BFN 102 INTRODUCTION TO FINANCE II

BASIC CONCEPTS OF MONEY

Money can be generally defined as a medium of exchange. Anything that is commonly accepted as a
medium of exchange and as an instrument for the final settlement of a debt can be regarded as money.
It confers on the holders, command over other assets.

Evolution of Money

The word money is derived from the Latin word “Moneta” which was the name of the Roman
goddess of Juno in whose temple at Rome, money was coined. The origin of money is lost in
antiquity.

Stages of Evolution of Money

Money has passed through five (5) stages depending upon the progress of human civilization at
different times and places:
a. Commodity money: Arose as a result of trade by barter or exchange. Various types of
commodities have been used as money from the beginning of human civilization e.g. stones,
bows, arrows, cattle, precious stones etc.
b. Metallic money: This took the place of commodity money as a result of spread in civilization
and trade relations among many nations. However, metal was an inconvenient thing to accept,
weigh and divide and assess in quality. To solve this problem, metal was made into coins by
King Midas of Lydia in 8 B.C. although gold had been used in India before then.
c. Paper money: Development of paper money started with the goldsmiths who had strong
safes and accepted to safe-keep gold for others while giving the depositors receipts. These
receipts or paper money were convertible to gold on demand as they were backed by gold.
This led to the development of bank notes which are issued by central banks in present day
economies.
d. Credit money: involves the use of cheques as money. The cheque is like bank note in that it
performs the same functions. It differs from bank note because it is made for a specific sum
and is used for a single transaction. Cheque is not money but only a written order to transfer
money. However, large transactions are made through cheques these days.
e. Near money: It involves the use of bills of exchange, treasury bills, bonds, debentures, plastic
money etc. They are close substitutes for money and are liquid assets.
f. Electronic Money: E-money is a type of money that is stored electronically. Its important
forms are credit cards, debit cards and electronic cheques. It enables people to purchase goods
by electronically transferring money directly from their accounts to the seller’s account.
Electronic cheques allow internet users to make their payments directly over the internet
without having to send a paper cheque.
g. Digital Money: Digital money, also known as digital currency or crypto currency, is a new
and upcoming way of storing value. Unlike traditional currency, which can be transferred to
paper money from a bank account, digital money is entirely digital with only a number as an
indication of value. The currency is often used by utilizing a digital wallet that can be
accessed from devices such as computers, smartphones, and tablets.

CHARACTERISTICS OF MONEY
a. Homogeneity: Each unit held by different individual must be identical.
b. General acceptability: Must be generally acceptable in exchange for goods and services.
c. Portability: must be easy to carry i.e. easily transferable.

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d. Divisibility: Must be capable of being divided into smaller units e.g. N1 into 100k, 50k,
25k etc.
e. Cognisability: The material with which money is made must be easily recognized by sight
or touch.
f. Durability: Should be storable and last long without losing its value over a period of time.
Animals, perishable commodities are not good money materials since they are not
durable.
g. Stability: Must be stable in value because it has to serve as a store of value.

FUNCTIONS OF MONEY
These can be broadly divided into four:
a. Primary functions
b. Secondary functions
c. Contingent functions
d. Other functions

Primary Functions
1. Medium of exchange: Money came into use to remove the inconveniences of barter as
money has separated the act of purchase from sale. People exchange goods and services
through the medium of money. Money acts as a medium of exchange or as a medium of
payment. Money by itself has no utility. It is only an intermediary.
2. Unit of value/account: The primary function of money is to act as a unit of value. Monetary
unit expresses the values of goods and services in terms of price. Money is the common
denominator which determines the rate of exchange between goods and services which are
priced in terms of the monetary unit. There can be no pricing process without a measure of
value. Money as a unit of account helps in calculations of economic importance such as the
estimation of the costs and revenues of a business.

Secondary Functions
1. Standard of deferred payment: Deferred payments are payments which are made
sometimes in the future. Debts are usually expressed in terms of the money of account. Loans
are taken and repaid in terms of money. The use of money as the standard of deferred
payment immensely simplifies borrowing and lending operations because money generally
maintains a constant value through time. Thus, money facilitates the formation of capital
markets and the work of financial intermediaries like Stock Exchange, Investment Trust and
Banks. Money is the link which connects the values of today with the future.
2. Store of value/wealth: In order to be a medium of exchange, money must hold its value over
time; that is, it must be a store of value. If money cannot be stored for some period of time
and still remain valuable in exchange, it would not solve the double coincidence of wants
problem and therefore would not be adopted as a medium of exchange
3. Transfer of value: Since money is a generally acceptable means of payment and also acts as
a store of value, it follows that it enhances/facilitates transfer of value from person to person
and place to place.

Contingent Functions
Money also performs some contingent/accidental functions which are:
1. Most liquid of all liquid assets: Individuals/firms may decide to hold wealth in various
forms. Whatever the form, they must ultimately be convertible to cash.

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2. Basis of the credit system: Business transactions are either in cash or credit. Credit
economizes the use of money and money is at the back of all credit. A bank cannot create
credit without having sufficient money in reserve.
3. Measurement of National Income.
4. Equalizer of marginal utilities and productivities. MUx=Px. MUx/Px=MUy/Py.
5. Distribution of national income: Wages, rents and profits are paid in money.

Other Functions
1. Helpful in decision making: Money is a means of store of value and a consumer meets his or
her requirements on the basis of money held by him or her e.g. you can sell your land to
educate your children.
2. Basis of adjustment: Adjustment between money and capital markets is done through money.
Same for foreign exchange and international payments.

TYPES OF MONEY
a. Commodity money - This is money whose value comes from the commodity of which it is
made. Commodity money consists of objects that have value in themselves as well as value in
their use as money.
b. Fiat money: Fiat money gets its value from a government order (i.e., fiat). That means, the
government declares fiat money to be legal tender, which requires all people and firms within
the country to accept it as a means of payment. If they fail to do so, they may be fined or even
put in prison. Unlike commodity money, fiat money is not backed by any physical
commodity. Most modern economies are based on a fiat money system. Examples of fiat
money include coins and bills.
c. Fiduciary money: Fiduciary money depends for its value on the confidence that it will be
generally accepted as a medium of exchange. Unlike fiat money, it is not declared legal tender
by the government, which means people are not required by law to accept it as a means of
payment. Instead, the issuer of fiduciary money promises to exchange it back for a
commodity or fiat money if requested by the bearer. As long as people are confident that this
promise will not be broken, they can use fiduciary money just like regular fiat or commodity
money. Examples of fiduciary money include cheques, banknotes, or drafts.
d. Commercial Bank Money: Commercial bank money can be described as claims against
financial institutions that can be used to purchase goods or services. It represents the portion
of a currency that is made of debt generated by commercial banks. More specifically,
commercial bank money is created through what we call fractional reserve
banking. Fractional reserve banking describes a process where commercial banks give out
loans worth more than the value of the actual currency they hold. At this point just note that in
essence, commercial bank money is debt generated by commercial banks that can be
exchanged for “real” money or to buy goods and services.

DEFECTS OF MONEY
Money is a useful servant but misbehaves when it tries to act like a master due to a number of defects
inherent in it. These are divided into two:

a. Economic defects
b. Non-economic defects

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Economic Defects
1. Instability in the value of money: Value of money does not remain stable over time due to
inflation or deflation. Large changes in the value of money are disastrous and even moderate
changes have certain disadvantages. Instability in the value of money adversely affects
consumers, producers and other sections of the society.
2. Unequal distribution of wealth and income: changes in the value of money lead to unequal
distribution of wealth and income. Inflation or deflation leads to redistribution of wealth and
income between social and industrial classes on the one hand and different people in the same
classes on the other. These changes widen the difference between the rich and poor and lead
to class conflict.
3. Growth of monopolies: Too much money leads to concentration of capital in the hands of a
few capitalists which may lead to the growth of monopolies that exploit both consumers and
workers.
4. Wastage of Resources: Bank credit may be used for productive and unproductive purposes. If
much credit is used for production, it leads to over capitalization and over production and
consequently to wastage of resources. Similarly, liberal credit given for unproductive uses
lead to wastage of resources.
5. Black money: money, being the store of value, loves people to hoard it. The tendency to
hoard money and become rich is the root cause of the evil of black money. This leads to the
creation of a parallel economy within the country which encourages conspicuous
consumption, black marketing, speculation etc.

Non-Economic Defects
1. Political Instability: Over-issue of money leading to hyper- inflation results in political
instability and downfall of governments e.g. many Latin American countries.
2. Tendency to exploit: people who want to amass money and wealth adopt under hand methods
and have tendency to exploit others. Even nations are not far behind in this. According to
Davenport “money has enabled strong nations to destroy backward communities to win them
on their side with the help of financial aid”.
3. Moral bankruptcy: the bible says “the love of money is the root of all evils”. The institution of
money has brought down the moral, social and political fibre of the country. It leads to
corruption, turpitude, political bankruptcy and artificiality in religion based on materialism.

