OVERVIEW OF FINANCIAL SYSTEM, MONEY, FINANCIAL MARKET AND FINANCIAL INSTITUTION

1. NAME: BUSARI, RASHEED AJIBOLA
INSTITUTION : LAGOS STATE UNIVERSITY, OJO LAGOS
PROGRAMME: PhD
COURSE CODE: BFN 909
COURSE NAME: MONEY BANKING AND REGULATION
MATRIC NO: 17/9G/02G/002
LECTURER: Dr. R. Oluyitan
OVERVIEW OF FINANCIAL SYSTEM AND MONEY (A CASE STUDY OF EGYPT)
1.0 INTRODUCTION
A financial system consists of institutional units (household, corporation, or government agency)
and markets that interact, typically in a complex manner, for the purpose of mobilizing funds for
investment and providing facilities, including payment systems, for the financing of commercial
activity. It can also be defined as a system that allows the exchange of funds between financial
market participants such as lenders, investors, and borrowers. They consist of complex, closely
related services, markets, and institutions intended to provide an efficient and regular linkage
between investors and depositors.
Financial system of a country comprises of the following:
1. Financial markets
2. Financial institutions
3. Financial instrument
Financial system is synonymous to financial economics which tries to explain how the individual
units that make up a financial system impact on the economy at the macrolevel. The broader view
of a financial system is the interaction of the individual units in a way that allows efficient
allocation of funds to enhance national output of a country (GDP). Thus, financial system explains
how financial markets, financial institutions and financial instruments have impact on the
following:

2. 1. Employment in terms of job creation
2. Wages in terms of salaries
3. Government in terms of expenditure, spending and taxes
4. Imports and exports
5. Output in terms of production of goods and services
6. Interest rates in terms of savings and capital
Likewise, the financial system of a country can be categorized into the following.
1. Money and banking
2. Financial market and financial institutions
3. Monetary policies
1.1 OVERVIEW OF THE FINANCIAL SYSTEM IN EGYPT
Egypt’s financial system plays a pivotal role in the process of economic development, as the
banking system is one of the major contributors to the strength of that development. The banking
system being one of the individual units that makes up a financial system plays an intermediation
role by matching seekers of funds with providers of funds. The link between banking sector
development and economic growth is unique. Economic growth cannot be achieved without
investment, which in turn cannot be realized without the mobilization of savings. Therefore, a
sound banking sector is essential for carrying out government economic policies to achieve low
inflation, high employment, and sustainable growth.
In Egypt, the banking sector has gone through many phases since the establishment of the first
bank in 1856, Followed by the emergence of nationalization of all banks by law 117/196 and the
establishment of the Central Bank of Egypt (CBE) in 1961, then the re-emerge of private sector
and joint venture banks during the period of the Open Door Policy in the 1970s. In addition to this,
the Egyptian banking sector has been undergoing various reforms and privatization since 1991 as
the need for development of banking evolves.
According to the Central Bank of Egypt, the Egyptian banking system consist of 40 banks
categorized as commercial, non-commercial public and private sector. In practice, the vast
majority of these banks operate as commercial banks although there are few specialized banks
(agriculture and real estate). The national bank of Egypt, Bank Misr and Banque Du Caire are large

