Name: Ian Kiprop

Registration Number: D61/33617/2019

Course: DFI 503 (Financial institutions and Markets)

Task: CAT
Question 1

a) Using organization chart, describe a structure of a financial system of a financial

market in which you are familiar. (8mks)
FINANCIAL SYSTEM

FINANCIAL FINANCIAL FINANCIAL FINANCIAL

INSTITUTIONS MARKETS INSTRUMENTTS SERVICE

Primary Secondary
Regulatory Intermediary Non-
intermediar
y

Short-term medium long-term

Organised Unorganisedd

Primary Secondary

Capital Market Money Market

Debt Market Equity Market Derivative Market

b) What is market based financial regulation? (4mks)
 This is a regulatory approach which is based on market in terms of competitions, how
dynamic the market is, and its sensitivity to customer demands.
 Its involves transmission of information and signals across the financial market to
consumers and providers of financial products and services
 It is not the government of the day that possesses this information and data but rather
the market players and participant thus validating this system to be more superior and
dynamic.
 This form of regulation utilizes the bottom-up analogy rather than top-down as it
seeks information from the players to facilitate formation of regulatory policies.
c) Explain the main securities that influence the development of capital market in
which you are familiar. (6mks)

Treasury bonds

This are secure investments, medium or long term normally offered by the government
and offers interest payment every six months.

Corporate bonds

These are bonds and a form of debt issued by various corporations to raise funds for
variety of reasons e.g. expansion and other expenditure well intended for the organization

Preferred stock

This are shares of a company's stock with dividends that are paid out to shareholders

before common stock dividends are issued.

Common stock

These are stock held by founders and employees of an entity. It represents the ownership
of the business.

d) Explain the role of moral hazard in credit rationing of financial institution in your
country. (7mks)
 Among other things like adverse selection, credit rationing is one of the reason
credit rationing exists. Morals hazard is a where someone is not entirely
responsibility for their risky undertakings and the costs that come with it.
 One of the example roles credit rationing play in credit rationing is when an
organization or company do not have enough assets then it cannot financed and
credit rationing will come in to place. This is the result of moral hazard which
creates what we call agency cost.
 Moral hazards facilitate the enforcement of contracts; debt, equity and other
contracts signed in the financial markets.
 They contribute to the Streamlining systems of debt collection
 They act as a tool for evaluating projects to minimize risk on investment
Question 2

a) Explain the concept of money laundering giving examples from your banking
sector.(8mks)
Money laundering – money laundering involves the process of concealing money that
was gotten from illegal means by passing it through a complex sequence of commercial
transfers and banking transactions, in a bid to disguise it as legal money.

Examples of money laundering.

Smurfing – Smurfing is a money laundering technique where money from illegal sources
is divided between deposit specialists also known as smurfs who then go on to make
multiple deposits across multiple accounts in different banks or financial institutions.
This makes it really difficult to detect since it gives the impression that multiple unrelated
people are making deposits without any connection to each other.

Structuring – This involves the breaking of one large financial transaction into smaller
ones. This is done by one person or in conjunction with other co-conspirators. It can be
done across one or more banks. The smaller transactions are usually amounts under the
reporting threshold.

Credit card advance payments – This technique involves a credit card holder making a
large payment for the credit card using the dirty money, which results in a negative
balance. The bank then writes a check to pay out the negative balance. The check is then
cashed into a personal bank account as clean money.

Wire and electronic funds transfer - This technique involves the transfer of dirty money
through different banks in different jurisdictions which make it difficult to know the
original source of the funds.

b) Explain the main aspects that are used to explain financial development giving
examples of financial markets in which you are familiar. (7mks)

Market capitalization as a share of GDP – This refers to the market cap of the stock
market within a counter as percentage of the GDP of that country. Market capitalization
of about 50% of the GDP, indicates a well-developed financial market. Kenya Market
Capitalization accounted for 26.1 % of its GDP in 2019.

Private credit as a share of GDP - This refers to financial resources provided to the
private sector such as through loans, purchase of no equity securities, trade credits, e.t.c,
establishing a claim of repayment.
 Domestic credit to private sector as a percent of GDP in Kenya was reported at 27.55% in
2019. High-income and financially-developed countries have percentages usually higher
that 140%.

c) What is financial deepening?. Explain the role of government in financial

deepening. (4mks)

Financial deepening is a term that is used to refer to the increase in provision of

financial services, both in terms of a broad range of financial services and in increased
access of financial services to more people in different socioeconomic groups.

Role of government in financial deepening.

Regulation - the government plays a key role in performing regulatory oversight to

ensure that the financial services benefit the citizens and are not exploiting them.
However overregulation can have a negative impact to financial deepening and may slow
it down.

Political Stability – maintaining political stability is done by the government and this
provides for a conducive environment for the growth of the economy which in turn
increases the purchasing power of its citizens hence allowing them to be able to afford a
broader range of financial services.

Legal Enforcement – the judicial arm of the government acts as an independent arm to
resolve disputes that might occur between competitors in the financial market. This
promotes and maintains healthy competition which positively impacts financial
deepening.

d) Explain how financial repression impacts on the activities of financial market giving
examples of main types of financial repression in financial market you are familiar.
(6mks)

High Bank Reserve Requirement – this refers to the amount of funds that commercial
banks are legally required to hold in the central bank. Increase this limit drastically is a
form of financial repression which has negative impacts in that it reduces the amount of
money that banks have available to lend to consumers which in turn leads to higher
charges to lend the money.

Interest Rate Ceiling – this refers to the maximum interest rate a lender can charge a
borrower when seeking a loan. This is done to protect borrowers from the risk of
significant rises in the interest rates as they repay the loan.
However, interest rate caps can also have negative effects particularly among high-risk,
low-income borrowers, who may experience a lack of credit from lenders, because
lenders are unable to charge higher rates for them to mitigate the risk.

Domestic lending to the government – Domestic lending refers to credit/loans that are
extended to the government from lenders within the country. This negatively impacts the
economy growth because a significant amount of revenue generated by the government is
consumed as a result of higher interest rates in comparison to external debt. This also
leads to domestic lenders reducing the amount of money they lend to their customers.