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FINANCIAL INTERMEDIARIES AND THEIR FUNCTIONS

Chapter · June 2018

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Ikechukwu Acha Gabriel Thompson Udofa

University of Uyo Akwa State College of Science and Technology, Ikono
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Anatomy of Finance, June 2018

i
Copyright © Department of Banking and Finance, University of Uyo, 2018

All Rights Reserved. No part of this publication may be reproduced, stored in any retrieval system, or
transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or otherwise,
without the prior written permission of the copyright holder.

ISBN: 978-978-917-981-1

Published by:
Department of Banking and Finance
University of Uyo, Uyo
Akwa Ibom State
P. M. B. 1017, Uyo
Nigeria

Printed by:
Parvenu Technologies, Uyo
Akwa Ibom State
E-mail: parvenuonline@gmail.com
08027228272

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 FOREWORD

This book, “Anatomy of Finance” is a bold statement by the Department of Banking and Finance,
University of Uyo. It is made up of forty two carefully selected chapters which are very
informative. An interesting aspect of this book is that while it succinctly covered many
fundamental topics in finance, it veered into ancillary areas like banking, insurance, accounting,
management and marketing, hence re-emphasizing the link between finance and these areas as
finance is the hub of economic activities.

In this book, topics like financial management, working capital management, time value of money,
elements of investment and investment processes, financial system, financial intermediaries and
their functions, balance of payments and international financial markets and exchange rates are
thoroughly examined. Others such as budget and budgetary control, Islamic banking, risk
management options for SMEs, management of organisations in Nigeria are treated with
commensurate expertise. It is encompassing, covering the functional areas of business
management.

This therefore is a compendium of well thought out chapters, properly sequenced ideas and
professionally documented theories for learning, teaching research and development. I have no
reservations in recommending this book – Anatomy of Finance – to scholars, students,
practitioners and the general public, for it is written point wise for easy assimilation and
understanding.

Walter C. Ndubuisi
Professor of Banking and Finance, University of Maiduguri (UNIMAID) and
Professor of Entrepreneurial Finance, Michael Okpara University of Agriculture, Umudike (MOUAU).

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 PREFACE

It is worthy to note that good intentions die, unless they are executed. The good intention of
publications cannot be overemphasized. It is the platform for academics to exhibit efforts in
learning and research by putting forward their findings on topical issues. Department of Banking
and Finance, University of Uyo, Uyo, muted the idea of a book of reading and published
“Readings in Banking and Finance” in 2007. In 2012, the department published a journal titled
Journal of Finance and Business Policy. This journal like the book of readings before it could not
be sustained. This book of readings titled “Anatomy of Finance” was introduced after critical
review of the causes of inability to sustain the previous publications in the department. It is
therefore believed that this book of readings will be sustained.

The book of readings “Anatomy of Finance” is a compendium of theoretical constructs of financial

issues, empirical studies and topical issues affecting the Nigerian and global economies. The
methods used by the respective authors are satisfactory as the search pattern is mainly descriptive
as well as inferential statistical analysis.

The book is made up of 42 chapters. It has a broad coverage of corporate finance, public finance
and personal finance. Other areas of finance covered include international finance, financial
services and financial system. Cognate areas such as Accounting, Business Management,
Marketing, Insurance and Risk Management are captured in the book. The authors who handled
the topics are experts in the various fields of management sciences, mainly lecturers in Nigerian
universities. The reviewers and editorial advisers of the book comprised of professors and senior
lecturers of reputable status.

The book is suitable for academic work, practice of banking and finance as well as for policy
makers on financial matters. It is recommended for students, lecturers, bankers, financial experts
and government. It is published for international consumption.

