MONEY MARKET The place of money in the economy enables us to separate our decisions on how we want to make a going from how we want to live. This therefore enables us to separate our production decisions from consumption decision thus enabling us to improve and facilitate our transaction methods of exchange. Also, money, as seen in earlier units, functioning as a medium of debt transaction gives a time dimension to it. This function of money necessitates the establishment of financial markets, a market or facilities created by financial institutions for holding and transferring of funds from one economic unit to another. It is a market that is concerned with the flow of funds from savings –surplus to saving – deficit economic units.
The organized financial market has two major outstanding segments – the money market and the capital market these are distinguishable mainly on the basis of the maturity structure of the instruments traded in them. The money market is the financial market for short-term debt instruments that are close substitutes for money. It therefore provided facilities for the exchange of financial claims and obligations for materials that vary from one day to one calendar year. The importance of this market derives from the opportunities which it created for raising short-term funds and/or for investing such funds, thus serving those economic units that require money market facilities for the profitable investment of their temporary excess funds.
Composition and Institutions Money Market
The money market institutions constitute the hub of the financial system. They include the discount houses, merchant banks, low income and rural sector-targeted institutions and commercial banks which are special purpose banks and the parallel market.While the discount houses and the banks, which are financial institutions, deal in bills of exchange by discounting them of less than their respective face values, the parallel money market is where there is horizontal transfer of credit to meet the “tailor –made” requirement of both lenders and borrowers.
A discount house is a special non-bank financial institution which specializes in mobilizing funds from the surplus sectors of the economy for channeling into the deficit sectors. It achieves this by providing discounting or re-discounting facilities in government short-term securities. In the process of shifting from direct to indirect monetary control which place emphasis on OMO, discount house have been established to serve as financial intermediaries between the CBN, licensed banks and other financial institutions.
Instruments traded in money market
(a) Treasury Bills (TB) These are 91-day maturity short-term debt instrument introduced by the CB to raise source of short-term fund to cover temporary excess of state expenditure over income, and as an instrument of monetary policy of the CB in the execution of OMO to mop up excess liquidity or the purchasing power in the economy. (b) Call money (CM) It is a means used by the commercial banks and other participating financial institutions to keep their temporary surplus cash with the CB. They are later invested in short term money market instruments like TB. The CM earned interest at slightly less than TB. (c) Commercial Bills/Trade Bills These are instruments issued by commodity boards in respect of export produce. They are rediscounted by the CB with most of the commercial banks participating as consortium. (d) Treasury Certificates (TC) They are similar to TB’s except in tenure, thus referred to sometimes as medium – term security instruments. (e) Certificates of Deposit These are inter-bank instruments with maturity dates ranging from 3 to 36 months. The certificates of deposits are mostly used by merchant banks to attract the surplus funds of commercial banks. They are two categories of certificates of deposit Negotiable Certificates of deposit issued for periods ranging from 3 months to 36 months, and Non- negotiable certificates of deposit issued for shorter periods ranging from 3 to 28 months. (f) Bankers’ Unit Fund This is introduced for banks and other financial institutions to invest part of their excess liquid resources. They are in large multiples while the CB invests the pooled fund in government stocks. They are reparable on demand in whole or part and attract some interest which is dependence on the maturity period. (g) Eligible Development Stocks (EDS) These were government development stock with less than 3 years maturity period and used by the CB to meet commercial bank’s liquidity ratios requirements. (h) Stabilization Securities They are used by the CB to mop up the excess liquidity of the banks. This is an effective monetary policy instrument which empowers the CB to issue the securities and sell same by allocation to banks and other financial institutions that are compelled by law to take up such, failure leads to imposition of stiff penalties by the CB.
Self-assessment exercise 1. Identify and explain the instruments of a money market.
Role of the Money Market in Economic Development
The money market which mirrors the economic health of a nation’s economy is of great importance. Its activities which are influence by the country’s reserves, balance of payments and the states of the economy generally serves the following functions in the economy. Promotion of efficient allocation and utilization of funds by ensuring that no idle fund is in existence Helping in the indigenization of the credit base of the economy Helps the commercial banks to hold lower cash reserves through the operation of the call money scheme Provides an avenue for the implementation of the CB monetary policy Acts as an important source of short-term borrowing to the government Provides opportunity for investment in fairly liquid and riskless assets in the economy Minimized cash holdings by banks by helping them invest their secondary line of reserves in earning assets Provides avenue for fund mobilization and allocation in the economy Its interest rates serve the CB as a barometer to judge the shortages and surplus of funds in the system It promotes liquidity and safety of financial assets thereby encouraging saving demand investments Promotes equilibrium between demand and supply of loanable funds It helps in economizing the use of cash by dealing in near – money assets and not paper money.
