotes) which is then put into
circulation through commercial banks.

(v) Implementation of government monetary
policy: It assists the government in executing
its monetary policies by the use of various
instruments such as open Market Operations,
Bank rates, directives, and Cash deposit ratio
, etc. These help to regulate the money supply
and stabilize prices.

(vi) Servicing of the national debt: It helps to
manage the national debt. Apart from helping
the government to secure loans (both from
within and outside the country) it helps to
service the loans.

(vii) Promotion of economic development: It does
this either directly or indirectly. It finances
projects directly on behalf of the government. By encouraging the growth of financial institutions, by Judicious application of monetary policy, and undertaking economic research, etc. it indirectly encourages economic development.

Instruments of credit control used by the Central
Bank;

The Central Bank exercises control over the
commercial banks through the use of the instruments of monetary policy. These instruments help to control their credit policies. Such instruments include:

(i) The bank rate: This is the rate at which the
central bank discounts first-class bills. If the
Bank Rate is high, commercial banks would
increase interest rates and this would discourage
borrowing by the public. A reduction of the bank
rate would encourage borrowing.

(ii) Liquidity ratio (i.e.cash – deposit ratio): This refers to the legal reserve requirements or the ratio of commercial bank cash reserves to total deposits. If it is decreased, the lending power of commercial banks would increase. But if it is increased, they would have less money to lend.

(iii) Open market operation (OMO): This involves
the buying and selling of securities such as treasury bills from or to the public. Buying from the public would increase the cash available with banks thereby increasing their lending power. But if they are sold to the public the amount of cash left with commercial banks would decrease. If cheques are drawn by people so those banks are cleared, this reduces their lending power.

(iv) Special deposits: These are additional deposits
To which the Central Bank may ask commercial banks to keep. This is used when the use of cash
no ratio is not sufficient to regulate the money
supply as desired.

(v) Directives: These refer to directives given by Central Bank to commercial banks regarding lending. It could be to either increase or decrease lending generally, or to increase lending to priority sectors.

(vi) Funding: This refers to the conversion of short-term securities (e.g. treasury bills) to long-term securities (e.g. bonds). If the conditions of the economy are not yet improved for the refund of the loans obtained through the sale of treasury
bills, they may be converted to bonds. This
controls the amount of money that is in commercial banks.