Types Of Financial Institutions And Their Functions You Need To No

In this chapter, we will identify and describe the major components of the financial system. 

We will specifically describe the activities of the financial institutions and financial instruments, their relationships, development and interactions. Finally, we will discuss the
two broad classifications of the financial system, money and capital markets. 

Modern  Financial Institutions

Here, we will discuss the functions and operational activities of Central Banks. Commercial Banks, Merchant Banks, Development Banks and others. While banks are major
institutions that make up the financial system, so also we have non-banking institutions like
insurance companies, building societies, etc. Their functions can be divided according to how to perform in both the money market and the capital markets. 

central Banks  

The Central Bank is the apex of the financial system. Apart from the government, it is the most important monetary and financial regulatory body within the country. Each independent country has its own Central Bank; for instance, Nigeria has the Central Bank of Nigeria. 

The Central Bank is owned solely by the government of the country. Its Board of Directors and Governor are appointed by the government. The Central Bank serves majorly as a government instrument for controlling the country’s economy (especially the monetary and financial aspects of the economy). Therefore, the government of the country seeks to substantially influence the activities of the Central Bank. 

Before political independence, all the English speaking West African countries have the West African Currency Board (WACB) acting as Central Bank. West African Currency

Board has its head office in London. Since its functions were majorly the printing of ml issuance of currency notes, it was more or less a currency issuing financial house As feather the English speaking West African countries gained political independence, it established a Central Bank of its own. Consequently, Ghana established a Central Bank in 1957; Nigeria 1959; Sierra Leone in 1964 and Gambia in 1971. These Central Banks perform the following specialized services and functions:

(i) Issuance of Currency

This is a major function of the Central Bank. It controls the quantity of all paper money or currency notes and coins which are produced by the mint (in the case of Nigeria, the Nigian Printing and Minting Company produces the currency notes and coins) in circulation. Consequently, the Central Bank is responsible for the volume of the country’s legal tender. II controls the total supply of money in relation to the quantity of goods and services produced in the economy so as to ensure price stability and avoid inflation.

(ii) Banker to the Government

It is the bank that provides banking and financial services to the government both state and federal government, as well as their agencies). The Central Bank maintains the (bank) account of the government and its agencies, thereby dealing with governments receipts and - payments. It grants overdraft privileges to the government pending its receipts of tax and other revenue. It maintains and services the public (government) debt on behalf of the government. The Central bank gives the government economic and financial Addison services in respect of government borrowing, financial planning and budgeting and other complementary services. Based on the above mentioned functions of the Central Bank. the Central Bank acts like a commercial bank to the government.

(iii) Banker to commercial Banks

All commercial banks have accounts with the Central Bank; in which they keep a proportion of cash reserves stipulated for commercial banks by law. It as well organised clearing houses in which cheques drawn on different banks are exchanged and net indebtedness between them settled. The Central Bank gives loans to commercial banks. 

The Central Bank Garth against bank failures (a situation whereby the people lose confidence in a commercial bank because of its inability to fulfill its financial obligations) by giving out loans to commence banks that need money urgently to meet increased unexpected demands for cash from their customers. in its performance of this laudable service, the Central Bank is referred to as Lender of Last Resort. This lending of last resort is either done by direct cash transfers discounting bills for commercial banks. Therefore, the Central bank assists in developing banking habit by guarding against bank failures which may discourage savings m banks ant thereby reduce the flow of funds needed for productive investment.

 (iv) Manager of the country’s Foreign Monetary Matters

The Central Bank keeps the nations’ gold and foreign currency reserves and services the

country’s external debt. It maintains a link between the country and other countries (and

their Central Banks) as well as international monetary institutions like World Bank or

International Bank for Reconstruction and Development (IBRD), International Monetary

Fund (IMF); African Development Bank (ADB). The Central Bank represents the country in international financial matters and at the same time provides international organisations both economic and financial information about the country. For instance, the Central Bank

of Nigeria (CBN) is a member of Central Bank of West Africa (CBWA), Association of

African Central Banks (AACB), and West African Monetary Fund (WAMF). In conduct of

international trade, it acts as an agent of government’s treasury.

(v) Bankers to Discount Houses

The Central Bank serves as banker to discount houses which include insurance companies and hire purchase companies. These companies borrow from the Central bank when in dire need of money. Since majority of these companies are young, they rely very much on the

Central Bank’s financial support.

‘vi) Facilitates Socia-Economic Development

The Central Bank plays a major role in facilitating socio-economic development of its

country’s economy. This,, it does by influencing positively the mobilization of funds for

rapid economic development of industries and distribution activities of businessmen

through the various credit institutions available within the economy. It therefore monitors

the activities of credit institutions. It as well promotes the development of specialized credit

institutions like Nigerian Agriculture and Cooperative Bank (NACB); Nigerian Bank for Commerce and Industry (NBCl) Nigerian Industrial Development Bank (NIDB) just to mention a few. These specialized credit institutions are motivated through Central Bank

policy regulations to promote agricultural and industrial growth and development.

The Central Bank promotes export of goods and services, thereby encouraging

increased foreign exchange earnings. It helps to maintain price stability by adjusting bank

rates to influence commercial banks’ interest rates. All these functions of Central Bank help

in keeping the economy in proper balance for rapid economic growth and development.

(vii) implements Government’s Monetary and Financial Poolsides

The quantity of money in circulation within a country economy will affect the price level

desiderata and the level of production and equitable distribution of national income.

Based on this fact, the government formulates monetary and financial policies to regulate

the supply of money, maintain stable price levels and redistribute income and maintain full

employment.

The Central Bank is charged with the responsibility of impingement these government monetary and financial policies through the various financial institutions and commercial banks they oversee or control. In implementing these government policies, the Central Bank uses variety of instruments to control the supply of money and granting of credits by the commercial banks. These instruments are discussed below:

(a) Bank Rate

This is the rate which the Central Bank charges for loans provided to cOmmercial banks and other financial institutions. This bank rate is closely tied to the interest rate at which the commercial banks will grant loans to their customers. Consequently, if Central Bank wants In reduce the supply of money, it increases the bank rate which results in increased commercial banks interest rate on loans and reduction in bank lending. It reduces the bank rate when it wants to increase the supply of money and granting of credits by banks.

(b) Minimum Cash or Liquidity ratio

Central Bank gives directives on the minimum proportion of commercial bank assets that must be held in cash or liquid form. Whenever this minimum cash or liquidity ratio is at a low level; commercial banks have the opportunity to create more credits, but when it is high, less credit can be created by commercial banks per unit of their assets.

(c) Special Deposits

Central Banks require that commercial banks keep a specific proportion of their deposit within it as special deposits. This is aimed at reducing bank lending. The higher the special deposits required, the lower the lending ability of commercial banks and vice versa.

(d) Open Market Operations (OMO)

The Central Bank deals in the buying and selling of government securities (both long tern and short term) like government’s development stocks, treasury bills and so on. Whenever the Central bank buys treasury bills or other government stocks, it increases the supply of money in circulation thereby encouraging increased bank lending. However, when it seeded government stocks, it withdraws money from circulation thereby reducing supply of money and bank lending activities commercial banks.

(e) Direct Control

The Central Bank can give specific instructions to commercial banks with respect to the volume of loans and Sectors to be given such loans. This action is taken especially when other instruments fail to provide expected result in influencing economic activities of banks and financial houses. For example in Nigeria, the Central bank has used this method extensively. It is now its usual practice to issue out directives to commercial banks on quarterly basis through quarterly monetary policy circulars or guidelines.