Self assessment exercise
1. Identify the areas of contribution of the money market to the economic Development of a developing country 2. What is a money market? 3. What are money market instruments? Describe various instruments in money market.
CAPITAL MARKET One of the segments of the financial market is the capital market. A Capital Market is a market for long term financial claims or obligations. It deals with long term funds and procedures for financing long term investments. Interactions in the market facilities the exchange of long term funds between savings- surplus and saving – deficit economic units.
The capital market is classified into two segments, the primary and the secondary segments. While the primary market is market where stocks are issued for the first time to members of the public, the secondary market is same as the stock exchange market. It is a market for stocks which are not being sold for the first time is the primary market. It can be referred to as the market for second hand stocks, though without diminishing value. The mode of offer in the primary market includes offer for subscription, right issues, offer for sale and private placement.
Self-assessment exercise 1. Differentiate between the primary segment and the secondary segment of the capital market.
Functions of a capital market
The provision of local opportunities for borrowing and lending on long-term basis To enable the government mobilize funds for long-term economic development To provide both the foreign and local companies with the opportunities to offer their shares for the purpose of raising capital The provision of opportunities for quotation and marketing of corporate stocks and securities To introduce a code of conduct, check abuses and regulate activities of the participants in the capital market
Instruments of a Capital Market
Equity This is a permanent source of capital for a business organization which confers ownerships right to the individual(s) through subscription to the shares of the company. There are two classes of equity viz – Common/Ordinary shares and Preferred Share. While common share holders’ area not entitled to fixed earnings of the company, preferred shares holders have fixed rate of returns attached to them.
Debentures These are also long-term debt instruments issued by a limited liability company. They are thus long-term promissory notes issued by a borrower who agrees to pay a fixed rate of interest on a specified amount on loan for a specific period of time and to redeem the loan on a stated future date. They are thus unsecured bonds, backed up only by the credit standing of the company issuing it.
Bond A bond is like a debenture but secured by some kind of collateral. A bond is generally a promise by a borrower to reply the principal sum and interest to the lender at the expiration of the bond period.
Institutions of a Capital Market
The institutions that operate in the Nigerian capital market can be categorized into two viz: Mediators and Facilitators. The mediators or financial intermediaries are those institutions that obtain financial resources from a lender and supply them to a borrower. They thus allow serves with small amounts of capital to pool their funds in order to diversify across a large number of investments. They through their expertise in portfolio management and diversification provide a high return for the savers on their investment. These institutions include commercial banks, building/mortgage societies, insurance companies and pension funds.
On the other hand facilitators help in the process of issuing, sale, registration and orderly transfer of shares in the market. These include the merchant banks, development banks Stock Exchange, issuing houses and stock broking firms.
The Nairobi Stock Exchange
In Kenya, dealing in shares and stocks started in the 1920's when the country was still a British colony. There was however no formal market, no rules and no regulations to govern stock broking activities. Trading took place on a gentleman's agreement in which standard commissions were charged with clients being obligated to honour their contractual commitments of making good delivery, and settling relevant costs. At that time, stock broking was a sideline business conducted by accountants, auctioneers, estate agents and lawyers who met to exchange prices over a cup of coffee. Because these firms were engaged in other areas of specialisation, the need for association did not arise.
In 1951 an Estate Agent by the name of Francis Drummond established the first professional stock broking firm. He also approached the then Finance Minister of Kenya, Sir Ernest Vasey and impressed upon him the idea of setting up a stock exchange in East Africa. The two approached London Stock Exchange officials in July of 1953 and the London officials accepted to recognize the setting up of the Nairobi Stock Exchange as an overseas stock exchange. In 1954 the Nairobi Stock Exchange was constituted as a voluntary association of stockbrokers registered under the Societies Act. Since Africans and Asians were not permitted to trade in securities until after the attainment of independence in 1963, the business of dealing in shares was then confined to the resident European community. At the dawn of independence, stock market activity slumped due to uncertainty about the future of independent Kenya. In 1988 there was the first privatization through the NSE is the successful sale of a 20% government stake in Kenya Commercial Bank. The sale left the Government of Kenya and affiliated institutions retaining 80% ownership of the bank.