3. public sector banks which control 40 percent of the banking sector however, the Arab international
bank, Nasr social bank and the national investment bank are exempted from CBE supervision due
to special provisions in law and treaty
1.2 HISTORICAL DEVELOPMENT OF BANKING SYSTEM IN EGYPT
The first financial institutions to emerge in the process of economic development in Egypt were
foreign-owned commercial banks. The first of these banks was the Bank of Egypt which was
established in 1856 with no agreement on the size of its capital. The objectives of this bank were:
to fund the cultivation of cotton (for which the demand increased due to the American civil war in
the beginning till the mid of 1960s), to encourage trade especially between Egypt and Britain and
to finance the government current spending through the purchase of Treasury Bonds. Due to debt
problems and crisis in 1870s, many foreign banks that were established, were short lived and were
liquidated. Therefore, there was an essential need for an institution to play a role of a state bank or
in other words to be as a bank of the government. Consequently, the National Bank of Egypt (NBE)
was established in 1898, even though it was owned and managed by British citizens3. The NBE
acted as the bank of the government, an exclusive private issuer of banknotes4, and financial
adviser to the government. However, the NBE did not function as a bankers' bank, last resort lender
or controller of credit supply; but as a commercial bank, participated with other foreign
commercial banks to provide short-term finance for cotton cultivators. After that, the 1919
Egyptian revolution inspired a campaign to establish a pure Egyptian bank as a necessary element
of economic independence. It was realized that operating banks concentrated on short term
financing that that was not compatible with industrial projects.
Thus, Banque Misr was founded in 1920 and became second only to NBE. However, due to the
bank's continued practice of short term borrowing and excessive long-term lending, the bank
suddenly found itself facing difficulties and involved in high risk activities in the late 1930s.
Finally, the distinctive role of Banque Misr started to vanish, and Banque Misr ended up acting
like the rest of commercial banks
1.2.1 NATIONALIST AND SOCIALIST ERA
After the 1952 revolution and under the central planning and domination of the public sector,
Nationalization of the banking sector began with the introduction of the law 22/1957 which

4. specified that the capital of operating banks should not be less than L.E. 500 thousand, in the form
of shares owned by Egyptians, and that all operating foreign banks should be sequestrated. The
rest of the operating banks had to take the form of joint stock companies, within five years. The
government wanted to have more control over the credit market.
So the NBE, as a Central Bank, was granted more power by the Law 163/1957 which added to its
existing objectives the authority to determine interest and discount rates; act as a supervisory
authority for bank registrations, opening of new branches and mergers; and control of the credit
market using reserve and liquidity ratios. In 1961 the NBE was divided into two banks; one
retained the original name and continued as a commercial bank, the other became the Central Bank
of Egypt (CBE).
In the same year laws were passed to safeguard the creation of a centrally planned economic
system, one being Law 117/1961 which nationalized all banks. By the end of 1963, after
liquidating some of the small banks and merging others, the banking system consisted of only five
public commercial banks. In addition to these there were several other banks, an agricultural bank,
and industrial bank and three real estate banks. By 1974 there were just four commercial banks
and three specialized banks. This government intervention, during the 1960s was not necessarily
corrective as it was mainly driven by ideological motives, which left the entire banking system
publicly owned and managed.
1.2.3 OPEN DOOR POLICY
The government started to adopt what has become known as the “Infitah” or open door policy
putting into consideration that improvement in the structure of the banking system and a reform of
credit policy was essential in order to find new resources of finance and encourage the private and
foreign capital to participate in the development process.
To move towards this policy some laws were enacted beginning with law 43/1974 that allowed
foreign capital to enter joint-venture commercial banks with up to 49% (That led the number of
operating banks to increase rapidly from 7 banks in 1974 to 81 banks in 1991) . Law 120/1975 (It
defined the nature of operating all banks. It identified 3 types of banks: commercial, business and
investment, and specialized banks; or it can be classified as public sector, private and joint venture
or foreign according to ownership. ) defined the legal status of CBE, gave the banking system

5. more freedom in conducting its business, reinforce the CBE’s ability to manage monetary policy
and more provisions than those given by law163/1957.
However, during this period, Egypt faced basic macroeconomic imbalances between saving and
investment and exports and imports that resulted in low productivity, high inflation, and weak
economic management. Moreover, the Egyptian financial sector was stifled by interest-rate
ceilings (as a source of financial repression), high reserve requirements, besides the few public
sector banks were still dominating the process of savings mobilization. And for example, the
Commercial International Bank (CIB), the first joint-venture bank to be established in Egypt in
19757, came under 100% Egyptian ownership in 1987
1.2.4 THE ERSAP
As a result of the economic and financial difficulties of the late 1980’s, Egypt had to embark on a
Structural Adjustment Program (ERSAP) under IMF and World Bank supervision. The program
was divided into two phases. The first phase of ERSAP (1991-1995) focused on financial and
banking sector reform, exchange rate liberalization and fiscal and monetary contraction. The
second stage of the program (1995-1998) focused on creating the necessary environment for FDI
inflows. This included trade liberalization, financial sector reform and investment reform. Under
ERSAP 1, specific measures were taken to reach a more liberalized banking system such as
liberalizing interest rates to reduce demand for credit and encourage more savings. By June 1992,
a positive real rate of return was attained through an increase in interest rates on domestic currency
deposits, combined with lower inflation rates. Direct ceilings on bank lending were eliminated in
1992 and 1993. In 1993 branches of foreign banks were allowed for the first time to conduct
business in Egyptian pounds.
Moreover, all preferential treatments granted to the public sector in the terms and conditions of
loans were removed. In 1994, the four public sector banks were requested to reduce their shares in
joint venture banks to less than 51% then to 20%. Majority foreign ownership (more than 49%
foreign ownership of joint venture banks) was also permitted under Law No. 97/1996, which also
liberalized charges and fees for banking services. On aggregate, the outcome of the first phase of
liberalization was positive with GDP growing steadily during this period.