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EVOLUTION AND STRUCTURE OF NIGERIAN BANKING & NON-BANKING

FINANCIAL INSTITUTIONS

Origin of Banking

The word ‘bank’ is used in the sense of a commercial bank. It is of Germanic origin although some
persons trace its origin to the French word ‘Banqui’ or the Italian word ‘Banca’ which means a bench
for keeping, lending and exchanging of money or coins in the market place by money lenders and
changers.

There was no such word as ‘banking’ before 1640, although the practice of safe-keeping and savings
flourished in the temple of Babylon as early as 2000 B.C. Chanakya in his Arthashastra written in
about 300 B.C. mentioned about the existence of powerful guilds of merchant bankers who received
deposits, and advanced loans and issued hundis (letters of transfer). The Jain scriptures mention the
names of two bankers who built the famous Dilware Temples of Mount Abu during 1197 and 1247
A.D. The Romans, great builders, and administrators in their own right took banking out of the
temples and formalized it within distinct buildings. During this time, moneylenders still profited,
as loan sharks do today, but most legitimate commerce—and almost all governmental spending—
involved the use of an institutional bank.

Julius Caesar, in one of the edicts changing Roman law after his takeover, gives the first example of
allowing bankers to confiscate land in lieu of loan payments. This was a monumental shift of power in
the relationship of creditor and debtor, as landed noblemen were untouchable through most of history,
passing debts off to descendants until either the creditor's or debtor's lineage died out.

The Roman Empire eventually crumbled, but some of its banking institutions lived on in the form of
the papal bankers that emerged in the Holy Roman Empire, and with the Knights Templar during the
Crusades. Small-time moneylenders that competed with the church were often denounced for usury.

Eventually, the various monarchs that reigned over Europe noted the strengths of banking institutions.
As banks existed by the grace, and occasionally explicit charters and contracts, of the ruling
sovereign, the royal powers began to take loans to make up for hard times at the royal treasury, often
on the king's terms. This easy finance led kings into unnecessary extravagances, costly wars, and an
arms race with neighbouring kingdoms that would often lead to crushing debt.

In 1557, Phillip II of Spain managed to burden his kingdom with so much debt (as the result of
several pointless wars) that he caused the world's first national bankruptcy — as well as the world's
second, third and fourth, in rapid succession. This occurred because 40% of the country's gross
national product (GNP) was going toward servicing the debt. The trend of turning a blind eye to the
creditworthiness of big customers continues to haunt banks up into this day and age.

The first bank, called the ‘Bank of Venice’ was established in Venice, Italy in 1157 to finance the
monarch in his wars.

History apart, it was the ‘merchant banker’ who first evolved the system of banking by trading in
commodities than money. Their trading activities required the remittances of money from one place to
another. For this, they issued ‘hundis’ to remit funds. In India, such merchant bankers were known as
‘Seths’.

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The bankers of Lombardy were famous in England but modern banking began with the English
goldsmiths only after 1640. The business of the goldsmith was such that he had to take special
precautions against theft of gold and jewellery. If he seemed to be an honest person, merchants in the
neighbourhood started leaving their bullions, money and ornaments in his care and as evidence for
receiving valuables, he issued a receipt. As this practice spread, the goldsmiths started charging a fee
for rendering these services.

Meanwhile, since gold and silver coins had no marks of the owner, the goldsmiths started lending
them. As the goldsmith was prepared to give the holder of the receipt an equal amount of money on
demand, the goldsmith receipt became like cheques as a medium of exchange and means of payment.
The goldsmith found that on an average, the withdrawal of coins was much less than the deposits with
him and so he started advancing the coins on loan and charging interest. As a safeguard however, he
kept some money in reserve. Thus, the goldsmith/money lender became a banker who started
performing two functions of modern banking i.e. accepting deposits and advancing loans.

What is Banking/What is a Bank?

A standard definition of the word ‘Bank’ that is internationally acceptable is yet to be found.
However, in the lending case-United Dominions Trust Ltd V Kirkwood (1966), a banker was defined
as one who takes money on current account, pays cheques drawn on himself and collects cheques for
his customers. In Roe’s legal charge of 1982, the scope of the earlier court definition was widened
when it was decided that an institution was deemed to be a bank even though it had no business
premises of its own but provided a service at the counter of another bank.

In the Nigerian context, a bank is defined in the banking Act 1969 as amended by the banking
amendment decree of 1970as any person who carries on banking business and this includes a
commercial bank, an acceptance hose, discount house and financial institutions. Banking is defined in
the Act as the business of receiving monies from outside sources as deposits irrespective of the
payment of interest, and the granting of money loans and acceptance of credits or the purchase of
bills and cheques or the purchase and sale of securities for the account of others or the incurring of
the obligation to acquire claims in respect of loans prior to their maturity or the assumption of
guarantees and other warranties for others or the effecting of transfers and clearings and such other
transactions as the commissioner may, on the recommendation of the Central Bank by order
published in the Federal Gazette, designate as banking business.

Banking may be viewed as an international economic activity which provides an array of risky
financial services including taking of financial decisions involving activities such as the acceptance of
money deposits (cash and specie), mobilization, channelization and creation of money and credit,
incurring financial obligations to acquire claims such as guarantees/bonds and providing a debt
mechanism that ensures economic growth in industry and commerce. Thus, the word ‘Bank’ may be
used as a generic term to include all monetary institutions whether licensed under BOFIA or other
specific charter which are authorized to undertake or offer a full range of financial services or
products of which deposit-taking, money lending and debt clearing activities are the most prominent

Banking Systems

There are various types of banking systems operating in different parts of the world. These are:

1. Unit Banking: This is a single entity that operates one office and is neither controlled nor owned
by other banks. Thus, in a unit banking system, all the banks that are not related to one another are
separate organizations. This is most common in the USA
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2. Branch Banking: A system where a single bank carries on its business from many offices in
addition to its head office. That is, a single bank may have many branches throughout a country.
This system is predominant in Nigeria and other former British colonies and in the USA
(alongside the unit banks)
3. Dual Banking: This is a situation whereby there are federal legislated banks existing side by side
with state legislated banks. Also common in the USA
4. Chain Banking: A situation whereby the same individual or organization owns two or more
different banks e.g. defunct ETB and DEVCOM both owned by Dr Mike Adenuga.
5. Correspondent Banking: A system where smaller banks carry deposits with larger banks in
exchange for the performance of various services e.g. MFBs and DMBs
6. Group Banking: A type of multiple office banking consisting of two or more banks under the
control of a holding company which itself may or may not be a bank. The term ‘Bank Holding
company’ is based on 25% ownership or control of two or more banks. The parent company
controls and manages the operating banks under the group but each bank continues to keep its
separate entity or name. This is common in the USA
7. Mixed Banking: A system in which the commercial banks advance both short term and long-term
loans to commerce and industry. Unlike in England where commercial banks only give short term
loans to commerce and industry, banks in the other European countries like Germany, the
Netherlands, Hungary and Belgium operate the mixed banking system whereby the commercial
banks lend money to meet short term and long-term requirements of industry and commerce.
Mixed banks perform the usual banking functions and also provide industrial finance.
8. Universal Banking: refers to the combination of deposit taking, making of advances and conduct
of stock exchange business all under the same roof. This continental European style universal or
comprehensive banking has its home in Germany.

Banking in Nigeria

The Nigerian banking system has undergone radical changes since independence. Banking in Nigeria
developed from an industry, which of the time of independence in 1960 was essentially dominated by
a small number of foreign banks into one in which the public sector ownership of banks predominated
in the 1970s and 1980s; and in which the Nigerian private investors have played an increasingly
important role since the mid-1980s

The different licensed banks in Nigeria fall into different generations and these generations fall into
the four phases of bank licensing viz.:

(i) First generation – Banks licensed before 1960

(ii) Second generation – Banks licensed between 1960 and 1980
(iii) Third generation – Banks licensed between 1980 and 1991
(iv) Fourth generation – Banks licensed from 1998 to date

Commercial banking activities started in Nigeria in 1892 with the establishment of the African
Banking corporation, which was saddled with the responsibility of distributing Bank of England notes
for the British treasury. Three of the largest banks currently operating in Nigeria had their origin in
the colonial period. These banks were set up to provide banking services for the British commercial
interest and colonial administration in West Africa. Indeed, when the West African Currency Board
was formed in 1912, the then Bank of British West Africa became the agent of the currency board.

For a considerable length of time, the foreign banks dominated the financial sector of the Nigerian
economy and their domination provoked resentment which led to the governments securing greater

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local control over the financial system and thereby improving access to banking services by the
indigenous banking public

Types of Banking Institutions in Nigeria

1. The Central Bank of Nigeria (CBN)

2. Deposit money banks/Commercial Banks
3. Merchant Banks
4. Microfinance Banks
5. Development Banks
(a) Bank of Industry
(b) Bank of Agriculture
(c) NEXIM
(d) FMBN etc.

