FINANCIAL INSTITUTIONS
This section deals with financial institutions. Discussion will centre mainly on Nigerianfinancial institutions, types, functions, and their contribution to the economic development of the country.
Financial institutions can be broadly defined as institutions that deal in, or trade on, the use of money or monetary instruments. They specialise in the creation, keeping, transfer, borrowing and
lending of money.
1. Functions of Financial Institutions
Financial institutions in general perform eight main functions. These include the following:
(a) They provide investment opportunities in common stocks, bonds, and other credit negotiable instruments such as bills of exchange, promissory notes and bank drafts.
(b) They provide investment services to the public in such areas as stock brokerage services, handling of documents for foreign trade transactions such as letters of credit, sale of drafts; and they act as collection agency, and provide investment advice.
(c) They provide, in addition, financial resources to meet borrowing needs of individuals.
(d) They also provide facilities for the collection and investment of savings funds.
(e) Financial institutions provide a sound payment mechanism through the use of cheques, drafts, credit cards, bills of exchange and other cash transfer methods.
(f) They provide security for idle cash through the banking systems’ deposits.
(g) They also supply capital funds for business investments. These include long terms loans, equity investments through sale of stocks and equity participation by some investment banks.
2. Types of Financial Institutions
Financial institutions vary from one country to another. They are generally classified into two groups. Banks and non-banking institutions. Banks include, the Central Bank of Nigeria,the commercial banks, and other specialized banks such as savings banks, mortgage banks and development banks.
The non-banking financial institutions include Insurance Companies, Stock Exchanges, Credit Unions, Pension Funds, and Mutual Funds.
Nigerian financial institutions include the following:
(a) Central Bank of Nigeria
(b) The Commercial Banks
(c) Merchant Banks
(d) The Co-operative Banks
(e) The Saving Banks
(f) Development Banks made up of;
Nigerian Industrial Development Bank.
The Nigerian Agricultural and Cooperative Bank
The Federal Mortgage Bank
The Nigerian Bank for Commerce and
Industry
(g) Others include the non-banking institutions such as:
The Insurance Companies The Stock Exchange
State Financial/Investment Companies Insurance Brokers
Credit Unions
Provident/Pension Funds
Commodity Marketing Boards
The major features and functions of some of institution will be discussed in the following sections.
(a) The Central Bank of Nigeria (CBN)
The Central Bank of Nigeria is the leading financial institution in the country. It was established in 1958 by the Central Bank Ordinance of that year. However, it effectively commenced operations on July I, 1959. The principal functions of the bank are:
(i) The issue of legal tender currency of Nigeria.
(ii) the maintenance of external reserves to safeguard the international value of currency.
(iii) the promotion of monetary stability and a sound financial structure.
(iv) acting as banker and financial adviser to the government.
Other important functions implied in the statutory functions include;
(v) the organization and provision of development finance.
(vi) the development and control of the financial system.
(vii) the development of research and the procurement of monetary data and statistics on the economy.
(viii) acting as an agent of the government.
For the development of the money market, the Central Bank issues and redeems Treasury Bills, and manages Certificates of Deposits and Bankers Unit fund. In the area of the capital market, it issues and redeems Federal Republic of Nigeria Development Stocks. It has also helped in the establishment of the Nigerian Stock Exchange, the Bank for Commerce and Industry, the Nigerian Industrial Development Bank, the Nigerian Securities and Exchange Commission etc. for the mobilisation of long -term investment purposes.
As an agent of the Federal Government, CBN administers the foreign exchange control regulations on behalf of the Federal Government, manages the national debt and is the government’s chief executant of monetary policy.
CBN’s Techniques of Control
The following weapons are used by the Central Bank to control credit in the economy:
| Monthly Average | Aggregate Credit to the Economy | Credit to Private Sector | Credit to Govt. Sector | Central Bank’s | Commercial Banks |
| 1972 | 1,151.1 | 651.7 | 499.4 | 251.7 | 895.0 |
| 1973 | 1,314.1 | 749.9 | 564.2 | 224.5 | 1,085.1 |
| 1974 | 443.4 | 899.1 | 455.7 | 933.3 | 1,372.1 |
| 1975 | 80.2 | 1,339.2 | 1,419.4 | 1,850.8 | 1,752.2 |
| 1976 | 1,451.2 | 2,064.4 | 613.2 | 748.6 | 2,193.2 |
| 1977 | 3,930.2 | 2,878.3 | 1,052.1 | 339.2 | 3,583.6 |
| 1978 | 7,293.8 | 4,059.9 | 3,233.9 | 2,926.3 | 4,969.9 |
| 1979 | 8,851.0 | 4902.0 | 3,949.0 | 2,926.3 | 5,924.7 |
| 1980 | 9,066.4 | 6,217.7 | 2,848.7 | 1,109.2 | 7,957.2 |
Source: CBN, Annual Report and Statement opof Accounts (various issues)
(i) Open Market Operations: This involves the CBN purchase and sale of government bonds in the open market. This measure is only effective in a fully developed money market which is not available in Nigeria at this time.