6. ERSAP 2 focused on increasing competitiveness by broadening and deepening the financial
system through privatization and enhancement of private sector participation in commercial
banking, securities, and insurance companies. However, privatization lagged behind as none of the
four banks was privatized even after the regulatory preparation through the issuance of Law No.
25/1998. In 1997, there was the start of a liquidity crunch caused by shortages in foreign currency.
These shortages were mainly due to the drip in tourism revenues after the November 1997 terrorist
attack in Luxor, the emerging markets crises, the drop in remittances from Egyptian expatriates,
in addition to the decline in Suez Canal receipts and the drop in oil prices, which all came at once.
The slowdown caused investment funds from international financial institutions to drop.
1.2.5 RECENT LEGAL REFORM
After public discussions for almost two years, the new banking law No.88 was passed in June
2003, and its executive regulations were issued in March 2004. This law addresses many of the
deficiencies in previous laws governing the banking system. One of the immediate implications of
the law is the improvement of capitalization of operating banks. The law will also indirectly result
in enhancing competition in the banking sector through lowering and eliminating barriers, which
limited operational flexibility.
Moreover Law 88/2003 abolished the distinction between specialized, business, and commercial
banks, and the special treatment of public banks. Inherent in its executive regulations, Law 88/2003
gives the CBE the formulation and the implementation of monetary policy with the primary
objective of keeping price stability. The CBE achieves this by using the instruments of the
overnight deposit and lending rates in addition to other instruments to manage liquidity such as
the reserve requirement ratio; CBE credit and discount rate; open market operations (deposits
acceptance, reserve repositories of treasury bills and outright sales conducted between the CBE
and banks).
The law also gives electronic signatures legal power, which will facilitate e-commerce and e-
banking services. Another recent legal reform was the passage of the anti-money laundering
(AML) law. Even before the issuance of the law, banks were required to obtain sufficient
information and documents to meet the 'know your customer' principle. The main monetary policy
parameters under the new Law No. 88/2003 are (1) the reserve requirement ratio held by banks at
the CBE is 14%. The CBE lending & discount rate is 10% per annum. (2) Rates for overnight

7. depositing and borrowing are 9.5% and 12.5% respectively as of June 2005, and (3) the Open
market operations conducted by the CBE aimed to absorb banks’ excess liquidity. LE 10.9 billion
deposits were blocked according to the market mechanism as of June 2004
2.0 THE NEED FOR FINANCIAL MARKET
Financial markets are markets in which funds are transferred from people who have an excess of
available funds to people who have a shortage. Financial markets perform the essential economic
function of channeling funds from households, firms, and governments that have saved surplus
funds by spending less than their income (Savers) to those that have a shortage of funds because
they wish to spend more than their income (Spenders). The lenders-savers and borrower-spenders
are
1. Households
2. Corporations
3. Governments
The channeling of funds between lenders-savers and borrowers-spenders side of the economy have
direct effects on personal wealth, the behavior of businesses and consumers, and the cyclical
performance of the economy.
There are two ways of financing the two side (lenders-savers and borrower-spenders) side of the
economy
1. Direct financing
2. Indirect financing
The financial market caters for the direct financing while the financial institutions caters for
indirect financing.
Direct financing is when channeling of funds between lenders-savers and borrower-spenders are
done directly by the market participants without an intermediary while indirect financing is when
channeling of funds between lenders-savers and borrower-spenders are done directly by the market
participants with the help of an intermediary (e.g. banks, insurance companies, pension funds etc.)