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 TABLE OF CONTENTS

Cover page - - - - - - - - - - i

Foreword - - - - - - - - - - iii

Preface - - - - - - - - - - - iv

Table of Contents - - - - - - - - - v

Chapter 1: Overview of Finance and Finance Functions: Uduak B. Ubom - - 1

Chapter 2: Sources and Challenges of Personal Finance: Ime T. Akpan - - - 8

Chapter 3: Financial Management: Uduak B. Ubom & Akpan James Williams - - 14

Chapter 4: Public Sector Financial Management in Nigeria: Ntiedo B. Ekpo - - 20

Chapter 5: Working Capital Management: K. O. Ogiedu & Chinwuba Okafor - - 29

Chapter 6: Time Value of Money: Sunday S. Akpan - - - - - 60

Chapter 7: Elements of Investment and Investment Process:

Akpan James Williams & Uduak B. Ubom - - - - 74

Chapter 8: Accounting: The Universal Language of Business: Etim Osim Etim - - 82

Chapter 9: Accounting and Accounting System for Small Scale Enterprises:

Samuel Sunday Charlie - - - - - - 91

Chapter 10: Orientations on Accountability: Essien Akpanuko - - - - 96

Chapter 11: Budgets and Budgetary Control: Augustine A. Udonsek - - - 114

Chapter 12: Elements of Cost: Augustine A. Udonsek - - - - - 132

Chapter 13: The Financial System: Sunday S. Akpan and Gabriel T. Udofa - - 151

Chapter 14: The Structure of Nigerian Financial System: Emilia Vann Yaroson and
Ahmad Bawa Abdul-Qadir - - - - - - - 163

Chapter 15: Financial Intermediaries and their Functions: Ikechukwu A. Acha and
Gabriel Thompson Udofa - - - - - - - 174
Anatomy of Finance, June 2018

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Chapter 16: History and Evolution of Banks in Nigeria: Dominic A. Akpan - - 180

Chapter 17: Non Banks Financial Institutions: Sunday S. Akpan and Francis Bassey - 191

Chapter 18: The Management of Financial Institutions in Nigeria: Anietie Efi and Itoro Ikoh - 207

Chapter 19: Regulation of Financial Institutions: Ahmad Bawa Abdul-Qadir &

Emilia Vann Yaroson - - - - - - 229

Chapter 20: Finance Without Banking: Paul O. Udofot - - - - - 239

Chapter 21: International Financial Markets and Exchange Rate Movements:

Emmanuel Ikpe Michael & Joseph Michael Essien - - - - 243

Chapter 22: Determinants of Exchange Rate: NseAbasi Imoh Etukafia - - - 254

Chapter 23: Components of Foreign Capital Inflows to Nigeria: John O. Udoidem - 258

Chapter 24: The Balance of Payments: Anthonia U. Ubom - - - - 269

Chapter 25: Marketing Environment of Financial Institutions: Samuel G. Etuk - - 276

Chapter 26: Electronic Marketing: Saviour Sylvester Okon - - - - 287

Chapter 27: Customers‟ Complaint in Service Provision: Agu Godswill Agu - - 300

Chapter 28: Enterprise Risk Management: Mfon S. Ukpong & Itoro M. Ikoh - - 311

Chapter 29: Risk Management Options for SMEs in Nigeria:

Ikechukwu A. Acha & Bassey I. Frank - - - - 323

Chapter 30: Elements of Motor Insurance Cover: Bassey Frank - - - - 342

Chapter 31: International Risk Exposures: Anthonia U. Ubom - - - - 351

Chapter 32: Corporate Social Responsibility and Financial Performance:

Adebimpe Otu Umoren & Tolulope Morenike Atolagbe - - 361
Chapter 33: Mergers and Acquisition: Ikenna E. Asogwa & Nseabasi I. Etukafia - - 370

Chapter 34: Customer Loyalty in the Financial Service Sector:

Uduak Joseph & Samuel G. Etuk - - - - - - 387

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Chapter 35: Approaches to Financial Service Marketing:
Ambrose Oloveze & Ikechukwu A. Acha - - - - - 397

Chapter 36: The Management of Organizations in Nigeria: Nsien, Christiana Ben - 406

Chapter 37: Strategic Performance Management in an Organization:

Itoro Moses Ikoh & Christiana Ben Nsien - - - - - 421

Chapter 38: Fundamentals of Business Communication: Emmanuel I. Michael - - 434

Chapter 39: Islamic Banking: Gabriel Tobi Edu - - - - - 450

Chapter 40: Safe Custody Service of Commercial Banks:
Joseph Michael Essien & Emmanuel Ikpe Michael - - - - 458

Chapter 41: Value Chain Financing and Agricultural Development in Nigeria:

Ntiedo B. Ekpo - - - - - - - 466

Chapter 42: Financial Ratios and Analysis: Ntiedo J. Umoren - - - - 472

Index: - - - - - - - - - - - 484

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 CHAPTER 15

FINANCIAL INTERMEDIARIES AND THEIR FUNCTIONS

Ikechukwu A. Acha1 and Gabriel Thompson Udofa2
1
Department of Banking/Finance, University of Uyo, Akwa Ibom State.
2
Akwa Ibom State College of Technology, Nung Ukim, Ikono, Akwa Ibom State.

