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Lesson Note

Subject: Economics

Topic: Financial Institutions

Subtopic: Financial Institutions Other Than Central And Commercial Banks.

Learning Objectives: This lesson is intended to acquaint learners with knowledge on other kinds of financial institutions other than central bank and commercial banks. So by the end of the lesson, they should be able to:

  1. Explain the following terms clearing house, development bank, merchant bank, mortgage bank, insurance companies;
  2. State and explain the types of clearing house;
  3. Explain the meaning and functions of development banks;
  4. Explain Merchant banks and give their functions;
  5. Explain Mortgage banks and state their functions.

Discussions.

The Financial Institutions Other Than Central And Commercial Banks

We started this lesson from the introductory aspect which can be seen from the previous lessons. We discussed Central bank, Commercial bank, and bank accounts separately. Now in this very post, we want to look at other kinds of financial institutions. They include:

  • Bank clearing house,
  • Development banks,
  • Merchant banks,
  • Mortgage banks,
  • Insurance companies,
  • Transitional financial institutions,
  • Money market. Money market will be discussed in our next lesson.

Banking Clearing House

Bank clearing house is an institution established by member banks to simplify exchanging and obtaining of payments for the cheques that are paid into bank branches throughout the country.
The clearing system is used among banks to settle cheques drawn on them. Indebtedness between the daily totals of cheques exchanged are set off against each other. Final settlement is affected through the banks’ accounts.

Types of clearing house

(1) Local clearing house: The local clearing house takes care of clearance of cheques among various banks in the same town. All large towns have their own clearing houses where representatives of the various banks in the town meet each day to clear cheques.
(2) Head office clearing house: Head office clearing system undertakes to settle cheques drawn by the customers of a bank from various branches.
(3) Bankers clearing house: Bankers clearing house is the place where ultimate clearance and settlement of cheques are carried out in a country. All banks in the country will come together to sort out cheques drawn on each other. The final settlement is through cheques drawn on the central bank.

Development Banks

Development banks are specialised financial institutions which provide long term credit or loan to other enterprises for capital projects. They provide loans for projects in the area of agriculture, commerce and industry. Examples of development banks in Nigeria are Nigeria Industrial Development Bank (N.I.D.B), Nigerian Bank for Commerce and Industry (N.B.C.I) and Nigerian Agricultural and Co-operative Banks (N.A.C.B).

Functions Of Development Banks

i. Provision of fund for capital projects: Development banks provide long-term loans for capital projects in specific areas.
ii. Manpower development: They contribute to manpower development by making funds available to manpower training institutes.
iii. Implementation of government policies: Development banks also help to implement government policies on Industrial, commercial and agricultural development.
iv. Render special advice: Development banks also advise the industrialist on the surest or best way to invest.
v. Supervision of development projects: They help industrialist and other investors to supervise development projects in order to ensure their success.

Merchant Banks

Merchant Banks are financial institutions which perform specialised functions, such as acceptance of bills of exchange, Issuance of loans for foreign trade transactions, issuance of new shares, and provision of medium and long-term loans. They are sometimes referred to as acceptance houses. In the past, merchant Banks were merchants who specialised in trade with particular parts of the world.
The first merchant bank in Nigeria was the Nigerian Acceptance Limited (NAL) established in 1966. There are many merchant Banks in Nigeria today. These include: ABC Merchant Bank, Merchant Banking Corporation, Merchant Bank of Africa, First City Merchant Bank, Intercontinental Merchant Bank etc.

Functions Of Merchant Banks

i. Discounting bill of exchange: Merchant banks accept and discount bill of exchange.
ii. Loan to foreign traders: Merchant banks arrange loans at the request of foreign traders.
iii. Advisers to companies: They act as company advisers by way of telling them possible areas to invest.
iv. Understanding of shares: They underwrite new issues of shares.
v. Provision of long-term loans: They issue long-term loans to the government and companies abroad for development of projects.
vi. Loan Syndication: Merchant banks undertake loan syndication by organising a consortium of institutions to finance business enterprise.