(ii) Reserve Requirements: The CBN has a right to raise or lower the reserve ratio of the commercial banks to achieve specific credit policy needs. Each commercial bank is required by law to keep a certain percentage of its total demand deposit liabilities with the Central Bank.
(iii) Bank Rate: The CBN can raise or lower the bank rate or discount rate as the need arises. The bank rate is very important because all interest rates charged by the commercial banks are influenced by it. It is actually the rate at which the Central Bank is willing to lend to the commercial banks.
(iv) Use of Directives: The Central Bank since 1969 consistently issues directives and guidelines for the banking industry in the area of loans and advances to the various sectors of the economy. These directiveshave proved very effective as a weapon of control.
(v) Bank Supervision: The Central Bank supervises the activities of the commercial banks to ensure compliance with the banking laws, and directives from CBN.
(vi) Moral Suasion: In addition to directives, the CBN also uses the traditional weapon of moral suasion. This involves advising and persuading the commercial banks to follow a given credit policy.
Banking System’s Credit to the Economy
The influence of CBN is seen mostly on the banking system’s credit to the economy. Table 38) gives the credit position from 1972 to 1980.
(b) The Commercial Banks
Commercial banks are those that operate checking accounts and engage in all banking operations involving both savings and checking accounts. By 1982, Nigeria had over 20 commercial banks with 600 or more branch offices.
Functions of Commercial Banks
Commercial Banks perform the following ten important functions:
(i) Serve as a depository for money.
(ii) Provide loans.
(iii) Act as a collection agency for negotiable instruments.
(iv) Serve as trustee offunds and administrator of estates.
(v) Supply commercial letters of credit.
(vi) Provide financial advice.
(vii) Handle documents for foreign trade transactions.
(viii) Sell travellers’ cheques.
(ix) Rent safe-deposit boxes.
(x) Provide bank drafts.
(c) The Development Banks
The group includes the Nigerian Industrial Development Bank (NIDB), the Nigerian Bank for Commerce and Industry (NBCI), the Nigerian Agricultural and Cooperative Bank (NACB), and the Federal Mortgage Bank of Nigeria (FMBN).
The main function of the development banks is to provide long-term loan capital to industry as well as equity share participation in some cases.
The NIDB was set up in 1964 with a paid up capital ofN4.5 million. The CBN is its major shareholder. The NBCI was set up in April 1973 with a paid up capital of N 10 million subscribed in the ratio of 2:3 by the CBN and the Federal Government respectively.
The FMBN was reconstructed in July 1977 from the Building Society which operated for 20 years. It is a wholly Federal Government mortgage bank with an initial equity base of N20 million, N12.5 million of which was paid up. The equity base has been expanded recently to N 150 million held in the ratio of 2:3 by the CBN and the Federal Government.
The NACB was established in 1973 and restructured in 1978 to include the finance of cooperatives.
(d) The Merchant Banks
A merchant bank may be described as a wholesale trader who takes on deposit other men’s money and who depends on his reputation for fair dealings to exploit the money in making his living. It provides finance in the form of acceptance credit, short-term, medium term, and long-.term loans, documentary import and export credits, and acts as authorised dealers in foreign exchange. In the area of corporate finance, merchant banks act as issuing houses, advise on capital structure of companies, mergers, amalgamations, and arrange syndicate loans. They also handle debt factoring, equipment leasing, investment management, and management of unit trusts.
(e) The Insurance Companies
There are about 72 registered insurance companies in Nigeria as of December 1980. Insurance companies provide two basic services – they offer protection and provide a means of accumulating savings. Such accumulated savings provide Insurance Companies with a pool of funds for investment purposes. They invest mainly in different securities stocks and shares, real estate, and mortgage loans. In 1979 for example, 29 of the Insurance Companies engaged in lending activities amounting toN47.2 million. In ·1980, 27 of the Companies granted loans amounting to N49.4 million with three large companies accounting for N42.5 million or 86.1 percent.
(f) The Stock Exchange
A Stock Exchange is a capital market where stocks and shares are bought and sold. It provides the facilities for companies and government to raise money from the citizens for businessand development projects. The Nigerian Stock Exchange was established in 1960.
Stocks and shares are bought and sold on the stock Exchange through dealing members or stock brokers. A stock broker is a firm or person who buys and sells securities on behalf of investors for a commission.
The Nigerian Security and Exchange Commission was established in 1973 to register securities to be offered to the public and to supervise the activities of the members of the stock exchange.
MONEY AND CAPITAL MARKETS
1. Money Markets
The Money Market is a market for the purchase and sell of monetary instruments such as Treasury Bills, call monies, Treasury Certificates, and Commercial Bills. A primary reasons for the establishment of the Market in Nigeria in 1960 is to provide the machinery for government short-term financing requirements.
