1. ECON 112 INTRODUCTION TO ECONOMICS II
Money and Financial System
Lecturers: Dr. Monica Lambon-Quayefio
Dr. Nkechi S. Owoo
Mr. Solomon Aboagye
5th April, 2017

2. Session Overview
This session focuses on the financial system which is crucial in the study of macroeconomics. Specific areas to be covered in this session include; the hierarchical structure of the financial systems as well as the role of the central and commercial banks in an economy.
Goals and Objectives
At the end of the session, the student will
Be able to distinguish between central bank and commercial bank.
Be able describe the functions of commercial bank.
Be able to describe the functions of central bank.

3. Financial System Financial System Financial Markets
A financial system in economic and finance is a system that allows the exchange of funds between lenders, investors, and borrowers. 
Financial System is the processes and procedures used by a country to exercise financial control and accountability in its Financial Markets.
Financial Markets
These are markets in which funds are transferred from people who have an excess funds to people who have a shortage.
The markets facilitate the exchange of financial assets such as stocks, bonds, government securities.
The financial markets operate through financial intermediaries.
Financial intermediaries
These are institutions that take/borrow funds from people who have saved and in turn make loans to others.

4. Flow of funds through financial system
Direct Finance:
Lenders: Households, Firms, Government, Foreigners
Borrowers: Firms, Government, Households, Foreigners
Lenders purchase securities- which are claims on borrower’s future income or assets.
Securities are assets to the person who buys them and liabilities to the person who sells them.

5. Flow of Funds through the financial system
Indirect Finance:
Lenders: Households, Firms, Government, Foreigners
Financial intermediaries
Borrowers: Firms, Government, Households, Foreigners

6. Classification of financial markets I
Debt and Equity Markets
Funds can be raised by issuing a debt instrument or by issuing shares.
Debt: Contractual agreement by borrower to pay a fixed cedi amount to the holder of the bond at regular intervals until the maturity date. These can be financial instruments that are:
Short term, i.e. less than one year
long term, i.e. Ten years or longer
Medium term, i.e. Between one and ten years
Equities: Claims to the share of net income and assets of a business. For example shares of Ecobank Ghana. Holders of Ecobank Ghana shares are part owners of the bank.
Owners of equity are residual claimants
Owners benefit from increases in profitability or asset value

7. Classification of Financial Markets II
Primary and Secondary Markets
Primary Market: New securities are issued in a primary market. The funds obtained from the new issue go to the company.
Secondary Market: This is the market in which previously issued securities are sold.
The funds do not go to the firm whose shares are being sold but go to the sellers of previously issued securities who are also the buyers of the newly issued securities in the Primary market.
Secondary markets make financial assets liquid. Can sell the shares for cash. This makes it easy for firms to issue shares in the primary market since people will be willing to buy them knowing they can be sold in the future for cash.
Secondary markets determine the price the firm can sell its shares on the primary market.

8. Classification of Financial Markets III
Money market and Capital market
Distinguishing markets on the basis of the maturity of securities traded in each market.
Money market: Trades in short term instruments. Tend to be more liquid because instruments are more widely traded.
Capital market: Trades in longer term debt and equity instruments.

9. Financial Instruments: Money Market II
Treasury Bills
Certificates of Deposit
Debt instruments: Sold by banks to depositors. Pays an annual interest rate. At maturity the original purchase price is repaid.
Commercial Paper
Issued on behalf of medium-sized and large companies for onward sale to investors. 30 day maturity.
Banker’s Acceptances
This is a bank draft issued by a firm, payable at some future date and guaranteed for a fee by a bank. Usually used to finance export and import trade.
Repurchase Agreements.
These are short term loans that use treasury bills as collateral. They allow banks to obtain immediate funds for their liquidity management. For example:
Cocoa purchasing company has GHS1,000,000 idle cash
It purchases treasury bills from a bank which requires cash immediately.
The bank agrees to repurchase the treasury bills next week at a slightly higher price

10. Financial Instruments: Capital Market
Stocks
Claims on net income of the issuer, usually a firm. Held by individuals, pension funds and insurance companies.
Mortgages
Loans to households to purchase housing, land and other real estate. The real estate purchased is the collateral.
Government Notes and Bonds
1-year treasury note
2-year treasury note
3-year medium term bond
5-year medium term bond

11. Structure of the financial system of Ghana
National Insurance Commission
Securities and Exchange Commission
Bank of Ghana
National Pensions Regulatory Authority
Deposit Taking Institutions
Non-Deposit Taking Institutions
Universal Banks
Rural/Comm Banks
Savings & Loans Com.
Micro Finance Institutions.
Finance Houses
Leasing Companies
Micro Finance Institutions
Forex Bureaux
Credit Bureaux
SSNIT
Occupational pension scheme
Private pension scheme
Insurance Companies
Insurance Brokers
Re-Insurance Companies
Stock Exchange
Brokerage Firms
Investment Management Companies

