Unit 1 Nigerian Financial Institutions

MODULE 2 OVERVIEW OF NIGERIAN FINANCIAL SYSTEM

Unit 1 Nigerian Financial Institutions
Unit 2 The Nigerian Money Market
Unit 3 The Nigerian Capital Market
Unit 4 The Security and Exchange Commission
Unit 5 The Role of the Central Bank of Nigeria

UNIT 1 THE NIGERIAN FINANCIAL SYSTEMCONTENTS

1.0 Introduction
2.0 Objectives
3.0 Main Content
3.1 Definition of Financial System
3.2 The Participants in a Financial System
3.3 Instruments Used in Financial System
3.4 The Structure of the Nigerian Financial System
5.0 Conclusion
6.0 Summary
7.0 Tutor-Marked Assignment
8.0 References/Further Reading

1.0 INTRODUCTION

In the previous unit, you studied the characteristics of small business. In
this unit, you are going to learn about the Nigerian financial system.
The Nigerian financial system has evolved over the years, from a
rudimentary stage to a more sophisticated stage. There are so many
operators, instruments, and institutions that facilitate its operation,
especially, the role of financial intermediation. Financial intermediation
is the process that facilitates the transfer of saved funds of some
economic units to others, for investment purposes. For example, the
personal savings of an individual, placed in a bank, can be loaned to
another individual or a business enterprise for the purchase of
machineries, equipment, raw materials, and so on, for productive
purposes.
For financial intermediation to occur, operators, instruments and
institutions in the financial system must operate together, with the ultimate aim of bringing about economic development in the country.
Thus, the state of the financial system of any country, in most cases,
reflects the state of the country.
In this unit, the structure of the Nigerian system is examined in order to assess the role of the financial system in Nigeria. You will also be
conversant with how operators, instruments and institutions work together to bring about economic development.

2.0 OBJECTIVES

At the end of this unit, you should be able to:
 explain the meaning of a financial system
 identify the participants and the roles they played in the financial system
 describe the instruments used in the financial system
 examine the structure of the Nigerian financial system.

3.0 MAIN CONTENT

3.1 Definition of Financial System
Financial system is an embodiment of rules and regulations within
various financial arrangements, institutions, agents, and the various
ways through which they relate and work with each other. Ekezie
(1997:6) defines financial system as a set of rules and regulations and
the aggregation of financial arrangements, institutions and agents that
interact with each other and the rest of the world to foster economic
growth and development of a nation.
In a financial system, various institutions, agents (operators) and
instruments are very important. They are linked by laws (rules and
regulations), contracts, and communications networks, in order to work
effectively, by providing a medium of exchange through financial
intermediation, which facilitates the channeling of funds from surplus
spenders (those with excess funds) to deficit spenders (those without
excess funds) for investment or productive purposes. This in turn will
enhance productivity, and consequently, foster economic growth and
development.
Thus, in a financial system, operators, institutions and instruments are
brought together, on one hand, while surplus spenders and deficit
spenders are brought together on the other hand. The functions of a
financial system, as outlined by Olowe (2008:59), are as follows.

1. It eases the flow of funds from surplus units to deficit
units thereby ensuring efficient allocation of resources.
2. It facilitates issuing of instruments of varying degree of
maturities
3. It facilitates the transformation of maturity of financial
instrument.
4. It facilitates the growth of the economy
5. It allows investors the opportunity to invest in a wide range of enterprise, thus allowing them to spread their risk
6. It offers the participants in the system the opportunity to reduce
risk A highly developed and efficient financial system, according to Ekezie (2008:6), must have facilities for creating capital by channeling savings into investment. He also opines that the financial system must be capable of providing markets and procedure for the transfer of claims to wealth.