Differences between Merchant banks and Commercial banks

Merchant Banks
Commercial Banks

i. Provide medium and long-term loans
Provide short term loans

ii. Render corporate financial services e.g management of investment portfolios
Render personal services such as keeping of jewellery and wills

iii. Understanding equipment leasing
Do not carry out equipment leasing

Accept only large deposits
Accept deposits from all categories of people

Mortgage Banks

Mortgage Banks are financial institutions that specialise in granting loans to individuals and corporate bodies for building purposes. Such loans are repaid by instalments and can be spread over several years.
Mortgage banks accept deposit from the investing public at a rate of interest and use the fund to lend, at a higher rate of interest, to people who wish to purchase their own houses.
The Federal Mortgage Bank was established with headquarters in Lagos to encourage people to save in order to own their houses. This is the apex mortage bank which works with other state housing corporations and mortgage institutions. The Federal Mortgage Bank supervises other mortgage institutions like Union Homes and Savings Ltd, AG Homes and Savings Ltd etc.

Fuctions Of Mortage Banks

i. Acceptance of deposit: Mortgage banks accept deposit from customers in order to encourage savings towards owning a house.
ii. Provision of long-term loans: They also provide long-term loans to people or to estate developers to build houses.
iii. Development of mortgage institutions: They supervise and encourage the development of mortgage institutions.
iv. Give advice on housing matters: They advise and assist the government on housing matters.
v. Provision of houses: Mortgage banks are also involved in the construction of houses and offer them for sales to the people.

Insurance Companies

Insurance companies are financial institutions that are concerned with insurance. Insurance maybe defined as a contact between an insurer and an insured, under which an insurer promises to indemnify (compensate) the insured against loss, which he may suffer in future, upon the payment of a premium. It is a provision made by an individual or an enterprise against the occurrence of some future loss.
There are certain risks which can be insured against. Examples include risks of fire, burglary or theft, accident, loss of goods in transit, untimely death, bodily injury to factory workers etc.
Examples of insurance companies in Nigeria are: Reinsurance Corporation of Nigeria, National Insurance Corporation of Nigeria, Industrial and General Insurance, Custodian and Allied Insurance Nig. Ltd, Lion of Africa Insurance etc.

Functions of Insurance companies

i. It facilitates international trade: Insurance stimulates and facilitates international trade. This is because marine policy, for example, provides cover for cargoes and vessels. The export credit guarantee also guarantees credit sales.
ii. It offers investment opportunities: Insurance makes funds available for investment. A large proportion of these resources are invested in the capital market, when businessmen can obtain loan. This helps in developing the country’s economy.
iii. It leads to risk reduction: Insurance helps to reduce or control loss or liabilities of a businessman. It spreads the financial losses of the insured.
iv. Provision of security: Insurance provides security to commercial activities. Some small enterprises would have collapsed as a result of major losses, but insurance always takes care of such uncertainty.
v. Provides a means of savings: Insurance companies provide a means of saving regularly, which will help to provide for the future, e.g endowment policy.
vi. It serves as collateral security: Life assurance policy can be used as a collateral security to obtain loan from the bank for business investment.

Traditional Financial Institutions

The traditional financial institutions came into existence several years before the establishment of modern banking system in many countries in the West African sub-region. It involves the coming together of a group of people with common interest in the same place of work or commonly who mutually agreed to pool their resources together in order to save, lend and manage money. These traditional financial institutions usually take the form of Co-operative societies known as credit and thrift Co-operative societies, which are given different names in different places, e.g “ESUSU” or “NSUSU” in Yoruba, or “ETIO-UTO” in Igbo. It takes the form of association of people in the village, office, market, etc who have mutually accepted to pool their resources together so as to save, manage and lend such money to its members when the need arises.

Functions Of Traditional Financial Institutions

i. It encourages savings: Members, through the pooling of their resources together are encouraged to save.
ii. Assists members to borrow: Members who are in need of money for whatever reason are permitted to borrow.
iii. It ensures proper management of funds: The saving and lending of funds to members assist the institution to manage their funds properly.
iv. Promotion of investment: Traditional financial institutions may decide to invest in viable businesses that can yield profit to the organisation.
v. Assistance to members in time of need: Traditional find institutions can assist members when they are in financial difficulties.

Done studying? See All Previous lessons in Economics

  1. List and explain the financial institutions other than central bank and commercial banks.
  2. State the functions of each listed in question two above.
  3. How is merchant banks different from commercial banks?
  4. Mention five examples of insurance companies in your country.

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