I. The CBN – Origin and Structure

The CBN was established by the CBN Act 1958 (amended in 1991, 1993, 1997, 1998 and 1999 but
re-enacted in 2007) to take over the functions of the defunct West African Currency Board. Under
the enabling Act, the policy and general administration of the affairs and business of the bank are
the responsibility of the board of directors made up of the governor of the CBN (as chairman),the
four (4) deputy governors, Permanent Secretary of the Federal Ministry of Finance, five directors
and the accountant-general of the federation. The board is assisted by the departmental directors
who are career employees of the bank.

Objectives of the CBN (S. 2, CBN Act 2007)

The principal objectives of the bank as stipulated in the enabling Act are as follows:
1. Issuance of legal tender currency (notes and coins) in Nigeria
2. Maintenance of Nigeria’s external reserves to safeguard the international value of the legal
tender currency
3. Ensuring monetary and price stability
4. Acting as banker and financial and economic adviser to the federal government
5. Promoting a sound financial system in Nigeria

Functions of CBN

To achieve its objectives, the CBN undertakes a number of functions which can be categorized into
three viz.

(a) Traditional functions

(b) Regulatory functions
(c) Developmental functions

a. Traditional Functions
1. Issuing legal tender
2. Acting as banker and financial adviser to the federal government
3. Acting as banker to other banks and financial institutions e.g. acting as a lender of last
resort (bail out of banks)
4. Managing the account and debt of the country
5. The supervision and examination of banks

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b. Regulatory functions

These regulatory functions are mainly directed at the objectives of promoting and maintaining
the monetary as well as price stability in the economy. To perform this regulatory function,
CBN formulates policies to control the amount of money in circulation, control other banks
and major players in the financial market, control rates of banks credits and therefore the
supply of money in the economy. Instruments used by CBN to achieve these functions
include:

 Open market operations

 Rediscount rate
 Special deposits
 Moral suasion

c. Developmental Functions (S. 31 CBN Act 2007)

(i) Promotion of the growth of the financial market

(ii) Assistance to development finance institutions and other institutions like the BOI,
BOA, FMBN, NDIC, NEXIM and SEC
(iii) Promotion of special scheme and funds to enhance economic development.

II. DEPOSIT MONEY BANKS/COMMERCIAL BANKS

These are resident depository corporations and quasi-corporations which have liabilities in the form of
deposits payable on demand, transferable by cheque or otherwise usable for making payments. The
BOFIA (1991) as amended defines a commercial bank as any bank whose business includes the
acceptance of deposit withdrawable by cheque. This definition is narrow in scope. A commercial bank
may be viewed as a joint stock, private or public enterprise licensed to undertake retail financial
services, especially banking services. Although, commercial banks have a broad deposit base, they
provide short term credits to their customers because their deposit base consists mainly of demand
deposits withdrawable by cheque without notice. In January 2001, the universal banking system took
off. The frontiers of the banking industry were expanded as banks were allowed to engage in any or a
combination of money market, capital and or insurance marketing services. New and uniform licenses
were issued. Banks were required to comply with the regulations/provisions in their preferred areas of
operations. However, the universal banking system was discontinued in Nigeria in 2009.

Functions of Commercial Bank

1. Acceptance of Deposits: This is the oldest function of a bank. Banks accept three kinds of
deposits:
a. Savings deposit – Deposit from small savers and on which the bank pays small interest.
b. Current account – usually owned by businesses. Deposits in this type of account do not
usually attract interest but the bank charges a nominal fee for services rendered. Deposits in
current accounts are withdrawable on demand and without notice.
c. Fixed or time deposit – from savers who do not need money for a stipulated period of time.
The bank pays a higher rate of interest on fixed deposits but also imposes stiff penalties
withdrawing the deposit before maturity.
2. Advancing loans: A bank lends a certain percentage of the cash lying in deposits to its
customers and charges a higher interest rate than it pays on such deposits. The bank advances
loans in the following ways:
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a. Term loans – short term, medium term and long-term loans.

b. Overdraft – permission granted credit worthy customers to draw above the deposit amount in
their current accounts in return for the payment of interest.
c. Bills discounting – this involves making money available to the holder of a bill of exchange
before the maturity of such bill. The amount provided is usually less than the face value of the
bill
3. Credit creation: credit is created when a bank accepts deposits and advances loans after meeting
the monetary authority’s statutory reserves and maintaining liquidity that guarantees reasonable
profitability.
4. Financing foreign trade: This involves accepting foreign bills of exchange and collecting them
from foreign banks on behalf of the bank’s customers. It also transacts foreign exchange
business and buys and sells foreign currencies.
5. Agency services: A bank acts as an agent of the customer in collecting and paying cheques,
bills of exchange, drafts, dividends etc. It also buys and sells shares and securities and act as
trustee and executor of the property and will of its customers.
6. Miscellaneous services: These include:
a. Custodian of valuable items (safe custody)
b. Issuance of letters of credits and acting as referee to its clients
c. Underwriting shares and debentures of companies
d. Issuance of various credit instruments e.g. cheques, drafts, Traveller’s Cheques.
e. Corporate social responsibility

III. MERCHANT BANKS

In modern terms, a merchant bank is a firm or financial institution that invests equity capital directly
in businesses and often provides those businesses with advisory services. A merchant bank offers the
same services as an investment bank. However, it typically services smaller clients and makes direct
equity investments in them. Generally, merchant banks are designed to provide medium to long-term
finances to the economy. The Banking Amendment Act 1979, defined a merchant bank as any person
in Nigeria, who is engaged in wholesale, banking, medium and long-term financing, equipment
leasing, debt factoring, investment management, issue and acceptance of bills and management of unit
Trusts.

Merchant banks are usually referred to as wholesale bankers for the following reasons:
i. They accept deposits in large amounts.
ii. They concentrate on corporate customers and high net-worth individuals.
iii. They have very few branches and mainly in urban towns.
iv. Their lending activities are usually on large scale and with medium to long term duration.
v. They render services of specialized nature to special customers mainly in international
banking and finance areas.

History of Merchant Banks

The history of merchant banks can be traced back to Italy in the late Medieval times as well as in
France in the 17th and 18th centuries. Merchant banks began operating as organized money
markets consisting of merchants financing the transactions of other merchants. French merchant,
Marchand Banquer invested all his profits by integrating the banking business into his merchant
activities and became a merchant banker. In the United Kingdom, merchant banking started in the
early 19th century. The oldest merchant bank in the United Kingdom was Barings Bank, which was
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established by a German-originated family of bankers and merchants. It was founded in 1762 and was
the second oldest merchant bank in the world after Berenberg Bank. The bank was, at one time,
referred to as the sixth great European power after Germany, Russia, United Kingdom, Austria, and
France after it helped finance the US government during the 1812 War.

The growth of trade and industries in the 19th century led to the emergence of merchant banks in the
United States. The first merchant banks in the United States were JP Morgan & Co and Citi Bank.
The industry was mainly dominated by German-Jewish immigrant bankers and Yankee houses with
close ties to expatriate Americans who settled in London as merchant bankers. However, with the
growth of the financial world, corporations overshadowed family-owned businesses in the banking
business. The corporations included merchant banking as one of their areas of interest, a characteristic
that banks hold until today.

Functions of Merchant Banks

The functions of merchant banks may be grouped into five as follows:

1. Portfolio Management Function - Merchant banks do undertake to manage the portfolio of

investments of some investors at a fee for such services.
2. Banking Function- The Banking function includes:
i. Mobilization of deposits from both the private and public sectors of the economy.
ii. Granting of loans/advances to individuals, corporate bodies and the government.
iii. Equipment leasing. This involves the purchasing and leasing of equipment for rental
fees to the bank.
iv. Loan Syndication (Consortium lending). Loan syndication involves the coming
together of banks or group of banks to provide credit to a customer. Syndication
arises if the project to be funded is risky for a single bank, amount involved is
enormous, there is need for loan portfolio diversification and the amount required
exceeds the legal lending limit of one bank.
3. Corporate Finance Services - The corporate services include acting as issuing house to
issuers, assisting in private placement, stockbrokerage services, investment and advisory
services.
4. Treasury Services - The merchant banks do invest in money market instruments such
Treasury Bills, Treasury Certificates, etc. They also issue short-term instruments such as
certificates of deposits commercial papers etc.
5. Operation's Services - This includes the remittance and receipt of funds for their
customers at both local and international levels. Merchant banks also open letters of
credit and accept bills on behalf of their customers in favour of foreign creditors and
issued by the creditors respectively.

Commercial and Merchant Banks Compared

FEATURE MERCHANT BANKS COMMERCIAL BANKS

Type of Wholesale Banking: Mobilize deposits and lend Retail banking: mobilize deposits and lend
Banking System in large amounts mainly to institutional in both small and large amounts to
investors and firms Individuals and firms.