Introduction
The primary role of financial intermediaries (institutions) is to create a platform for mobilization of
savings and extension of credit facilities to worthy borrowers for investment purposes. Through this
process, financial institutions perform the role of intermediation. In making credit available for investment,
financial institutions create wealth by increasing production capacity of businesses and consumption of
private individuals and governments. The intermediation function promotes economic growth by providing
opportunity for businesses to expand the means of production which ultimately leads to increase in the
output of goods and services.

Financial Intermediation Process and Flow of funds between economic units.

Financial intermediation is the process of facilitating the flow of savings from surplus economic
units to deficit economic units. The economic system of any nation consists of household, business and
government sectors. Financial institutions form a vital component of the total economic system. They
intermediate between the sectors and facilitate the transfer of savings from one economic unit to another.
The funds move between those economic units because of the returns it provides and the goods and services
it could produce.
Where the movement/transfer of funds is done directly ignoring financial intermediaries, it is
known as financial disintermediation. Financial disintermediation occurs when borrowers and lenders by-
pass financial intermediaries to borrow and/or lend to each other differently. When funds flow from the
surplus economic unit (lenders) through financial intermediaries (institutions) to the deficit economic units
(borrowers), it is called financial intermediation. This means that the intermediation process entails the
borrowing and lending of funds through the participation or involvement of financial intermediaries. In this
process, the risk of lending assumed by providers of funds is much lower compared to direct financing.

a b
Surplus Economic Financial Deficit economic
unit (Savers) d Intermediaries units (Investors)
c

Direct Finance (Disintermediation)

Figure 1: Financial intermediation/flow of funds between the surplus economic unit and deficit economic
unit.
Where:

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a: Mobilization of savings through various accounts e.g savings, current and deposit accounts.
b: Extension of credit facilities (or funds) to deficit economic unit.
c: Repayment of loans and interest to financial intermediaries.
d: Payment by financial intermediaries to surplus economic unit (depositors) on demand or at
maturity.

Ways of transferring capital from savers to borrowers

i. Direct transfer of money and securities – The business sells its financial securities or borrow from
savers directly, without passing through any type of financial institution. This method of funds
transfer is known as direct finance or financial disintermediation.

Securities (Stock or bonds)

Business Money to the business Savers

ii. Indirect transfer through merchant bankers (or underwriters). An underwriter, which serves as a
middleman, facilitates the issuance of securities. The corporation sells its financial assets
(stock/bonds) to the investment bank, which in turn sells them to savers. Merchant bank is an
organisation that underwrites and distributes new investment securities and help businesses obtain
funds. They (i) design securities with attractive features to attract investors (ii) Buys securities from
corporations and (iii) resale them to savers.

Securities (Stock or bonds) Securities (Stock or bonds)

Merchant Bank
and stock Savers
Business Money
broking firms Money

iii. Indirect transfer through financial intermediaries (banks or mutual funds). This involves obtaining
money from savers in exchange for securities (e.g certificate of deposit) and the bank then lends the
money to small business in the form of mortgage loan, thereby creating new securities.
Securities (Stock or bonds)
Financial
Business’ Securities
Intermediary
Business Money Money Savers

Surplus Economic unit is an economic unit which spends less than its net receipts. Deficit economic
unit is an economic unit which spends more than its net receipts.

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iv. Financial intermediation in a closed economy. Within these sectors of the economy, there is a
continual movement of funds from individuals, businesses, and governments directly to one another
within the sector or through financial intermediaries.

Savings Savings
Financial
Household Intermediaries
Business
Loans
(Personal) Loans Sector
Sectors

Taxes
Government Taxes
Taxes
Sector
Surplus Budget

Fig 2: Financial Intermediation between the sectors (or Fund Flow System) Adapted from
Essien (1994).