Notably, in 1994 the NSE 20-Share Index recorded an all-record high of 5030 points on Feb. 18, 1994. The NSE also moved to more spacious premises at the Nation Centre in July 1994, setting up a computerized delivery and settlement system (DASS). For the first time since the formation of the Nairobi Stock Exchange, the number of stockbrokers increased with the licensing of 8 new brokers. On Monday 11 September 2006 live trading on the automated trading systems of the Nairobi Stock Exchange was implemented.
i. The Role of the Stock Exchange in the Economy
To promote a culture of thrift, or saving.-The very fact that institutions exist where savers can safely invest their money and in addition earn a return, is an incentive to people to consume less and save more ii. The transfer of savings to investment in productive enterprises as an alternative to keeping the savings idle iii. Assists in the rational and efficient allocation of capital, which is a scarce resource. The fact that capital is scarce means systems have to be developed where capital goes to the most deserving user. iv. To promote higher standards of accounting, resource management and transparency in the management of business.-This is because financial markets encourage the separation of owners of capital, on the one hand, from managers of capital, on the other. v. To improves the access to finance of different types of users by providing the flexibility for customization. This is made possible as the financial sector allows the different users of capital to raise capital in ways that are suited to meeting their specific needs. vi. To provides investors with an efficient mechanism to liquidate their investments in securities. The very fact that investors are certain of the possibility of selling out what they hold, as and when they want, is a major incentive for investment as it guarantees mobility of capital in the purchase of assets. vii. Others The mobilization of savings for investment in productive enterprises as an alternative to putting savings in bank deposits, purchase of real estate and outright consumption. The growth of related financial services sector e.g. insurance, pension and provident fund schemes which nurture the spirit of savings The check against flight of capital which takes place because of local inflation and currency depreciation Encouragement of the divorcement of the owners of capital from the managers of capital; a very important process because owners may not necessarily have the expertise to manage capital investment efficiently Encouragement of higher standards of accounting, resource management and public disclosure which in turn affords greater efficiency in the process of capital growth Facilitation of equity financing as opposed to debt financing Improvement of access to finance for new and smaller companies -This is now possible on the Alternative Investments Market Segment (AIMS). This can also be realized through Venture Capital institutions which are fast becoming key players in financing small businesses. Encouragement of public floatation of private companies which in turn allows greater growth and increase of the supply of assets available for long-term investment The establishment of an efficient stock market is, therefore, indispensable for any economy that is keen on using scarce capital resources to achieve economic growth.
International Banking International Banking is a process that involves banks dealing with money and credit between different countries across the political boundaries. It is also known as Foreign/Offshore Banking. International Banking involves banking activities that cross national frontiers. It concerns the international movement of money and offering of financial services through off shore branching, correspondents banking, representative offices, branches and agencies, limited branches, subsidiary banking, acquisitions and mergers with other foreign banks. All the basic tools and concepts of domestic bank management are relevant to international banking.
Reasons for Engaging in International Banking
Banks undertake international operations in order to expand their revenue/profit base, acquire resources from foreign countries, or diversify their activities. Specific reasons expanding operations abroad include the saturation of domestic market; discovery of lucrative opportunities in other countries; desire to expand volume of operations in order to obtain economy of scale. Further motives for operating internationally are as follows: Commercial risk can be spread across several countries Facilitation of international businesses and trade Involvement in international banking can facilitate experience curve effect Economies of scope might become available Reduce cost of service delivery Recognition and reputation
Modes of International Banking
There are a lot of available methods for entry into international banking operations. These include; (i) Correspondent Banks In order to adequately provide needed international banking services, commercial banks establish a network of foreign correspondent banks to supplement their own facilities worldwide. The correspondent bank relationship gives the domestic bank a presence in overseas markets, which permits international transactions to be concluded. (ii) Representative Offices A representative’s office is both the most commonly used and the most limited in function of all foreign banking operating internationally. The international representative office functions mainly as liaison between correspondent banks and the parent bank. (iii)Branches and Agencies Depending upon the extent of services that the institution wishes to offer, either a branch or an agency may be established. The basic definition of “branch” and “agency” may be found in the A branch is any office of a foreign bank at which deposits are received. (iv) Limited Branches This is an office chartered by the Authority subject to the condition that the foreign bank enter into an agreement with the country’s apex bank or regulatory authorities restricting the branch’s deposit-taking activities to those permitted by law. (v) Subsidiary Banks Foreign banks gain control of subsidiary banks by establishing new institutions or by acquiring existing domestic banking institutions and these subsidiaries generally may engage in a full line of banking activities. (vi) Bank Mergers Bank mergers are another option that is opened to those who wishes to provide international banking services in foreign countries. There are several reasons for a foreign bank merging with a domestic bank.