Account type Deal with a relatively small number of large Deal with a relatively large
accounts. number of small accounts.

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Deposits Usually fixed and interest bearing. May be fixed or on demand, with or
without interest.

Loans Less of overdraft type, more of term loans on More of overdraft type or on short-term
long term basis basis

Cash reserves Less need to be concerned about liquidity Greater need for cash and liquidity - little
because of ‘matching principle application. application of ‘matching’ principle, as it
relies more on law of large numbers.

Branch Less need as concentration is on industrial/ Greater need as presence

Networking financial centres. is needed everywhere.
Customers Special and concentrated. Of various types and widespread.

Services: Of specialized nature to special customers, Of more varied nature to different types
mainly in the international banking and finance of customers mainly in the domestic
areas. banking areas
General Relatively more flexible and dynamic. Relatively more conservative and less
operation dynamic.

Microfinance Banks

Microfinance is the provision of financial services to low income clients including consumers and the
self-employed, who traditionally lack access to banking and related services. More broadly, it is a
movement whose objective is “a world in which as many poor and near-poor households as possible
have permanent access to an appropriate range of high-quality financial services including not just
credit but also savings, insurance and funds transfers.”

Microfinance policy was introduced in Nigeria in 2005 in exercise of CBN’s power contained in
Section 528(1)(b) of the CBN Act of 1991 (as amended) and in pursuance of the provisions of
sections 56-60(a) of the BOFIA 25of 1991 (as amended). The policy which recognized the then
existing informal institutions and brought them within the supervisory purview of the CBN was
revised in 2011

Objectives of MFBs

1. Make financial services accessible to a large segment of the potentially productive Nigerian
population who otherwise have little or no access to financial services
2. Promote synergy and mainstreaming of the informal sub-sector into the national financial
system
3. Enhance service delivery by microfinance institutions to micro, small and medium
entrepreneurs
4. Serve as a vehicle for rural transformation
5. Promote linkage programme between universal/development banks, specialized institutions
and the microfinance banks
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 BFN 102 INTRODUCTION TO FINANCE II

Categories of MFBs

There are three categories of microfinance banks. These are:

1. Unit MFB- community based banks that can have only one business office anywhere within
the local government area in which they are registered. They are expected to have
shareholders’ funds unimpaired by losses of N20m (N200m from April 2020)
2. State MFB – authorized to operate in all part of the state or FCT in which they are registered
subject to meeting a prescribed prudential requirements and availability of free funds for
opening branches. Minimum capital or shareholders’ funds unimpaired by losses for this
category is N100m (N1billion from April 2020)
3. National MFB – Authorised to operate in all the states of the country including the FCT and
allowed to open branches all over the country subject to meeting prescribed regulatory
requirements. Minimum paid up capital or shareholders’ funds required is N2billion ( N5
billion from April 2020)

Functions of MFBs

1. Providing diversified, attractive and dependable financial services to the active poor in a
timely and competitive manner
2. Mobilizing savings for intermediation, employment opportunities and increasing the
productivity of the active poor in the country
3. Enhancing organized, systematic and focused participation of the poor in the socio-economic
development and resource allocation process
4. Providing veritable avenues for the administration of government and high net worth
individuals’ micro credit programs on non-recourse basis
5. Rendering payment services such as salary, gratuity, pension administration for the various
tiers of government

Development Finance Institutions

A development finance institution (DFI) or development bank is a financial institution which

includes multilateral development banks, bilateral development banks, microfinance
institutions, community development financial institution and revolving loan funds. These institutions
provide a crucial role in providing credit in the form of higher risk loans, equity positions and risk
guarantee instruments to private sector investments in developing countries. DFIs are usually
majority-owned by national governments and source their capital from national or international
development funds or benefit from government guarantees. This ensures their creditworthiness, which
enables them to raise large amounts of money on international capital markets and provide financing
on very competitive terms. Development Finance Institutions in Nigeria include:

1. Bank of Industry
2. Bank of Agriculture
3. Federal Mortgage Bank of Nigeria
4. Nigerian Export-Import Bank
5. The Infrastructure Bank
6. Development Bank of Nigeria
7. National Economic Reconstruction Fund (NERFUND)

Roles of Development Banks

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 BFN 102 INTRODUCTION TO FINANCE II

i. As an initiator - with a ‘supply-leading’ role (in anticipation of future demand) such

as in technology transfer, strategic industries, environment issues.
ii. As an institution-builder - developing new methodologies and systems in raising
capital and increasing investments through non-traditional areas such as financing
large projects via Build-Operate and Transfer/Lease/Own (BOT, BOL, BOO), bonds,
microfinance, etc.
iii. As a catalyst - taking a lead role in creating new financial packages with
involvement of commercial banks and other financial institutions such as loan
syndication of large projects, guarantee schemes for start-up industry sectors, etc.
iv. As a development advocate - promoting the ‘business of development’ such as job
generation, domestic resource mobilization, countryside development, urban renewal,
etc.
v. As a bank of last resort - providing finance to projects which no other financial
institution will fund, thus promoting new and innovative economic activities, e.g.,
funding for inventors, cooperatives and high-risk investments.

NON-BANK FINANCIAL INSTITUTIONS (NBFIs)

Non-bank financial institutions are defined under S61 of BOFIA (as amended) as anybody,
association or group of persons whether corporate or non-corporate, other than the banks and other
institutions (such as funds established under NPF (NSITF) Act exempted under S51 of BOFIA, which
carries on the business of a discount house, finance company and money broker. The non-bank
financial institutions sub-sector of the financial services industry includes a wide range of
organization operating as regulators, facilitators and investors. In Nigeria, the deregulation of the
economy has given impetus to the growth of non-bank financial institutions and their growth has been
faster than those of commercial banks. The reasons for this phenomenon are:

i. Lower interest rate on capital.

ii. Lower set-up cost.
iii. Reduced legal and regulatory surveillance.

The major distinction between banks and non-bank financial institutions is that the former create
money autonomously on their own, while the latter create credit, which can only be done through
borrowing idle funds from the financial system.

Roles of Non-Bank Financial Institutions (NBFIs)

a. Brokers of Loanable Funds – NBFIs act as intermediaries between the ultimate lenders and
ultimate investors by selling indirect securities to savers and buying primary securities from
investors. Indirect securities are short-term securities for the financial intermediaries while
primary securities are those earning assets which are debts to the borrowers. Thus, NBFIs act
as brokers of loanable funds by turning debts into credits.
b. Reducing Risks – By acting as intermediaries between the lenders and the borrowers of funds,
NBFIs take the risk on themselves and reduce it on the ultimate lender (i.e. the depositor of
funds). Moreover, by holding diversified portfolio of risk assets, they decrease their own risks
as low return on some assets can be offset by higher returns on some others.
c. Mobilising Savings – NBFIs raise funds from the capital market and supply credits to
investors. Expert financial services by them have been attracting larger share of public
savings.
d. Investment of Funds – NBFIs earn profits by investing and by mobilising funds or savings
depending on their nature of operation as well as the laws and regulations guiding them.

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 BFN 102 INTRODUCTION TO FINANCE II

e. Creation of new assets and liabilities.

f. Economy of Scale – A lot of economies of scale is derived through specialisation ion funds
mobilisation and investment. It could be costly and cumbersome for individual savers to lend
their funds to individual borrowers.

Examples of NBFIs include:

(a) Finance companies

(b) Discount houses
(c) Mortgage finance institutions
(d) Bureau de change
(e) Insurance companies
(f) Stockbroking firms
(g) Pension institutions

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 BFN 102 INTRODUCTION TO FINANCE II

EVOLUTION AND STRUCTURE OF FINANCIAL MARKETS IN NIGERIA

The financial system consists of financial intermediaries, financial markets, financial instruments,
rules, conventions and norms that facilitate and regulate the flow of funds through the macro
economy. The financial system is controlled by the government through the central bank which
supervises the activities of financial intermediaries and monitors adherence to government’s monetary
and fiscal policies. The major types of financial intermediaries are the deposit money banks
(commercial banks), merchant banks, development banks, finance institutions, insurance companies,
mortgage institutions etc.

Financial markets are simply the various facilities provided by the financial system for the creation,
custodianship and distribution of financial assets and liabilities. Financial asset can either be money or
a financial security e.g. bond and shares. The financial market consists of individuals, institutions and
instruments which make it possible for the deficit spending unit of an economy to use the surplus
funds of the surplus spending unit. A deficit spender is an individual, business or government whose
expected expenditure exceeds expected income while the surplus spender has income in excess of
expenditure. The market has two major segments, the money market and the capital market.

