BUAD 808: Business & Company Law. Registration Number: DP17MBA0967
Financial institutions are businesses which offer multiple services in banking and finance. Financial institutions are divided into depository and non-depository institutions. Financial institutions serve as financial intermediaries between savers and borrowers and direct the flow of funds between the two groups (Hamouda, 2018). Insurance companies belong to the category of financial institutions known as non-deposit institutions. There exist life insurance involved in annuities and pensions products, while the other non-life insurance which sells other types of insurance (Dusan, et al, 2015. This article will overview the financial system and then compare the primary functions of an insurance company a nondepository institution and a commercial bank a depository institution on financial intermediation, interest rate risk, asset-liability mismatch, systemic interconnection, money creation; regulatory authority.
The financial system consists of the money and capital markets which are guided by regulatory institutions as illustrated by the diagram below: Figure 1
(Dusan, et al, 2015).
Financial System and Regulatory Institutions
Financial system refers to a set of rules and regulations and the aggregation of financial arrangements, institutions agents that interact with each other and the rest of the world to foster economic growth and development of a nation. It does this by providing a medium of exchange which promotes specialization, mobilization of savings from the surplus units and channeling them into deficit units of the economy for productive capacity and overall output and employment (ABU, 2016). In Nigeria, several financial institutions, instruments and operators constitute its financial system. They include the Central Bank of Nigeria (CBN), Federal Ministry of Finance (FMF); The Nigerian Deposit insurance Corporation (NDIC) which was established on 15 June 1988 to strengthen the safety net for the newly liberalized banking sector and Securities and Exchange Commission (SEC) which are the major players and regulatory bodies (ibid).
The National Insurance Commission, NAICOM was set up by decree No. 1 of 1997 with a mandate to ensure the effective administration, supervision, regulation and control of insurance business in Nigeria The decree replaced an earlier Decree No. 62 of 1992 that established the National Insurance Supervisory Board, NISB. The long title and section 6 of the National Insurance Commission Act Cap. N53 puts beyond doubt that NAICOM is both a supervisory and a regulatory body. However the importance of an adequate regulatory framework in insurance cannot be over-emphasized, failure of the American International Group (AIG), an octopus in the insurance industry, the world’s largest insurance company by assets with subsidiaries all over the world sheds light. Nonetheless, the Legal regulatory infrastructure for insurance in Nigeria may be described as extensive, yet there are gaps in which the regulatory regime requires further visit, either by inclusion of new guide lines or the establishment of additional specialist units in existing regulatory bodies or the establishment of new distinctive regulatory bodies (Idhiarhi, 2013).
The CBN is the apex regulatory body of the financial system. Primarily, it has responsibility for fostering monetary stability and soundness in the system. The CBN plays its role directly through circulars and guidelines issued to the banks and non-bank financial institutions. Of great importance is the introduction of prudential guidelines in 1990 to ensure that banks comply with prudent banking practices. Its powers and actions within the system derive from the CBN Decree No. 24 and Banks and Other Financial Institutions Act (BOFIA) No. 25 of 1991, which substantially revised and replaced the earlier CBN Act and Banking Decree (ibid).
The bank’s role also includes the development and growth of the money and capital markets and support for government-sponsored financial institutions and schemes. The bank is actively involved in managing Nigeria’s domestic and external debts. Among other things, it is involved in agricultural and industrial finance (ibid).
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Money Market and Capital Market
Financial market is an institutional arrangement which facilitates the exchange of financial assets such as deposits and loans, stocks and bonds, government securities, bills, etc. Financial markets operate through brokers, banks, non- banking financial institutions, merchant banks, mutual funds, discount houses, central bank, etc. There are two major markets, Money and Capital markets. While money market provides facilities for the trading of short-term instruments, capital market is for the trading of long-term instruments. All the markets provide avenue for the transfer of funds from surplus to deficit units (ibid). In Nigeria, the debt instruments traded in this market include treasury bills, treasury certificates, commercial papers, bankers’ acceptances, promissory notes, certificates of deposit and call money.
The Nigerian Securities and Exchange Commission (SEC) is the apex institution for the regulation and monitoring of the Nigeria capital market. The commission was established under the Securities and Exchange Commission decree 1979, operating retrospectively from 1st April 1978 (ibid). The capital market deals in ordinary stock, shares and debentures of corporations, and bonds and securities of governments. The funds that flow into the capital markets come from individuals who have savings to invest, the merchant banks, the capital market functions through the stock exchange market and are self-regulated by the Nigerian Stock exchange providing the framework and facilities for the trading of securities in the secondary market (ibid). The Nigerian Stock Market effectively came into being in 1960 with the establishment of the Lagos Stock Exchange. It became the Nigerian Stock Exchange (NSE) in 1977 with branches in different parts of the country.
Financial institutions are businesses which offer multiple services in banking and finance. We can divide financial institutions into depository and non-depository institutions. Financial institutions serve as financial intermediaries between savers and borrowers and direct the flow of funds between the two groups. To do so, savings accounts are pooled to mitigate the risk brought by individual account holders in order to provide funds for loans (Hamouda, 2018). Those that accept deposits from customers are depository institutions including commercial banks, savings banks, and credit unions; those that don’t are nondepository institutions like finance companies, insurance companies, and brokerage firms (ibid).