12. Types of Financial Institutions in Ghana
Banking Institutions
Class 1 Banking Business – 30
Rural and Community Banks – 137
Non-Bank financial institutions
Finance House – 25
Credit Reference Bureau – 3
Savings and Loans – 24
Leasing Company – 2
Mortgage Finance – 1 (Banks such as Barclays and Fidelity Bank also provide mortgage finance.
Forex Bureau – 333
Microfinance – 291
Source:

13. Types of Financial Institutions in Ghana
*Insurance Companies
Life Companies – 19
Non-life Companies – 26
Re-insurance Companies – 2
Broking Companies – 60
Loss Adjuster – 1
Re-insurance Broker – 1
**Pension Funds – 45
***Credit Unions – 433
Mutual Funds – 30
*Insurance Companies are regulated by the National Insurance Commission
**Pension Funds are regulated by the National Pensions Regulatory Authority
***Credit Unions; BoG is yet to pass an Legislative Instrument to regulate activities in this sector, but the sector is currently managed by Ghana National Union and Thrift Association
Source:

14. The Central Bank
The central bank is the head of all banking institutions in in a country.
Article 183 (1) of Ghana’s Constitution establishes the Bank of Ghana stating:
“The Bank of Ghana shall be the Central Bank of Ghana and shall be the only authority to issue the currency of Ghana.”
To maintain stability in the general level of prices.
Support the general economic policy of the Government and promote economic growth and effective and efficient operation of banking and credit systems in the country, independent of instructions from the Government or any other authority.

15. Functions of the Central Bank
The central bank is established to perform the following key functions:
Formulate and implement monetary policy aimed at achieving the objectives of the Bank;
Promote by monetary measures the stabilization of the value of the currency within and outside Ghana;
Institute measures which are likely to have a favourable effect on the balance of payments, the state of public finances and the general development of the national economy;

16. Functions of the central bank cont’d…
4. Regulate, supervise and direct the banking and credit system and ensure the smooth operation of the financial sector; 5. Promote, regulate and supervise payment and settlement systems; 6. Issue and redeem the currency notes and coins; 7. Ensure effective maintenance and management of Ghana's external financial services; 8. Lender of last resort to commercial banks 9. Banker to Government

17. Commercial Bank
A bank is commercial if it provides financial services , including receiving deposits of money, lending money and processing transactions and the creating of credit to the public.
Unlike the central bank, the commercial bank deals directly with the public while the central bank regulates the commercial banks.

18. Functions of the commercial bank
1. Taking deposits from their customers and issuing current or checking accounts to individuals and businesses
Extending loans to individuals and businesses.
Cashing cheques.
Facilitating money transactions such as wire transfers and cashier's checks.
Issuing credit cards, ATM cards, and debit cards.
Storing valuables, particularly in a safe deposit box.
7. Consumer & commercial financial advisory services.
8. Pension & retirement planning.

19. Functions of Financial Intermediaries
Pooling savings
Payments services
Liquidity
Diversification
Information

20. Pooling savings Many small savers…
Pooled together to make large loans or investments
100 savers with $1000 becomes a
$100,000 loan by a bank OR
$100,000 stock portfolio with a mutual fund

21. Payments system Funds are kept safe
Funds are easily accessed for payments
Checks, ATM, debit cards, online banking
Tracks our finances

22. Reducing Cost Through Economies Of Scale
This function has large economies of scale
As output rises, per unit cost falls
Very true for financial services
Economies of scale: Financial intermediaries bundle the funds of many investors together so that they can take advantage of economies of scale, the reduction in transaction costs per cedi of investment as the size (scale) of transactions increases.
Example: mutual funds, banks. Expertise: Financial intermediaries are better able to develop expertise to lower transaction costs.

23. Liquidity Ease/cost of converting assets to cash
ATMs, checks, etc. to depositors
Lines of credit to borrowers

24. Diversification of risk
Small savers cannot diversify on their own
Pooled savings mean large, diversified investment portfolios
Loan portfolios
Stock/bond portfolios
Money market accounts

25. Collecting And Processing Information For Use By Stakeholder
Collecting it and using it
Info about borrowers
Info about investments
By doing this on a large scale
become experts at it
Do it for a lower per unit cost

26. Some Facts about Financial structure
Stocks are not the most important source of external financing for businesses
Issuing marketable debt and equity securities is not the primary way in which businesses finance their operations.
Financial intermediaries, particularly banks are the most important source of external funds used to finance businesses
The financial system is among the most heavily regulated sectors of the economy.
Only large, well established corporations have easy access to securities markets to finance their activities.
Collateral is a prevalent feature of debt contracts for both households and businesses.
Debt contracts are complicated legal documents that place substantial restrictions on the behaviour of borrowers.