Functions of Financial Markets

i. Liquidity: Markets help to ensure that buyers and sellers have quick and cheap access to
financial instruments. Agents will have the ability to quickly move in and out a financial
instrument.
ii. Information: Markets will pool and communicate information about the buyers and sellers of
a financial instrument. This is one of the basics of supply and demand.
iii. Risk Sharing: Markets allow individuals to share or pool risk across the entire market. Agents
prefer stability and sharing risk is one way to help increase stability.
iv. Efficient intermediation separates the savings and investment functions such that those who
save need not be those who invest. The separation therefore allows each function to be better
performed.
v. Intermediation encourages savings through the provision in financial markets of various
institutions with a variety of financial securities and plans which differ in risk, yield and
maturity.
vi. Investment is encouraged through a variety of sources of funds with differing maturities,
interest charges and repayments of principal.
vii. The risk of default on loans is reduced through diversifying projects in which borrowed funds
are committed.
viii. Funds are efficiently allocated as funds in the market flow to the most productive uses while
the unprofitable projects are starved of funds.

THE MONEY MARKET

Money markets exist to transfer funds from individuals, corporations, and government units with
short-term excess funds (suppliers of funds) to economic agents who have short-term needs for funds
(users of funds). Specifically, in money markets, short-term debt instruments (those with an original
maturity of one year or less) are issued by economic agents that require short-term funds and are
purchased by economic agents that have excess short-term funds. Once issued, money market
instruments trade in active secondary markets. The need for money markets arises because the
immediate cash needs of individuals, corporations, and governments do not necessarily coincide with
their receipts of cash. For
example, the federal government collects taxes monthly; however, its operating and other expenses
occur daily. Similarly, corporations’ daily patterns of receipts from sales do not necessarily occur with
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 BFN 102 INTRODUCTION TO FINANCE II

the same pattern as their daily expenses (e.g., wages and other disbursements). Because excessive
holdings of cash balances involve a cost in the form of forgone interest, called opportunity cost, those
economic units with excess cash usually keep such balances to the minimum needed to meet their
day-to-day transaction requirements. Consequently, holders of cash invest “excess” cash funds in
financial securities that can be quickly and relatively costless converted back to cash when needed
with little risk of loss of value over the short investment horizon. Money markets are efficient in
performing this service in that they enable large amounts of money to be transferred from suppliers of
funds to users of funds for short periods of time both quickly and at low cost to the transacting parties.
A money market instrument provides an investment opportunity that generates a higher rate of interest
(return) than holding cash (which yields zero interest), but it is also very liquid and (because of its
short maturity) has relatively low default risk.

History of the Nigerian Money Market

The history of the Nigerian Money Market is closely linked to the history of the Central Bank of
Nigeria which dates back to 1959. Prior to the establishment of CBN, commercial banks in Nigeria
had to export their cash surplus to foreign money markets to earn income. The alternative was to hold
large cash balances which yielded no income. On the establishment of the CBN, licensed commercial
banks were required to hold a minimum amount of specified liquid assets as a proportion of their
deposit liabilities. The specified liquid assets included notes, coins, balances at the CBN, balances
with other licensed banks, money at call, treasury bills, treasury certificates, bills of exchange and
rediscountable promissory notes.

Thus, a market for the specified liquid assets was created for licensed banks to invest surplus funds
for short periods so as to earn income and to satisfy liquidity requirements. The market also facilitated
trading in government securities.

The basic functions of the Nigerian money market include:

i. Provision of short tenured liquid financial instruments for public and private investment thus
covering for financial gaps of short duration. Consequently, the market facilitates expansion
of trade, industry and commerce
ii. It facilitates proper implementation of CBN monetary policies. Indeed, without effective, well
developed money market, the practice of indirect monetary management will be difficult.
iii. The market facilitates financial mobility from one sector of the economy to another and also
from the surplus to deficit economic agents within the economy.
iv. By its nature, the money market provides facilities and instruments for financial liquidity and
safety. Accordingly, it encourages savings and therefore, investments
v. The market can also serve as the barometer for interest rate adjustment both for lending and
borrowing. This arises from the level of liquidity, mainly in the banking system.

Participants in the Nigerian Money Market

The major participants in the money market are:

i. Central Bank of Nigeria

ii. Nigeria Deposit Insurance Corporation
iii. Deposit Money Banks (Commercial Banks)
iv. Merchant Banks
v. Discount Houses

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vi. Microfinance Banks

Features of the Money Market

i. The rate of return in the market generally reflects the rate of inflation in the economy.
ii. The market is available to both small and big fund users.
iii. Transaction costs are very low compared to capital market transactions
iv. Return on investment is very low but is usually sufficient to take care of that part of the
investor’s capital that could be lost to inflation.

Money Market Instruments

Money market instruments are the medium through which short-term funds are raised in the market.
The instruments are generally issued in the primary money market and can be discounted or traded for
funds prior to maturity in the secondary money market. The major money market instruments in
Nigeria include:

i. Treasury Bills (TBs) – These are instruments issued by the CBN to raise short-term funds for
the government treasury. The bills have a maturity of 91 days and are usually sold at a
discount. Each bill has a face value of N100 but they are sold in multiples of N1000 as the
minimum unit. The first TBs were raised in April 1960 to raise N8m for the Federal
Government Treasury. The major buyers of TBs are the commercial banks and the CBN.
ii. Treasury Certificates (TCs) – They are medium-term securities of one or two-year tenor
issued by the CBN to raise funds for the Federal Government treasury. The securities are
usually sold to bridge the gap between TB issue and long-term Federal Government Loan
Stock issue. Like treasury bills, TCs are sold at a discount although the discount on TCs is
usually higher than that on TBs because of their longer tenor. The first sets of TCs were
issued in 1968. The major buyers of TCs are the CBN, commercial and merchant banks.
iii. Bankers’ Unit Funds (BUFs)–BUFs were first issued in 1975nto allow commercial banks,
merchant banks and other financial institutions invest their excess funds in Federal
Government Development Loan Stocks. Participation in the scheme is in multiples of
N10,000 and the CBN uses the proceeds to acquire development loan stocks. Participating
institutions can withdraw part or all of their investments on demand provided it is made in
multiples of N10,000. From September 1989, banks stopped buying BUFs due to the liquidity
squeeze prevalent during the period and consequent upon which there was no outstanding
BUF in the market by the end of 1991.
iv. Eligible Development Stocks (EDS) – These are Federal Government Loan Stocks with less
than three years to maturity. Although development loan stocks are capital market
instruments, those with less than three years to maturity are traded in the money market. The
CBN allows banks with holdings of EDS to include the value of such instruments among the
banks’ liquid assets for the purpose of calculating the banks’ statutory liquidity ratios. The
traditional holders of EDS are commercial and merchant banks.
v. Certificates of Deposits (CDs) – CDs come in two variants – the Negotiable Certificates of
Deposit (NCD) and the Non-Negotiable Certificates of Deposits (NNCD). The value on a
Negotiable Certificate of Deposits can be transferred by negotiation whereas the value on a
Non-Negotiable Certificate of Deposit cannot be transferred and so must be held to maturity
and be redeemed by the purchaser. These certificates were first issued in 1975 to enable the
transfer of surplus funds between banks especially from commercial to merchant banks. The
certificates are generally issued in denominations of N50,000 with maturities of three to

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 BFN 102 INTRODUCTION TO FINANCE II

thirty-six months. NCDs can be discounted. The major holders of CDs are the commercial
banks.
vi. Commercial Papers (CPs)– Commercial papers are commercial bills issued by reputable
business houses through issuing houses which are generally banks. Commercial paper is an
unsecured short-term promissory note issued by a corporation to raise short-term cash, often
to finance working capital requirements. Commercial paper is generally held by investors
from the time of issue until maturity. Thus, there is no active secondary market for
commercial paper. Because commercial paper is not actively traded and because it is also
unsecured debt, the credit rating of the issuing company is of particular importance in
determining the marketability of a commercial paper issue. CPs generally have maturities
ranging between 1 and 270 days but the common maturities are 30,60 and 90 days while
interest is normally paid upfront.
vii. Bankers’ Acceptances (BAs) - A banker’s acceptance is a time draft payable to a seller of
goods, with payment guaranteed by a bank. Many banker’s acceptances arise from
international trade transactions and the underlying letters of credit (or time drafts) that are
used to finance trade in goods that have yet to be shipped from a foreign exporter (seller) to a
domestic importer (buyer). Foreign exporters often prefer that banks act as guarantors for
payment before sending goods to domestic importers, particularly when the foreign supplier
has not previously done business with the domestic importer on a regular basis. Because
banker’s acceptances are payable to the bearer at maturity, they can and are traded in
secondary markets. Maturities on banker’s acceptances traded in secondary markets range
from 30 to 270 days. Denominations of banker’s acceptances are determined by the size of
the original transaction (between the domestic importer and the foreign exporter).

Features of Money Market Instruments

i. They are short term in nature i.e. usually less than one-year maturity
ii. Securities are usually cash in nature and where not cash can be traded for cash.
iii. Securities are easily transferable.
iv. Money market instruments can be traded over-the counter (OTC) because the market does not
have a permanent or designated place of business like it happens in the capital market.