8. Financial market can be broadly categorized into:
1. Primary market
2. Secondary market
2.1 PRIMARY MARKET
This is a market where new issue of financial instruments are offered directly to the public. It is a
market where funds are raised directly by channeling funds from savers (households, corporations)
to user of funds (households, corporations). Those that provide funds are called investors.
2.2 SECONDARY MARKET
This is a market where instruments purchased via primary market are sold again. In this market,
fresh issues are not offered but existing issues are re-sold to another investors. Thus, it can be said
it is a market where investors sell financial instrument to another investor. Secondary market
measures the following
1. Liquidity of the financial instrument
2. Pricing of the instrument
The ease of selling instruments in a secondary market reflects the performance of the corporation
which in turn increases the value or price of the corporation’s instruments in primary market.
Thus, Financial market is composed of the following
1. Money market
2. Capital market
Money market are market where short term financial instruments of a year and less than a year are
traded and the price of the instruments are usually fixed while capital market is a market for trading
long term financial instruments of more than a year and always experience price fluctuations.
Money market instruments can be the following
1. Treasury bills: this is short term debt instruments issued by the government to borrow
money from the public (households, corporations, and financial institutions). Its usually
issued at a discounted rate and it is offered in 3 Months, 6 Month, 9 Months & 12 Months.

9. Treasury bills is the most actively traded and liquid money market instrument and its
usually risk free because its issued by the government
2. Certificates of Deposit: A certificate of deposit (CD) is a debt instrument sold by a bank
to depositors that pays annual interest of a given amount and at maturity pays back the
original purchase price. Negotiable CDs are usually sold in secondary markets are an
extremely important source of funds for commercial banks, from corporations, money
market mutual funds, charitable institutions, and government agencies.
3. Commercial papers: is an instrument issued by large corporations with good credit ratings
and outstanding performance to source funds from households, corporations, and
government agencies. They are issued at a discount rate and the tenor is always less than a
year
4. Repurchase agreements (REPO): Repurchase agreements (repos) are effectively short term
loans (usually with a maturity of less than two weeks) for which Treasury bills serve as
collateral, an asset that the lender receives if the borrower does not pay back the loan.
REPOS are usually used by large corporation that have idle funds in their banks to loan
banks in which the corporations now used the treasury bills purchased as a collateral.
Capital market is a market for trading long term financial instruments of more than a year and the
market always experience price fluctuations. Capital market can be divided into
1. Equity market
2. Debt market
Equity market is a market where stocks/shares are traded. Stocks can be defined as the residual on
the net income and asset of a corporation. Trading in this market can be done via an exchange
market like stock exchange or via over the counter (OTC).
Debt market are market where bonds, real estate, commodities, golds currency are traded. Debt
market usually trade in instrument that are of long-term instruments and the most common type is
the bond market. Bonds are long term instruments usually issued by corporations and government
with strong credit ratings and its usually a debt instrument. Bonds issued by corporations are called
corporate bonds while those issued by government are called government bond. The typical bond
sends the holder an interest payment twice a year and pays off the face value when the bond
matures. Some corporate bonds, called convertible bonds, have the additional feature of allowing

10. the holder to convert them into a specified number of shares of stock at any time up to the maturity
date. This feature makes these convertible bonds more desirable to prospective purchasers than
bonds without it and allows the corporation to reduce its interest payments because these bonds
can increase in value if the price of the stock appreciates sufficiently.
To raise more capital and allow the internationalization of the corporation brand, most corporations
and government issued a special type of bond called Eurobond and foreign bond. Eurobond is a
type of bond issued in another country and currency other than the corporation’s country and
currency. For example. A corporation in Egypt can issue an Eurobond type of bond in United states
and it will be denominated in US dollars, while foreign bond is a type of bond issued in the
corporation country and currency but sold in another country.
3.0 THE NEED FOR FINANCIAL INSTITUTIONS
Financial institution matches savers of fund in the surplus side of the economy tot the user of funds
in the deficit side of the economy. The process of linking savers and user funds is known as
financial intermediation. Financial intermediation ensures efficient allocation of funds with an
economic system. Financial intermediation uses indirect financing by serving as agents for the
distribution of funds between the savers of funds and users of funds.
Financial institutions are the most important and easiest source of financing than financial market.
Financial institutions are important to both the surplus and deficit side of the economy because of
the following
1. Transaction cost.
2. Risk sharing
3. Economies of scale and conflicts of interest
4. Asymmetric information
Asymmetric information is a major factor threatening the existence of financial institutions.
Asymmetric information is when a party to a transaction has more and perfect information
regarding the transaction than the other party.