The Treasury Bills are promissory notes used by the Federal Government of Nigeria to borrow for short periods of about three months, pending the collection of its revenues. They are issued in multiples of Nl000 for ninety-one days and at a fixed discount.
The Treasury Certificate on the other hand, is a medium-term government security which matures after a period of one to two years and is intended to bridge the gap between the Treasury Bill and long-term government securities.
The Call Money Market is an arrangement whereby the participating institutions invest monies surplus to their immediate requirements on an overnight basis with interest and withdrawable on demand.
As a result of the Governments’ buoyant revenues arising from the oil boom, the Central Bank of Nigeria abolished the call money scheme in July 1974.
2. Capital Market
While the money market is for short-term credit, the capital market is for long-term loans and equity investments. The Nigerian Capital Market comprises the following institutions: – the Nigerian Stock Exchange, the Nigerian Industrial Development Bank (NIDB), The Securities and Exchange Commission (SEC), The Nigerian Bank for Commerce and Industry (NBCI), and the Nigerian Agricultural and Cooperative Bank (NACB).
The primary function of the Capital Market is to provide local opportunities for borrowing and lending for long-term purposes. It provides facilities for the quotation and ready marketability of shares and stocks, and opportunities and facilities to raise fresh capital in the market.
FINANCIAL INTERMEDIATION
A financial intermediary is an institution which creates and issues financial claims against itself and uses the proceeds to acquire and hold financial claims against others. The claims acquired and held by an intermediary are usually direct securities, either debt or equity. Among the important types of financial intermediaries in Nigeria are Commercial Banks, Credit Unions, Savings Banks, Life Insurance Companies, Development Banks, and Provident and Pension Funds.
For example, commercial banks issue indirect securities ‘in the form of demand, savings, and time deposits. They on the other hand, hold direct securities in the form of loans and debt securities of many types. Similarly, life insurance companies issue indirect securities in the form of life insurance and annuity policies and hold direct securities in the form of mortgages on real estate and corporate bonds.
Investment companies or development banks on the other hand, issue indirect securities in the form of shares or stocks and hold direct securities in the form of corporate stocks.
1. Advantages of Intermediaries
Financial intermediaries are reducers of risk and manufacturers of liquidity and safety. Through diversification of assets, they reduce risk to a degree that could not be achieved or could be achieved only at higher cost by individual owners of savings. An intermediary operating with a large pool of funds can mobilize experts in its various functions, reaps the increased productivity and lower costs resulting from a high degree of specialization and employ efficient machinery and equipment. Forexample, it can gather and analyse information at low cost per unit by spreading the total cost over a large number of assets.
Questions and Discussions
1. Enumerate the different sources of business finance, and describe each of them.
2. Distinguish between common stock and preferred stock. What are the advantages and disadvantages of each?
3. What are the various features of preferred stock?
4. What do you mean by debt capital? Distinguish between short, intermediate term and long term debts?
5. Describe the different types of short term and intermediate term debts?
6. Distinguish between over and undercapitalization. How are they brought about?
7. What are financial institutions? Describe their functions.
8. Distinguish between Central, Commercialand Merchant Banks. How does the Central Bank control other financial institutions?
9. What do you mean by a money market. How does it differ from a capital market?
References
1. Parkinson, C.N. Big Business (Boston: Little Brown and Co.) 1974, p. 34.
2. Friend, 1. “What Business can do to prevent recessions” Problems in Antirecession Policy (New York: Committee for Economic Development 1954), p. 6. Cited in J.E Welson and E.E Brigham, Essentials of Managerial Finance (New York: Holt Rinehart and Winston 1968) p. 14.
3. Linter, John. “Distribution of Incomes of Corporations Among Dividends, Retained Earnings and Taxes” American Economic Review, 46 (May 1956) pp. 97-113.
4. Johnson, R. W. Financial Management (Boston: Allyn and Bacon, Inc.) 1971.
5. Rudelius, W. et al, An Introduction to Contemporary Business (New York: Harcourt Brace Jovanovich, Inc. 1976,) p. 313.
6. West, J.E and Brigham E. Managerial Finance, The Dryden Press Hinsdale Illinois 1975 p. 20 I.
7. Van Horne, J. C. FinancialManagementandPolicy, New Jersey: Prentice-Hall Inc. 1971, p. 543.
8. G.O. Nwankwo. The Nigerian Financial System. (London: The Macmillan Press Ltd.) 1980, p. 8. See also Chapters 2 and 3 for detailed information on the functions of the Central Bank of Nigeria.
9. C.B.N. Annual Report and Statement of Accounts for December 31, 1980, p. 69.
10. G.O. Nwankwo: For Detailed information on the Nigerian Stock Exchange Commission see Chapter 19.
11. Lester V. Chandler; The Economics of Money and Banking (New York, Harper and RowPublishers) 1973 p. 69.