THE CAPITAL MARKET

A capital market is the segment of the financial market where long-term funds are raised. The tenor of
the funds is over two years and the major instruments are ordinary shares, preference shares and
bonds/debentures. The process of the transfer of funds is done through instruments, which are
documents (or certificates), showing evidence of investments. The market actually performs the
function of financial intermediation whereby the savings of some members of the society are
harnessed and made available to other members of the society for productive investment. For this
process of financial intermediation to take place, the capital market is categorised into two – the
primary market and the secondary market.

The Primary Market – This is the new issues market as it is concerned with the issue and sale of
new securities. The operators in this market are the issuing houses, stockbrokers, banks, the Central
Bank of Nigeria, corporate bodies and governments. Investors pass on their resources to these
institutions for investment purposes. Such investments can be in the form of stocks and shares. The
Securities and Exchange Commission (SEC) sits at the apex of the primary market in Nigeria,
regulating the issues of public companies and all private companies with foreign participation. In
summary, the primary market caters for:

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 BFN 102 INTRODUCTION TO FINANCE II

i. New issues i.e. when a company not previously quoted on the Exchange issues its securities
for the first time
ii. Issues of a company previously quoted on Exchange which may, in the course of time, place
another issue in order to raise additional funds. This is considered as a new issue.

The Secondary Market – This is the market for the sale and purchase of existing shares and stocks.
The centre of activities in the secondary market is the Stock Exchange which provides a market in
which holders of existing quoted shares wishing to sell such shares can make contact with individuals
and institutions who are interested in buying them. While the primary market is concerned with the
issue of new securities, the secondary market provides facilities for the sale and resale of such
securities. The existence of a secondary market allows companies to enjoy a measure of stability and
continuity as the stock exchange provides facilities which make it unnecessary for companies to fold
up merely because some shareholders have decided to dispose of their shares. The main participants
in the market are the stockbrokers who are the dealing members of the stock exchange. Also operating
in the market are insurance companies and pension fund managers looking for investment avenues for
their funds.

Features of the Capital Market

i. The market is a means of long-term source of investment.

ii. Transaction costs are higher in the capital market than the money market.
iii. Accessibility to the market is limited to governments, multinational corporations and big
companies.
iv. Investors’ rights are protected as regards security of capital.
v. Different segments are created for medium size and big companies as against what obtains in
the money market.

The Nigerian Capital Market

A formal capital market came into existence in Nigeria in 1961 with the establishment of the Lagos
Stock Exchange (LSE). The non-profit organisation was intended to offer an avenue for companies
and government to raise capital, to encourage Nigerians to participate in the nation’s industries and to
encourage savings and investment. The exchange started with 19 securities. Some years after the
establishment of the Lagos Stock Exchange, the government decided to establish branches outside
Lagos. In 1977, the Nigerian Stock Exchange (NSE) took over the activities of the Lagos stock
exchange and branches were opened at Kaduna and Port Harcourt.

Securities and Exchange Commission (SEC)

The SEC which is the apex regulatory institutions of the Nigerian capital market is a federal
government agency established by the Securities and exchange commission Act 71 of 1979 (which
was re-enacted as Decree 29 of 1988). Since inception, SEC has been playing within the capital
market, a role similar to that of the CBN in the money market

Objectives of SEC

1. Investor protection – ensuring that issuers of financial instruments provide investors with
relevant, timely and adequate information about securities and institutions that are subject of
public issues. Furthermore, such protection is pursued to prevent fraudulent practices such as
false claims, deceit, price manipulation and unfair use of disclosed price sensitive information
that could dent public confidence in the securities business.

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 BFN 102 INTRODUCTION TO FINANCE II

2. Capital market development – this involves creating general awareness about the market as
an important source of investment finance and therefore, a catalyst for rapid socio-economic
advancement.

Functions of SEC

a. Determining the price at which securities are to be sold, the amount to be sold as well as the
appropriate time to issue the securities either through offer for sale or offer for subscription
b. Registration of securities proposed for offer for sale or subscription
c. Maintaining surveillance over the securities market to ensure orderly, fair and equitable
dealings in securities
d. Registering stock exchanges or their branches, registrars, securities dealers and other capital
market operators with a view to maintaining proper standards of professionalism in securities
business
e. Protect the integrity of the securities market against any abuse arising from the practice of
insider trading
f. Acting as the regulatory apex organization for the NSE and its branches to which it would
beat liberty to delegate power.
g. Creating the necessary atmosphere for the orderly growth and development of the capital
market
h. Reviewing, approving and regulating business combinations
i. Undertaking such other activities as are necessary or expedient for giving full effect to the
provisions of the Act.

The Nigerian Stock Exchange (NSE)

The NSE started operations in 1961 as the Lagos Stock Exchange which was a non-profit making
organization and as a private company limited by guarantee. Some years after the establishment of the
Lagos Stock Exchange, the government decided to establish branches outside Lagos. In 1977, the
NSE took over the activities of the Lagos Stock Exchange and branches were opened at Kaduna and
Port Harcourt

Functions of NSE

(a) To act as a central meeting place for members to buy and sell existing securities and for
granting quotation to new issues through the provision of new or fresh capital raised through
the market.
(b) To provide machinery through stocks and shares for mobilizing private and public savings
and making these available for productive investment.
(c) To facilitate the purchase and sale of securities, thereby reducing the risk of illiquidity.
(d) To provide opportunities for the continued operation and attraction of foreign capital for
Nigeria’s development.
(e) To facilitate dealings in government securities.
(f) To prescribe requirements for new listings (listing requirements) and to regulate secondary
trading activity and the activity of its dealing members.

Instruments: Instruments traded (media of exchange) on the capital market are:

(a) Debt instruments

(b) Equities (a.k.a. common stock)
(c) Preference shares
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(d) Derivatives

i. DEBT INSTRUMENTS: A debt instrument is used by either companies or governments to

generate funds for capital intensive projects. It can be obtained through the primary or
secondary market. The relationship in this form of instrument is that of borrower-creditor and
thus does not imply ownership of the business of the borrower. The contract is for a specific
duration and interest is paid at specific periods as stated in the contract agreement (trust
deed). The principal sum invested is repaid at the expiration of the contract period. The
interest payable may be fixed or flexible depending on the contract agreement while the
tenure ranges from 3-25 years. Investment in debt instruments is mostly risk-free and
therefore yields lower returns when compared to other instruments traded in the capital
market.

Types of Debt Instruments

(a) Sovereign bond- Federal Government debt instrument

(b) State bond – debt instrument issued by a state government
(c) Municipal bond –issued by a local government
(d) Debenture/industrial loan/corporate bond – issued by a corporate body or company

ii. EQUITY: This instrument is used by companies only and can also be obtained either in the
primary market or secondary market. Investment in this form of business translates to
ownership of the business as the contract stands in perpetuity unless sold to other investors in
the secondary market. The investor therefore possesses certain rights and privileges (e.g. right
to vote and hold position) in the company. The equity holder receives dividends which may or
may not be declared. The risk factor in this type of instrument is high and thus yields a higher
return (when successful)

iii. PREFRENCE SHARES: This instrument is issued by corporate bodies and possesses the
characteristics of equity in the sense that it is added to equity (or common stock) in the
calculation of a company’s authorized and paid up capital. Preference shares can also be
treated as a debt instrument as they do not confer voting rights on their holders and have a
dividend payment that is structured like interest (coupon) paid for bond issues.

Types
(a) Irredeemable and Convertible: Upon maturity of the instrument, the principal sum is
converted to equities even though interest (dividends) had earlier been paid.
(b) Irredeemable and Inconvertible: Here, the holder can only sell his holding in the securities
market as the contract will always be rolled over upon maturity and cannot be converted
to equities
(c) Redeemable: the principal sum is paid at the end of a specified period. In this case, it is
treated strictly as a debt instrument

NOTE: Interest may be cumulative, flexible or fixed depending on the agreement in the trust
deed (contract)

iv. DERIVATIVES: These are instruments that are derived from other securities which are
referred to as underlying assets (i.e. the derivatives are derived from them). The price,
riskiness and functions of the derivatives depend on the underlying assets since whatever
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 BFN 102 INTRODUCTION TO FINANCE II

affects the underlying assets must affect the derivative. The derivative might be an asset,
index or even situation. Derivatives are mostly common in developed economies.

Examples of Derivatives
i. Mortgage Backed Securities
ii. Asset Backed Securities
iii. Futures
iv. Options
v. Swaps
vi. Rights
vii. Exchange Traded Funds or Commodities

The common one in Nigeria is Rights where the holder of an existing security gets the
opportunity (right) to acquire additional quantity to his holding in an allocated ratio.