SELF-ASSESSMENT EXERCISE 1

Explain the meaning of a financial system.
3.2 The Participants in a Financial System
There are six participants in a financial system, they are as follows.
1. The households
2. Non-financial intermediaries (firms)
3. Financial intermediaries
4. Government
5. The central bank
6. Foreign sector or participant
Let us consider the above, one after the other.
1. The households
They are also referred to as consumers. They receive income from wages paid by firms, which are saved and spent on goods and services.
The household spends its income on two types of goods which are durable and non-durable goods.
Durable goods can be used beyond the current period. Consumers borrow to fund them, e.g. cars, television, etc. Non-durable goods are consumed within the current period, funding of non-durable goods is done by current income of consumers.
The household can also lend the money paid to them by the firm, to others. This involves a flow of funds from the household to the firm.
2. Firms
They are the producers of goods and services for both households and for themselves (the firm). They produce consumer goods which are
durable or non-durable; and also produce goods for the firm- these are
used in the production process. For example, machinery, plants, etc;
they make use of raw materials, labour input, and so on. As a result, they incur a lot of expenses, but receive revenue and make profit by selling their goods.
Firms pay taxes to the government and invest in government securities, which involve the flow of funds from firm to government.
3. Financial intermediaries
They are institutions that channel funds from lenders to borrowers or from surplus spenders to deficit spenders. They hold the funds of individuals, which they use in making loans and other investments.
Financial institutions are of the following categories.
1. The depository or banking institutions- these are divided into two:
 Informal institutions, which are the traditional financial
institutions. Examples are esusu, traditional money lenders,
and so on.
 Formal institutions like banks (commercial banks,
development banks etc).
2. Non-depository or non-bank financial institutions- these are
divided into two:
 Contractual institutions- they offer legal contract to protect
savers against risk; examples are pension funds custodians,
insurance companies etc.
 Investment institutions- they sell shares to the public and
invest the proceeds in stocks, bonds and other assets.
4. Government
In some countries like Nigeria, we have three tiers of government which are the federal, state, and local governments. As a result, we include the federal ministry of finance in this group.
They are involved in the collection of tax revenue as approved by the legislature. In collaboration with the central bank, they offer financial instrument to finance government expenditure.
5. The central bank
The central bank is a fundamental force to reckon with, because it is in charge of the national financial system and the economy.
6. Foreign participants
They are made up of the foreign sector. We lump foreign participants which include households, firms, financial institution, government and the central bank, which are from outside the economy. It also includes goods and services and financial instruments exchanged across national boundaries.

SELF- ASSESSMENT EXERCISE 2

Mention the participants in the financial system.
3.3 Instruments used in the Financial System
Financial instruments are tools of trades within the financial system.
Financial instruments package financial capital in a readily tradable permit. They do not exist outside the context of the financial market.
Financial instruments are categorised according to whether they are securities, derivatives of other instruments or cash securities. If they are derivatives, they are further categorised depending on whether they are traded as standard derivatives or traded over the counter.
Alternatively, they can be categorised by asset class depending on whether they are equity based or debt based, reflecting a loan that the owner has made. If it is a debt security, it can further be categorised as short term (less than a year) or long term (more than a year). Foreign exchange instruments are neither debt nor equity based; they belong to their own category. Financial instruments are classified as follows.

Table 1.1 : Classification of Financial Instruments
ASSET CLASS CASH STANDARD
DERIVATIVE OVER THE COUNTER DERIVATIVE
Debt (long term)
Bond (float rate) Bond (future) Interest rate swap Interest rate cap
Interest rate floors Debt (short term) Deposit (loans) Certificate of deposit Commercial papers
Future Forward rate agreement
Forex swap
Equity Stock (Equity index)
Stock options
Equity futures
Stock options
Forex Forex spot Forex futures Forex spot or forex futures

SELF- ASSESSMENT EXERCISE 3

Identify the instruments used in a financial system.
3.4 The Structure of the Nigerian Financial System
As earlier mentioned, the Nigerian financial system is made up of financial institutions, instruments, and operators. Here, you will be aware of the various institutions in the financial system.
The financial institutions include regulatory agencies, like the Federal Ministry of Finance (FMF), Central Bank of Nigeria, the Nigerian Deposit Insurance Corporation (NDIC) and the Securities and Exchange Commission (SEC). Others are banks (the commercial and merchant banks), development finance institution, specialised banks, such as
micro-finance banks and community banks. Other institutions include
insurance companies, finance houses, discount houses, bureaus de
change, pension fund administrators, and so on. Thus, the Nigerian
financial system is quite robust, in terms of the number and the variety.

These institutions are discussed below:

1. The Central Bank of Nigeria (CBN)
This is the apex regulatory body of the financial system in Nigeria. The CBN was established by the Central Bank Act of 1958. Its responsibilities were defined in the CBN Act of 1958, which was amended in 1991; these include:
 issuance of legal currency in Nigeria
 maintenance of Nigeria external reserves in order to safeguard the international value of the national currency
 promotion of monetary stability and a sound and efficient
financial system in Nigeria
 acting as banker and financial adviser to the federal government
 acting as lender of last resort to banks
2. The Federal Ministry of Finance (FMF)
It advises the government on its fiscal operations. The ministry handles budgeting and planning and interacts with the CBN on monetary issues.
The FMF is currently in charge of licensing bureau de change and regulating insurance companies.
3. The Securities and Exchange Commission (SEC)
This is the apex regulatory organ of the capital market. It was established by the SEC Act of 27th September, 1979 and was re-enacted by the SEC Decree of 1988. The major objective of SEC is the promotion of an orderly and active capital market.
4. The Nigerian Deposit Insurance Corporation (NDIC)
This was established by decree 22 of 1988, and began operations in February 1989. Its primary responsibility is to provide protection for bank deposits in order to promote confidence in the banking sector and ensure stability of the system. In carrying out this major function, the NDIC insures deposit liabilities of licensed banks operating in Nigeria.
It assists banks to overcome temporary illiquidity problem in the interest of the system; it also guarantees payments to insured depositors, up to a maximum of N50,000 per depositor (Aderibigbe, 2004:5)
5. Commercial Banks
These are privately owned financial institutions, established in 1892, to transact business with funds in order to earn profit for their shareholders (Ademu, 2003:332). Commercial banks accept deposits and repay cash on demand. They also manage both current and savings accounts in order to meet the aspirations of their customers; they undertake activities like provision of credit facilities to sectors, safekeeping of valuables and
money, business advisory services, among others.
5. Merchant Banks
They take deposits and cater for the needs of corporate and institutional customers, by way of providing medium and long term loan financing, and engaging in activities such as equipment leasing, loan syndication, debt factoring and project advisory services. The first merchant bank in Nigeria, Nigeria Acceptance Limited (NAL), started operations in 1960.
By the end of 1996, there were 51 merchant banks, with 147 branches, while their assets amounted to N111,266.9 million (Nigerian Investment Promotion Commission, 2005).
It is important to note that in 2001, Deposit Money Banks (DMB) emerged, following the adoption of the universal banking system and the removal of the dichotomy between commercial and merchant banks.
A universal bank performs the most important role of financial intermediation in the Nigerian economy.
6. Development Finance Institutions
These provide medium and long term finance to the industrial and agricultural sectors of the economy. Some of the development finance institutions operating in Nigeria are Bank of Industry, Nigeria Agricultural Cooperative and Rural Development Bank (NACRDB), Federal Mortgage Bank of Nigeria etc. Each of these was established to meet specific financial needs, in some sectors of the economy.
7. Specialised Banks
These are banks established to cater for the needs of some segments of the economy. These banks include micro- finance banks, community banks etc.
8. Insurance Companies
These are companies that provide protection against unpalatable consequences like loss of life, property etc., arising from accident. Olowe (2008: 38) explains that by accepting premiums, insurance companies undertake to pay compensation to policyholders, if certain pre-specified events occur. The premiums collected by insurance companies are invested in other outlets such as bonds, stocks, mortgages
and government securities. The insurance companies in Nigeria are classified into life and non-life institutions.

9. Finance Houses
These are financial institutions where an individual or a firm can obtain small, secured and unsecured, personal loans and business loans, usually, at a higher interest rates and higher cost of processing fees than banks. They mobilise funds, manage projects, provide leasing finance,
consumer installment lending etc., but are prohibited from accepting deposits and undertaking foreign exchange transactions.
10. Discount Houses
They are licensed to act as intermediaries between the central bank and the licensed banks in open market operation transaction and other eligible securities. They provide discounting /rediscounting services
which will assist in providing liquidity
11. Bureaus de Change
In order to broaden the foreign exchange market and improve
accessibility to foreign exchange, Bureaus de change have, since 1989, been authorised to act as dealers in the market for foreign exchange. The federal ministry of finance is charged with the responsibility of licensing
them (Ekezie, 1997:15). From the 2006 CBN annual report and statement of accounts, there are 352 bureaus de change operating in Nigeria.
12. Pension Fund Administrators
These are limited liability companies licensed by the National Pension
Commission (NPC) to manage pension funds in Nigeria.

SELF-ASSESSMENT EXERCISE 4

With the aid of a diagram, explain the structure of the Nigerian financial
system.

Next Unit 2 The Nigerian Money Market

4.0 CONCLUSION
In this unit, you are exposed to the financial system, which is an embodiment of rules and regulations within various financial arrangements, institutions, agents, and the various ways through which they relate and work with one another. The system comprises institutions, instruments, and operators. There are six participants in the financial system and they include- the household, non-financial intermediaries (firms), financial intermediaries, the government, the
central bank, and the foreign sector or participant.

5.0 SUMMARY
In this unit, you have learnt about the structure of the Nigerian financial system. You are now aware of the institutions, instruments and operators that make up the financial system. In the next unit, you will learn about the money mar ket.

Next Unit 2 The Nigerian Money Market

6.0 TUTOR-MARKED ASSIGNMENT

1. Explain the meaning of a financial system.
2. Identify the participants in the financial system and describe their roles.

7.0 REFERENCES/FURTHER READING

Ademu, W.A. (2003). “The Nigerian Banking System.” In: Mai-lafia,
D.I. (Ed.). Reading in the Nigerian Banking System. Jos:
University Press Ltd.
Aderibigbe, J.O. (2004). An Overview of the Nigerian Financial System.
Bullion, 28, (1), p.5.
Ekezie, E.S. (1997). The Elements of Banking. Ibadan: Intec Printers
Limited.
Olowe, R.A. (2008). Financial Management: Concepts, Financial
System and Business Finance. Lagos: Brierly Jones Nigeria
Limited.