11. Asymmetric information leads to the following
1. Adverse selection
2. Moral hazard
Adverse selection occurs before transaction exist and this is when the lender feels that lending
money to a borrower might potentially result in an undesirable outcome(adverse selection) due to
some information like bad credit ratings, personality of the borrowers management etc. that the
lender has about the borrower
Moral hazard occurs after the transaction has occurred and this when the borrower might engage
in hazards (risk) that might affect the borrower from paying back her loan.
3.1 STRUCTURE/TYPES OF FINANCIAL INSTITUIONS
1. Depository institutions: this can be categorized into commercial banks, savings and loans
institutions, credit unions and mutual savings institutions.
2. Contractual savings institutions: this can be categorized into insurance companies and
pension funds institutions
3. Investment institutions: this can be categorized into finance companies, mutual funds
companies and money market funds companies
4. Specialized institutions: this can be categorized into agriculture financing institutions, real
estate financing institutions, infrastructure, and development financing institutions
3.2 FUNCTIONS OF FINANCIAL INSTITUTIONS
1. Financial institutions like the central bank help in regulating the money supply in the
economy. They do it to maintain stability and control inflation.
2. Financial institutions, like commercial banks, help their customers by providing savings
and deposit services. They provide credit facilities like overdraft facilities to the customers
for catering to the need for short-term funds.
3. Financial institutions, like insurance companies, help to mobilize savings and investment
in productive activities. In return, they provide assurance to investors against their life or
some particular asset at the time of need. In other words, they transfer their customer’s risk
of loss to themselves.

12. 4. Financial institutions help in capital formation, i.e., increase in capital stock like the plant,
machinery, tools and equipment, buildings, means of transport and communication, etc.
They do so by mobilizing the idle savings from individuals in the economy to the investor
through various monetary services.
5. There are several investment options available at the disposal of individuals as well as
businesses. But in the current swift changing environment, it is very difficult to choose the
best option. Almost all financial institutions (banking or non-banking) have an investment
advisory desk that helps customers, investors, businesses to choose the best investment
option available in the market according to their risk appetite and other factors.
6. These institutions provide their investors access to several investment options available in
the market that ranges from stock, bonds (common investment alternative) to hedge funds,
and private equity investment (lesser-known alternative).
7. Financial institutions, through their various kinds of investment plans, help the individual
in planning their retirement. One such investment options is a pension fund, where the
individual contributes to the pool of investment set up by employers, banks, or other
organizations and get the lump sum or monthly income after retirement.
8. Financial institutions are regulated by the government on a national level. They act as a
government agent and help in the growth of the nation’s economy. For example, to help an
ailing sector, financial institutions, as per the guidelines from the government, issue
selective credit line with lower interest rates to help the sector overcome the issues it is
facing.
4.0 THE NEED FOR MONEY
Economists define money (also referred to as the money supply) as anything that is generally
accepted in payment for goods or services or in the repayment of debts. Money could mean
anything that serves as a means of payment for goods and services and it does not necessarily mean
currency or coins.
Money could also be defined as anything that serves as a store of value (gold, assets, properties,
luxury items, stocks etc.) which made some school of thought to define money as wealth.
Money is a pivotal aspect of the economy as it is a measure of wealth distribution, medium of
exchange and allocation of resources in the economy. Money serves important role in the economy