Financial Intermediaries
Financial intermediaries are financial institutions which link lenders with borrowers by obtaining
deposits (through various accounts) from depositors and lending them to borrowers. They are specialized
financial firms that facilitate the transfer of funds from savers to demanders of capital. These institutions
channel the savings of various parties into loans or investments. In an economy, there are individuals,
households, firms and government institutions which either have an excess of money above their immediate
needs (surplus units) or have less money than they want for their expenditure or investment plans (deficit
units). Financial intermediaries provide a mechanism (facilities and instruments) to mobilize the excess
funds and extend same to worthy borrowers for investment purposes.

Types of financial intermediaries

In Nigeria, financial intermediaries include:
i. Commercial Banks
ii. Merchant banks
iii. Development banks
iv. Mortgage banks
v. Microfinance banks
vi. Finance houses (institutions)
vii. Insurance companies
viii. Pension funds
ix. Unit trust companies
x. Investment trust companies

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 xi. Credit and savings institutions
Banks are the major financial intermediaries in Nigeria. Some non-bank financial intermediaries do not
intermediate exclusively between savers and investors. For example, discount houses act mainly as
intermediaries between other institutions. Sometimes, financial institution act as go-between or market
maker, finding investors for companies that want to raise funds (through issue of share capital, commercial
papers, etc), without taking on any financial commitment or risk themselves (paying interest to depositors,
guaranteeing safety, and paying of the deposits on demand).

Intermediaries Investor
Borrower

Go-between or Buys the financial

Issue of financial
market maker instruments that
instrument
the borrower has
issued

The intermediation function exposes the bank to various types of risks such as loss of confidence risks,
liquidity risks, earning risks, operating risks, credit risks and so on. Financial intermediaries create financial
instruments such as bank deposits and bank loans, which help the transfer of funds between lenders and
borrowers.

Functions/Roles of Financial Intermediaries in the Development of an Economy

Financial intermediaries facilitate and foster economic growth and development of a nation. They
provide the needed funds to boast productive activities, which increase aggregate output and enhance
economic growth. Transferring savings from the surplus economic unit (i.e. those who ultimately use them
for investments or consumption) helps to stimulate the economy for wealth creation. Financial
intermediaries vigorously seek to attract surplus funds or reservoir of idle funds to channel same to
households, business/entrepreneurs and government for investment purposes.

The developmental functions are discussed specifically below:

i. Mobilization and Redistribution of savings for investment in the economy. Financial intermediaries
facilitate economic development by mobilizing and redistributing savings to their most efficient
use. In all sectors of the economy, there are two economic units – the surplus economic unit
(lenders) and the deficit economic unit (borrowers). Financial intermediaries mobilize savings from
savers or surplus spending units and repackage them as short, medium and long term loans for sale
to borrowers or deficit spending units. The packaging of savings involves four intermediation
functions: maturity intermediation, liquidity intermediation, size/denominational intermediation,
and risk intermediation.
a. Maturity Intermediation involves satisfying the borrowers need for long term funds as well as the
lenders need for liquidity. Financial intermediaries also provide market for the sales of second-hand
securities for investors that invested in long-term securities (such as equity shares and bonds) who
may want liquidity.