Features of Capital Market Instruments

a. They are means of long-term sources of investment.

b. Easily marketable since they are traded daily on the stock exchange (If quoted) hence, they
ensure liquidity for the holders at all times.
c. Most capital market instruments (e.g. ordinary shares, unit and investments trusts) have
growth potentials. Their market values are based on public perception of the economic
powers of the issuing companies.
d. They are easily transferrable hence their use as collateral for bank borrowings.

AUTOMATED TRADING SYSTEM

An automated trading system is a computer trading program that automatically submits trade to an
exchange. It is designed to trade stocks, futures and foreign exchange based on a pre-defined set of
rules which determine when to enter a trade, when to exit and how much to invest in it

Advantages of Automated Trading System

1. Minimises Emotions: Automated Trading System minimizes emotions throughout the trading
process. By keeping emotions in check, traders typically have an easier time sticking to the
plan. Since trade orders are executed automatically once the trade rules have been met, traders
will not be able to hesitate or question the trade. In addition to heling traders who are afraid to
“pull the trigger”, automated trading can curb those who are apt to overtrade-buying and
selling at any perceived opportunity
2. Ability to Back-test: Back-testing applies trading rules to historical market data to determine
viability of the idea. When designing a system for automated trading, all rules need to be
absolute, with no room for interpretation (the computer cannot make guesses, it has to be told
exactly what to do). Traders can take these precise sets of rules and test them on historical
data before risking money in live trading. Careful back-testing allows traders to evaluate and
fine-tune a trading idea and to determine the system’s expectancy i.e. the average amount that
a trader can expect to win (or lose) per unit of risk
3. Preserves Discipline: Since the trade rules are established and trade execution is performed
automatically, discipline is preserved even in volatile markets. Automated trading helps
ensure that discipline is maintained because the trading plan will be followed exactly

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 BFN 102 INTRODUCTION TO FINANCE II

4. Improved Order Entry Speed: Since computers respond immediately to changing market
conditions, automated systems are able to generate orders as soon as criteria are met. Markets
can move quickly and it is demoralizing to have a trade reach the profit target or blow past a
stop loss level before the orders can even be entered. An automated trading system prevents
this from happening
5. Diversifies Trading: Automated trading systems permit the user to trade multiple accounts or
various strategies at one time. This has the potential to spread risk over various instruments
while creating a hedge against losing positions. What would be incredibly challenging for a
human to accomplish is efficiently executed by a computer in a matter of milliseconds. The
computer is able to scan for trading opportunities across a range of markets, generate orders
and monitor trades

Disadvantages of Automated Trading Systems

1. Mechanical Failure: If there is a mechanical error e.g. a loss of internet connection, an order
might not be sent to the market especially where the order resides on the computer instead of
the server
2. Monitoring: It is possible for an automated trading system to experience anomalies that could
result in errant orders, missing orders or duplicate orders. If the system is monitored, these
events can be identified and resolved quickly
3. Over-Optimization: Traders who employ back testing techniques can create systems that look
great on paper but perform terribly in a live market. Over-optimization refers to excessive
curve-fitting that produces a trading plan that is unreliable in live trading

The Central Securities Clearing System (CSCS)

CSCS was established in July 1992 as a subsidiary of the Nigerian Stock Exchange as well as the
clearing house of the Nigerian stock market. It commenced business operations on 14 April 1997 with
the aim of improving the efficiency and effectiveness of the clearing arrangement of the Nigerian
capital market in the area of transfer of shares and production of new share certificates for traded
shares. Also, it aimed at improving the processing time for transactions done on the floor of the NSE
which was hitherto done manually. The CSCS was incorporated to implement a computerized Stock
Exchange Management System (SEMS) of share certificates in a Central Securities Depository
(CSD). Transactions are processed and concluded within four days in electronic book entry form.
Dematerialized certificates are recycled to the registrars for scrutiny and retention. CSCS sends
transaction updates to relevant registrars to constantly update the registers of members of listed
companies. Thus, the concept of CSCS provides for an integrated Central Securities Depository
(CSD) clearing (i.e. electronic book entry transfer of shares from seller to buyer) and settlement (i.e.
payment for bought shares) for all stock market transactions.

Functions of CSCS

1. Provision of central depository for all share certificates of quoted securities including new
issues
2. Provision of safe-keeping facilities for securities not quoted on the Nigerian Stock Exchange
3. Functioning as clearing and settlement of stock market transactions
4. Issuing of clearing house numbers and account numbers to stockholders and investors
5. Functioning as a custodian agency for foreign instruments
6. Acting as sub-registry for all quoted securities in conjunction with the registrars of quoted
companies.

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 BFN 102 INTRODUCTION TO FINANCE II

Trade Alert

The NSE/CSCS introduced an investor Protection scheme known as the Trade Alert which involves
the installation of a software to the rear-end of the mainframe computer system of the CSCS, such that
whenever there is a transaction on the account of a subscriber at the CSCS, an SMS massage is
triggered into the GSM number of the investor, detailing sales or purchases made and specifying
volume and price. In the event that the investor did not authorize the transaction, he can summarily
abort the process by placing a call to CSCS/NSE. This protects all subscribers of the product against
unauthorized stock activities on their stock account in CSCS database. Subscribers are regularly
updated of all capital market related activities.

Benefits to the Investor

i. Stops unauthorized trades before they are concluded.

ii. Knowledge of in and out bound transactions on investor’s account.
iii. Reduces chances of fraud on the account of the investor.
iv. Effective control of transactions.
v. Improves confidence in the Stock market

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 BFN 102 INTRODUCTION TO FINANCE II

NEGOTIABLE INSTRUMENTS

A negotiable instrument is a chose in action, the full and legal title to which is transferable by mere
delivery of the instrument (with the transferor’s endorsement where it is an order bill) with the result
that complete ownership of the instrument with all the property it represents passes free from equities
to the transferee provided the latter takes the instrument in good faith and for value.

Basic Attributes of Negotiable Instruments

i. The title in a negotiable instrument may be transferred by mere delivery together with
endorsement of the transferor, where it is an order bill.
ii. The transferee can sue on the instrument in his own name.
iii. A bonafide transferee of a negotiable instrument takes it free from equities if he has given
valuable consideration for it. By equities is meant any defects in the transferor’s title.

It is not all choses in action that enjoy the characteristics of negotiability. Therefore, it is not all of
them that are negotiable instruments. Examples of negotiable instruments are:

i. Bill of exchange
ii. Cheques
iii. Promissory notes
iv. Bearer bonds
v. Bearer debentures
vi. Share warrants; and
vii. Dividend warrants.

Postal orders, money orders, share certificates, bills of lading and debentures other than bearer bonds
are however not negotiable instruments because they are not transferable by mere delivery, so the
aspect of negotiability is missing in them. The negotiable instruments to which the Bills of Exchange
Act applies are:

i. Bill of Exchange
ii. Promissory notes
iii. Cheques
iv. Banker’s draft.

Bills of Exchange

Bills of exchange and cheques are credit instruments used in the discharge of both internal and
external debts. Bills of exchange as used internationally, may be either bank bills or trade bills. Bank
bills have greater security and are more attractive for international trade payments. Trade bills are
those drawn by one company or individual upon another. They do not bear the acceptance of a bank.

In Nigeria, bills of exchange and cheques are handled by banks. Since these payments systems cannot
operate without banks, they may be considered as special services offered by banks.

According to the Bill of Exchange Act 1882 (England) and 1990 (Nigeria), a Bill of Exchange is “An
unconditional order in writing addressed by one person to another, signed by the person giving it,
requiring the person to whom it is addressed to pay on demand, or at a fixed or determinable future
time, a sum certain in money to or to the order of a specified person or to bearer”
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 BFN 102 INTRODUCTION TO FINANCE II

Essential Characteristics of a Bill of Exchange

1. It must be an order.
2. It must be an unconditional order.
3. It must be in writing – type written or in ink, written on paper or any other material.
4. It must be addressed by one person to another
5. It must be signed by the person giving it
6. It must require the person to whom it is addressed to pay.
7. It must be payable on demand or at a fixed or determinable future time.
8. The amount payable must be a sum certain in money
9. The payment must be to or to the order of a specified person or bearer
To satisfy the valuable consideration requirements in the law of contract, bills of exchange
usually contain the words value received after the amount in words.
Parties to a Bill

The Drawer: This is the person making the order to pay. Such a person must sign the bill personally
or through some authorized person and he is deemed to undertake to pay the sum stated on the bill to
the payee personally if the drawee refuses to do so.

The Drawee: This is the person on whom the bill is drawn i.e., the person who is to pay. He must be
specifically named or indicated. If there is more than one drawee, their liability will be joint and
several. Where the drawee is unknown, lacks capacity or is fictitious, the bill will become a
promissory note deemed to have been made by the drawer.

Acceptor: The drawee upon of a bill assumes the obligation of an acceptor thus giving additional
security to the payee. Acceptance is usually done by writing the word “accepted” together with the
signature of the acceptor.