13. because it is a measure of value as it relates to income (per capita income) and wealth with respect
to households, corporations, and government. Another important need of money in an economy is
reduction of transaction cost as this eliminates the wasting of time and resources in looking for
another person that needs a resource that another party want to exchange (barter system)
For a commodity, items, or resources to function effectively as money, it must meet some criteria:
(1) It must be easily standardized, making it simple to ascertain its value.
(2) it must be widely accepted.
(3) it must be divisible, so that it is easy to “make change”
(4) it must be easy to carry
(5) it must not deteriorate quickly.
4.1 FUNCTIONS OF MONEY
Irrespective of the form of money whether paper, rock, stone, gold etc., money serves three
important functions
1. As a medium of exchange
2. As a store of value
3. As a unit of account
Out Of the three functions, its function as a medium of exchange is what distinguishes money from
other assets such as stocks, bonds, and houses.
4.2 EVOLUTION OF PAYMENT SYSTEM
The payments system has been evolving over centuries, and with it the form of money. At one-
point, precious metals such as gold were used as the principal means of payment and were the
main form of money. Later, paper assets such as checks, and currency began to be used in the
payments system and viewed as money. Where the payments system is heading has an important
bearing on how money will be defined in the future.

14. The timeline for the evolution of payments are:
1. From times unknown to 3000 B.C.: Payment system is in its nascent phase. The barter
system is followed. People exchange goods for goods with the value of each good
predecided.
2. 3000 B.C.: Barley is used as token money. Payment system now works with commodity
money instead of simple barter.
3. Around 700 B.C.: Coins are minted. Payment is now distinct coins that hold value.
4. 17th Century: Heavy coins have started becoming a menace and we have upgraded to bank
notes. (There still hangs the question of which came first? The note or the cheque) This is
plain hard cash we still use. Funny how we are still using a 17th Century payment method
right?
5. 1659: Cheques are introduced only they are called drawn notes. It was first used by Messrs.
Morris and Clayton, scriveners, and bankers of the city of London.
6. 20th Century: Digital payment is here. You can pay money without cash or cheque. Value
is now assigned to 1’s and 0’s on a system that recognizes you and knows how much cash
you have. Life without cash/cheque is possible.
7. 21st Century: Digital payments have evolved at breakneck speeds. We now have one-click
payments, e-wallets, and cryptocurrencies. But we still are using cash, cheques, and cards,
just to be safe.
The following are the categorization of payment system.
1. Commodity money: Money made up of precious metals or another valuable commodity
is called commodity money, and from ancient times until several hundred years ago,
commodity money functioned as the medium of exchange in all but the most primitive
societies. The problem with a payments system based exclusively on precious metals is
that such a form of money is very heavy and is hard to transport from one place to another.
2. Fiat Money: The next development in the payments system was paper currency (pieces of
paper that function as a medium of exchange). Initially, paper currency carried a guarantee
that it was convertible into coins or into a fixed quantity of precious metal. However,
currency has evolved into fiat money, paper currency decreed by governments as legal
tender (meaning that legally it must be accepted as payment for debts) but not convertible

15. into coins or precious metal. Paper currency has the advantage of being much lighter than
coins or precious metal, but it can be accepted as a medium of exchange only if there is
some trust in the authorities who issue it and if printing has reached a sufficiently advanced
stage that counterfeiting is extremely difficult. Because paper currency has evolved into a
legal arrangement, countries can change the currency they use at will.
3. Checks: A check is an instruction from you to your bank to transfer money from your
account to someone else’s account when she deposits the check. Checks allow transactions
to take place without the need to carry around large amounts of currency. The introduction
of checks was a major innovation that improved the efficiency of the payments system.
4. Electronic payment: The development of inexpensive computers and the spread of the
Internet now make it cheap to pay bills electronically. In the past, you had to pay bills by
mailing a check, but now banks provide websites at which you just log on, make a few
clicks, and thereby transmit your payment electronically. Not only do you save the cost of
the stamp, but paying bills becomes (almost) a pleasure, requiring little effort. Electronic
payment systems provided by banks now even spare you the step of logging on to pay the
bill. Instead, recurring bills can be automatically deducted from your bank account.
Estimated cost savings when a bill is paid electronically rather than by a check exceed one
dollar per transaction. Electronic payment is thus becoming far more common in the United
States.
5. E-Money: Electronic payments technology can substitute not only for checks but also for
cash, in the form of electronic money (or e-money)—money that exists only in electronic
form. The first form of e-money was the debit card. Debit cards, which look like credit
cards, enable consumers to purchase goods and services by electronically transferring
funds directly from their bank accounts to a merchant’s account.
6. Virtual Money: this is the latest trend in payment system in which currency are generated
electronically and virtually via mining of currency on the computer. It come in form
cryptocurrency.
As the various payment system evolves, the evolution solves the convenience in carrying out
transactions and payment of goods and services.