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b. Liquidity Intermediation: Financial intermediaries despite the short duration of savings and the long-
term nature of the loans granted, banks still ensure liquidity to meet customers request on demand.
c. Size/Denomination Intermediation: Financial intermediaries accept both small and large deposits from
customers and loan it to investors for investment purposes.
d. Risk Intermediation: Financial intermediation accept deposits with different risk elements to form a
portfolio of loanable funds for investors. By making the loan available to diverse borrowers of various
sizes, the lending risks are minimized.
ii. Manpower Development and Employment Generation: The business of financial intermediation
requires skilled high-level manpower. Financial intermediaries recognising this, play active role in
training and retraining of staff both on-the-job and off-the-job training. This training equipped the staff
to meet the challenges in the industry and also create more employment opportunities. Financial
intermediaries also liaise closely with institutions of higher learning in the country in the production of
personnel through scholarship and provision of infrastructure such as books and e-learning facilities.
The central bank together with all licensed banks (under the auspices of the Bankers‟ Committee
established the Financial Institutions Training Centre (FITC) in 1982. The objectives of the FITC
include among others:
a. To carry on the business of training and education of persons employed or to be employed by the banks
and other financial institutions.
b. To protect, promote and advance the knowledge of banking and finance throughout Nigeria by
organizing seminars, lectures, workshops and other practical and theoretical courses.
Financial intermediaries fund employment generating activities by providing loans to young
entrepreneurs, medical and engineering graduates, and other technically trained persons to establish
their own businesses thereby generating employment, developing human capital and encouraging
entrepreneurial activity in Nigeria.
iii. Financing and Sustaining Economic Growth and Development. Financial intermediaries influence long
term economic growth and development through financing, investment, and advisory services. Financial
intermediaries ensure that there is high level of savings mobilization system, allocation mechanism to
the preferred sectors, and sustenance of credit delivery activity in the sectors. The preferred sector may
include: agriculture, small-scale industries, the rural sectors, exports and manufacturing. Thus, financial
intermediaries directly or indirectly enhance high level of productivity (high level of aggregate output),
encourage growth of indigenous industries and small-scale businesses, generate employment and
increase the per capita income of citizens in the economy.
iv. Poverty Alleviation and Financial Inclusion of Rural Populace. Financial intermediaries are agents of
poverty reduction. Extending banking facilities to rural areas inculcate banking habits in the rural areas
of the Nigeria economy. The idle funds in the area are mobilized and allocated to needy investors in the
area, which enhance economic growth and development of the area. According to Onaolapo, (2015),
„bringing financial services to the rural sector and packaging it in such a way that can be accessed by
the rural area is an pre-requisite for poverty reduction, employment creation, social cohesion and overall
economic development for Nigeria‟.
v. Facilitation and Development of money and capital markets. Financial intermediaries, specifically,
commercial banks and merchant banks facilitate the operation and development of money and capital
markets by encouraging capital formation investment and e-trading activities. These banks engage in
brokerages services for their customers in the process, perform, the functions of issuing houses.
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 vi. Development of International Trade: Financial intermediaries, particularly, commercial banks and
merchant banks are in one way or the other involved in financing of international trade and payments on
behalf of their clients. This functions are performed in a number of ways including bills for collection,
bill for negotiation, documentary credit and open account (Adekanya, 1986)
vii. Corporate Responsibility: Financial intermediaries owe some basic responsibility to their host
communities. Apart from the traditional function, which they render in the form of financial
intermediation to efficiently deliver to retain the confidence of their clients, they must sufficiently be
responsible to the needs of the host communities. Financial intermediaries perform this function by
providing infrastructural facilities, scholarship awards, and employment quota.
viii. Risk Avoidance and Management: Financial intermediaries provide strong safe for safe-keeping of
valuable assets to avoid risk associated with possible loss, injury, damage or peril, which the customer
could have been exposed to. They render financial advisory services to clients and educate them on the
risk-return trade-off of proposed businesses, use of hedging devices to minimise risks, administrative
efficiency in credit policy implementation, investment portfolio to reduce market risks and money rate
risks, adequate internal control measure and avoidance of risky exposures.
Specifically, insurance companies encourage business and economic growth by insuring
calculated risks of businesses. The primary function of insurance is to ensure that the financial losses of
an individual or business are fairly and equitably distributed over the insured community.

References

Adekanye, F. (1986). The Elements of Banking in Nigeria. Lagos: F &A Publishers Ltd.

Akinsulire, O. (2014). Financial Management (8th ed). Lagos: El-Toda Ventures Ltd.

Brigham, E. F. and Houston, J. F. (1998). Fundamentals of Financial Management. New York: The Dryden
Press.

Ekezie, E. S. (2006). The Elements of Banking (Money, Financial Institutions and Markets). Onitsha:
African First Publishers Ltd.

Essien, E. O. (1994) Foundation of Finance & Banking, Uyo: KIV Publishers.

Jhingan, M. L. (2003). Money, Banking, International Trade and Public Finance (6thed). Delhi Vrinda
Publications (p) Ltd.

Nzotta, S. M. (2004). Money, Banking and Finance: Theory and practice. Owerri: Hudson – Jude Nigeria
Publishers.

Onaolapo, A. R. (2015). Effects of Financial Inclusion on the economic Growth of Nigeria (1982 – 2012).
International Journal of Business and Management Review. Vol.3. No. 8 pp11-28, September
2015.

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