Commercial Banks accepts deposits from customers and in turn makes loans, even in excess of the deposits; a process known as fractional banking. Some banks (called Banks of issue) issue banknotes as legal tender (Hamouda, 2018).
Saving Banks is a financial institution whose primary purpose is accepting savings deposits. It may also perform some other functions (ibid).
Credit union is a member-owned financial cooperative, controlled by its members and operated on the principle of people providing its members credit at competitive rates as well as other financial services (MCUA, 2007; Arthur, 2003).
Security Brokers assist people in investing, online only companies are called discount brokerages companies with a branch presence are called full service brokerages or private client services (Hamouda, 2018).
Real estate investment involves the purchase, ownership, management, rental and/or sale of real estate for profit (GIG, 2017).
Investment Company is a company (corporation, business trust, partnership, or Limited Liability Company) that issues securities and is primarily engaged in the business of investing in securities (Hamouda, 2018).
Mutual funds is an investment which comprised of a pool of funds collected from many investors for the purpose of investing in securities such as stocks, bonds, money market securities and similar assets(ibid).
Finance company also known as a non-bank are financial institution that provide banking services without meeting the legal definition of a bank. I.e. one that does not hold a banking license (ibid).
Insurance companies belong to the category of financial institutions known as non-deposit institutions. Insurance can be defined as a financial device whose main aim of an insurance company is to mitigate financial risk or provide protection in the event of an adverse occurrence (Dusan, et al, 2015).
Mortgage Company is a firm engaged in the business of originating and funding/or funding mortgages for residential or commercial property. A mortgage company is often just the originator of a loan (investopedia, 2018).
Figure 2: A tabular representation of differences and similarities in Financial Institutions
Non depository institution Depository institution
Commercial Banks Insurance Company
Financial intermediary Savers Deposits = Loans Client Premium = investment
Interest Rate Risk Interest Rate volatility Interest rate fluctuations
Asset-Liability Mismatch Liabilities ; Assets in short run Liabilities ? insurance long-run
Systemic Interconnection Central Banking System Lacks systemic contagion
Money creation Deposits = Money creation Premiums ? Money creation
regulatory authorities Subject to regulatory control Less susceptible to regulation
From the table above decision on the primary function of the insurance company is majorly providing protection through premiums, while the banks provide funds from pooled deposits for customers with short term to long term investment appetite from deposits. In this it is shown from the above table that insurance and banks act as financial intermediaries as they both utilize funds gathered through deposits and premiums to other investments in securities, real estate, bonds and other financial intermediaries.
Secondly, the insurance company in their distribution of risk among the insured investing the pooled funds suffer the same interest rate risk in their choice of low or high yield investment because interest rate tends to be volatile depending on the central banks intended policy.
Thirdly there is a difference from the primary functions of insurance companies compared to the banking firm when it comes to asset matching the table shows us that some time the banks liabilities exceed its asset match compared to insurance companies whose clients might not request payments until there exists a disaster like fire burn of property or otherwise, hence banks are in a dilemma if depositors request funds at once which in all instances might not be the case.
Fourthly, banks are different from insurance companies based on systematic integration. The Central Bank which is the lender of last resort provides funds among the financial stream for the commercial banks and ensures smooth system balances to foster monetary policy. However this is not the case for the insurance houses.
Fifthly, the commercial banks tend to create money due to the deposit from customers in the long run, but that of the insurance is different because it might only be able to raise premiums patterning to risk aversion through spreading risk amongst clients, provision of certainty and protection from adverse circumstances.
Finally the insurance companies are perceived not to be highly regulated as the commercial banks. Though we have the Central Bank of Nigeria, Nigeria Deposit Insurance Corporation who scrutinize and penalize the commercial banks the insurance companies are supervised and regulated by the National insurance company . Nevertheless scholars have pressed for more scrutiny in the Nigerian insurance industry to avoid the calamity of American Insurance Group a world class insurance firm with subsidiaries spread all over the world which failed for sake of invalid insurance promises.
This work has looked at financial institutions consisting of non- depository institutions with special emphasis on the insurance company and a depository institution, the commercial bank. In all selecting the primary functions of the insurance company and that of the commercial bank, it was discovered that haven reviewed the regulatory bodies such as the CBN, NDIC and the NAICOM (just to mention a few) that the similarity between insurance and the bank are as follows, both are financial intermediaries, insurance companies and banks suffer interest rate risk, never the less the differences lie in the asset mismatch, money creation capabilities, systematic integration and regulation. The banks have mismatches in assets compared to the insurance firms, also insurance companies cannot create money like the banks do; lastly there tends to be more stringent regulation in the banking system which forms some sort of systematic integration as compared to the insurance regulators. We concluded that despite these similarities and differences the financial institutions are the bedrock for the financials systems drive toward economic growth and development enhanced by top notch regulation.