Payee: This is the beneficiary of the bill. His name must be stated if the bill is an order bill, but a bill
may be payable to bearer in which case there is no need to state the name of the payee.

Others who may be parties to a bill include: an endorser who is a payee who countersigns or endorses
a bill in such a way as to render it in a negotiable or deliverable state to another person and an
endorsee who is the person to whom the bill is endorsed.

Type of Bills
Broadly speaking, there are 2 types:
a. Inland – Drawn and payable within Nigeria and upon persons living therein.
b. Foreign – Drawn or payable outside Nigeria or drawn within Nigeria upon persons
outside Nigeria.
Either types of bills may also be a bearer, demand or order bill.
Bearer bill: Bill expressed payable to bearer or in which the last endorsement is in blank or
payable to a fictitious or non-existing person.
Demand bill: It is a bill payable on demand. A demand bill does not have a due date or time
specifically mentioned and hence, payment can be made when the bill is presented
Order bill: it is a bill payable to a given person, or as such person shall direct by an
endorsement, he may make on it. Until the bill is so endorsed, no other person shall take an
action on it
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 BFN 102 INTRODUCTION TO FINANCE II

Types of Holders of a Bill

Holder for value - A holder is the payee or endorsee who is in possession of a bill. A holder for
value is a holder of a bill who has given value for the bill or holder of a bill for which value has been
given by some previous holder. A holder is regarded as a holder for value as regards all parties to the
bill prior to him including his endorser, but where the value was supplied by someone else, he will be
a holder for value as regards all parties to the bill prior to that person, but not as regards an endorser to
whom he has supplied no value.

Holder in Due Course - A holder in due course is defined as a holder who has taken a bill, complete
and regular on the face of it under the following conditions:

a. That he became the holder of it before it was overdue and without notice that it has been
previously dishonoured, if such was the case, or
b. That he took the bill in good faith for value and at the time the bill was negotiated to him he
had no notice of any defect in the title of the person who negotiated it to him.

A holder in due course is therefore a person to whom a bill is negotiated and whom has taken the bill:

i. complete and regular on the face of it.

ii. before it was overdue
iii. without notice of dishonour (if any):
iv. in good faith and for value without notice of any defect in the title of its transferor at the
time the bill was negotiated.

A bill is said to be complete and regular on its face when no apparent irregularity either in the
endorsement of the bill can be found. A bill payable on demand is deemed to be overdue if it appears
to have been in circulation for an unreasonable length of time, which is a question of fact. But if the
bill is payable at a fixed date or at sight, it does not become overdue until the last of the statutory three
days of grace.

Good faith in this connection means honesty while value includes past consideration but it must have
been personally given by the person claiming to be a holder in due course. Notice here means actual
notice, though not necessarily formal notice, and will include a deliberate disregard of the means of
obtaining knowledge. The title of a person who negotiates a bill is defective if the bill or its
acceptance is obtained by fraud, duress, force and fear or by other unlawful means for an illegal
consideration, or when the bill is negotiated in breach of faith.

A transferee from a holder in due course has all the rights of a holder in due course as regards the
acceptor and all the parties to the bill prior to the holder in due course, whether or not he supplies
value for the bill, provided he is not himself a party to any fraud or illegality affecting the bill.

Duties of a Holder

1. To present the bill for acceptance.

2. To present bill not payable on demand for payment, otherwise the drawer and endorsers will
be discharged.
3. To give the drawer and each endorser notice of its dishonour by non-acceptance or by non-
payment as the case may be. Failure to give such notice will discharge them from liability on
the bill.

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 BFN 102 INTRODUCTION TO FINANCE II

4. To note and protest the dishonour of a foreign bill either by non-acceptance or by non-
payment.

Promissory Notes

Section 85 of the Act defines a promissory note as “an unconditional promise in writing, made by one
person to another, signed by the maker agreeing to pay on demand or at a fixed determinable future
time a sum certain in money to, or to the order of a specified person or bearer”.

A promissory note is also a bill of exchange and thus any expression in the definition above which are
found in the definition of a bill of exchange has the same meaning in both contexts.

he main distinction however between a bill of exchange and a promissory note is that it is an
unconditional promise while a bill of exchange is an unconditional order. Furthermore, the parties to a
bill of exchange are three i.e. the drawer, the drawee and the payee but in the case of a promissory
note, there are only two parties namely and the promisor and the promisee.

The maker of a promissory note i.e. the promisor occupies the capacity of both the drawer and the
acceptor in a bill. A promissory note does not therefore need acceptance. However, a bill of exchange
is treated as a promissory note when the drawee is non-existent or fictitious.

A promissory note is also negotiable either by mere delivery or delivery coupled with endorsement as
in the case of a bill of exchange. But unlike an endorsee or subsequent transferee of a bill who may
not be a holder in due course if the bill is overdue as at the time of negotiation, an endorsee of a
promissory note will be regarded as a holder in due course notwithstanding that a reasonable time has
elapsed between the negotiation and presentation for payment.

A foreign bill needs noting and protesting in the event of dishonour by non-acceptance or non-
payment but local note does not need such protesting. Notes cannot be issued in set while bills may be
drawn in sets. Apart from these distinctions, all other provisions of the Act relating to a bill of
exchange are also applicable to promissory notes.

Cheques

Section 73 of the Act defines a cheque as “a bill of exchange drawn on a banker and payable on
demand”. A cheque is a bill of exchange. Therefore, all the features of a Bill of Exchange are
applicable to it.

However, there are certain distinctions between cheques and other bills of exchange which include:

1. A bill of exchange may be drawn on anybody while cheques can only be drawn on a banker.
2. A bill of exchange may be payable either at a fixed or determinable future time or on demand
but a cheque can only be paid on demand.
3. The rules relating to acceptance are not applicable to a cheque, as cheques do not require
acceptance. It thus follows that while acceptance makes the drawer/acceptor liable to the
payee or endorsee of a bill; a banker cannot be liable to the payee of a cheque for the tort of
conversion if the banker negligently pays or collects the cheque for someone else.
4. Failure to present a bill for payment within a reasonable time or to give a drawer notice of its
dishonour may discharge a drawer of a bill. A drawer of a cheque will however not be
discharged from liability because of such failure on the part of the payee or his order.
However, in practice, a cheque becomes stale six months after the date it is issued.

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 BFN 102 INTRODUCTION TO FINANCE II

5. Bill of exchange will be overdue if, in case of a bill payable on demand, it has been in
circulation for more than a reasonable length of time, and in the case of a bill payable at a
future date, after the statutory three days of grace. In the case of a cheque, the bank will not
pay the proceeds of a cheque which has become stale.
6. The provision of the Bill of Exchange Act relating to crossings apply to cheques but not to
other bills of exchange.
7. Bankers are protected against forged or unauthorized endorsements provided they have paid
the proceeds of cheques in good faith in the ordinary course of business and without
negligence whereas other drawers are not so protected.

Protection of the Banker

A banker who pays the wrong person cannot debit his customer’s account and he will by so doing be
liable “in conversion to” the customer or the true owner of the cheque. So also will a bank be liable to
the true owner of a cheque if it collects the amount represented by the cheque for a wrong person. The
Bills of Exchange Act however protects the banker, in certain circumstances.

Paying Banker

The paying banker is the actual drawee of a cheque, who shall either pay the proceeds directly to the
payee or his order or from whom the proceeds of the cheque is collected by the collecting bank.
Paying banks are protected as follows:

Section 60 of the Act provides that a paying banker who pays a cheque drawn on it in good faith and
in ordinary course of business is not prejudice by the fact that an endorsement was forged or without
authority. In order to be protected under this section the banker must pay the cheque:

i. in the ordinary course of business

ii. in good faith.

“Ordinary course of business” means that the money must be paid during the normal working hours of
the bank. It has however been held in a decided case that a cheque paid five minutes after closing time
was paid in the ordinary course of business as that was a reasonable period after the banker’s
advertised closing time. To act “in good faith” means to do so honestly and without knowledge. So, if
the endorsement on a cheque is forged and the banker without knowledge whether actual or
constructive pays money on the cheque, he cannot be liable to the drawer or the holder thereof.

Secondly, S.82 protects a paying bank that has paid a crossed cheque to another bank in accordance
with the crossing on the cheque in good faith and without negligence. Such a paying bank is
discharged from any liability with respect to that cheque. All that the banker needs to have done is to
comply with the crossings on the cheque.

Collecting Bank

A collecting bank is the payee’s bank in the case of a crossed cheque or in any other circumstances
when the payee or holder prefers to collects the proceeds of a cheque through his banker. A collecting
bank is also protected by S.2 of the Bill of Exchange Act 1964 (now 1990) where it is provided that if
he collects payment for a customer on a bill to which the customer has no title and credits the
customer’s account, the bank is not liable. The effect of the protection is that the collecting bank will
neither be liable for conversion to the payee or to the true holder of the cheque.

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