ROLE OF FINANCIAL INSTITUTIONS IN KENYA

WHAT ARE ROLES OF FINANCIAL INSTITUTIONS IN KENYA IN THE FINANANCIAL MARKET

    A financial institution is a company other than a bank which carries on or proposes to carry on financial business and includes any other company which minister may be by notice in the Gazette, declared to be a financial institution. It is possible for a company to start as a financial institution and then later apply for this status. If the minister accepts, then it becomes a financial institution. Financial institution accepts money from the public as deposits.

A perfect market is one that fulfills the following conditions:

•  Have a large number of savers and investors.
• The saver and investors are rational and have the capacity to transact.
•  All operators in the market are well informed and information is freely available to all of them
•  There are no transaction costs.
• The financial assets are infinitely divisible.
•  The participants in the markets have homogeneous expectations such as maximizing returns.
•  There are no taxes.

   These types of markets does not exist may be in theories only, thus markets are imperfect. Information is not accessible freely by all participants in the financial market and securities cannot be broken indefinitely.

   Financial institutions are needed to resolve the problems of imperfect markets. They receive requests from surplus and deficit units on what securities are to be sold. They use this requests to match up buyers and sellers of securities in this markets. However financial institutions in order to provide for divisibility, they may at times un-bundle the securities by spreading them across several investors until the entire amount is sold. Without financial institutions, transaction costs and information cost would be expensive and prohibitive.

ROLE OF DIPOSITORY INSTITUTIONS

Depository institutions accept deposits from surplus units or savers and provide credit to deficit units or borrowers through loans and purchase of securities.  

The importance of depository institutions in the financial market includes the following;

1)      They offer deposit accounts that can accommodate the amounts and liquidity characteristics desired by most savers.

2)      They package funds received from deposits to provide loans of the sizes and maturity desired by borrowers.

3)      They accept the risks on loans provided

4)      They have more expertise than most individual surplus units in assessing the credit worthiness of deficit units

5)      They diversify their loans among numerous deficit units and therefore they can absorb defaulted loans better than individual surplus units could.

The importance of depository institutions can be appreciated if we consider what would happen if the institutions were not there.

Role of commercial banks as depository Institutions.

     Commercial banks are the most dominant depository institutions. They offer a wide range of deposit accounts. They transfer the deposits to deficit units through loans, advances, overdrafts, letters of credit, letters of guarantee and they can also buy debt securities. Commercial banks serve both private and public. Their services are utilized by households, businesses and government.

Savings institutions

These institutions are also called thrift institutions. They include; savings and loans (S&L) and savings banks. Like commercial banks, S&L offer depository facilities to surplus units they then channel these surplus to deficit units. S&L concentrates on residential mortgage loans unlike commercial banks who concentrate on commercial loans

Credit unions

These institutions differ from commercial banks and savings institutions in that they are

• Nonprofit making organizations,
•  Restrict their credit to the credit union members who share a common bond e.g. common employer, common business, common geographical location etc. they use most of their funds to advance loans to their members ( these are normally referred to as savings and credit organizations. Examples include Mwalimu Saco Nakuru

Role of non depository financial institutions

None depository financial institutions generate funds from other sources other than deposits. But also play a major role in financial intermediation. These institutions include:

• Finance companies

Most finance companies obtain funds from issuing securities then lend the money to individuals and small businesses. Although the functioning of finance companies overlap those of depository institutions, each type of institution concentrates on a particular segment of the financial market. Many large finance companies are owned by multinational corporations

• Mutual funds

These types of companies sell shares to surplus units and use these funds to buy a portfolio of securities. The Kenyan capital market is still in its infancy and such companies are not very common. Some mutual funds concentrate their investment in capital market securities, such as stocks or bonds. Others Known as money market mutual funds concentrate in the money market securities.  

• Security firms   

Securities firms use their information sources to act as brokers, executing securities transactions between two parties. In order to ease the securities trading process the transactions are normally in multiples of 100 shares and the delivery procedure is somewhat standard. Brokers earn their profits by charging a brokerage fee by differentiating between bid and asking prices. Small or unique transactions are likely to have a higher commission due to time taken to complete the transactions. Securities firms also provide investment banking services. Securities firms also underwrite new issues for government and private companies. Securities firms also act as dealers in which case they i.e. they can make a market for a specific security by adjusting their portfolio inventory.

Securities firms also provide investment banking services which include advisory services on mergers and other forms of corporate restructuring. And also execute the change in the firm’s capital structure by placing the securities issued by the firm.

Insurance companies

They provide insurance services to individuals and other firms that reduce the financial burdens associated with death illness and damage to properties including theft. Insurance companies charge premiums in exchange of the insurance that they provide. The funds collected in form of premiums, is invested (mainly in stocks or bonds issued by companies or bonds issued by the government) by the insurance companies until the funds are required to pay for the risks insured when it happens.

Pension funds

The working population, know very well that their energy to work is limited. To guard themselves against the eventuality, employers and employees save for old age where they contribute periodically. Such funds are available for a long time i.e. until retirement. The pension funds manage the funds until they are required when the employee retires. The money saved is normally invested in securities and bonds issued by corporations and governments. This way they pension savings are used to finance the deficit units thus acting as intermediaries.