16. 4.3 MEASUREMENT OF MONEY
The definition of money as anything that is generally accepted in payment for goods and
services tells us that money is defined by people’s behavior. What makes an asset money is
that people believe it will be accepted by others when making payment. As we have seen, many
different assets have performed this role over the centuries, ranging from gold to paper
currency to checking accounts. For that reason, this behavioral definition does not tell us which
assets in our economy should be considered money. To measure money, we need a precise
definition that tells us exactly which assets should be included. The following parameters
measure money:
1. M1; this is the narrowest measure of money and it includes asset that are in liquid form
(checking account deposit, travellers cheque and currency). M1 does not include money
in ATMS and bank vault. However, it includes paper money and coins in the hands of
non-bank public. M1 measures currency and coins in circulations.
2. M2: The M2 monetary aggregate adds to M1 other assets that are not quite as liquid as
those included in M1: assets that have check-writing features (money market deposit
accounts and money market mutual fund shares) and other assets (savings deposits and
small-denomination time deposits) that can be turned into cash quickly at very little
cost. M2 are money that you can withdraw and spend, but which require a greater effort
to do so than the items in M1. M2 includes items in M1 plus money and coins in the
hands of public bank, time deposit, savings deposit, money market funds, treasury bills
and certificate of deposit.
5.0 THE NEED FOR MONETARY POLICY
Monetary policy is an economic policy that manages the size and growth rate of the money supply
in an economy. It is a powerful tool to regulate macroeconomic variables such as inflation and
unemployment.
These policies are implemented through different tools, including the adjustment of the interest
rates, purchase, or sale of government securities, and changing the amount of cash circulating in
the economy. The central bank or a similar regulatory organization is responsible for formulating
these policies.

17. 5.1 OBJECTIVES OF MONETARY POLICY
The primary objectives of monetary policies are the management of inflation or unemployment,
and maintenance of currency exchange rates.
INFLATION
Monetary policies can target inflation levels. A low level of inflation is considered to be healthy
for the economy. If inflation is high, a contractionary policy can address this issue.
UNEMPLOYMENT
Monetary policies can influence the level of unemployment in the economy. For example, an
expansionary monetary policy generally decreases unemployment because the higher money
supply stimulates business activities that lead to the expansion of the job market.
CURRENCY EXCHANGE RATES
Using its fiscal authority, a central bank can regulate the exchange rates between domestic and
foreign currencies. For example, the central bank may increase the money supply by issuing more
currency. In such a case, the domestic currency becomes cheaper relative to its foreign
counterparts.
5.2 TOOLS OF MONETARY POLICY
Central banks use various tools to implement monetary policies. The widely utilized policy tools
include:
INTEREST RATE ADJUSTMENT
A central bank can influence interest rates by changing the discount rate. The discount rate (base
rate) is an interest rate charged by a central bank to banks for short-term loans. For example, if a
central bank increases the discount rate, the cost of borrowing for the banks increases.
Subsequently, the banks will increase the interest rate they charge their customers. Thus, the cost
of borrowing in the economy will increase, and the money supply will decrease.

18. CHANGE RESERVE REQUIREMENTS
Central banks usually set up the minimum amount of reserves that must be held by a commercial
bank. By changing the required amount, the central bank can influence the money supply in the
economy. If monetary authorities increase the required reserve amount, commercial banks find
less money available to lend to their clients and thus, money supply decreases.
Commercial banks cannot use the reserves to make loans or fund investments into new businesses.
Since it constitutes a lost opportunity for the commercial banks, central banks pay them interest
on the reserves. The interest is known as IOR or IORR (interest on reserves or interest on required
reserves).
OPEN MARKET OPERATIONS
The central bank can either purchase or sell securities issued by the government to affect the money
supply. For example, central banks can purchase government bonds. As a result, banks will obtain
more money to increase the lending and money supply in the economy.
5.3 EXPANSIONARY VS. CONTRACTIONARY MONETARY POLICY
Depending on its objectives, monetary policies can be expansionary or contractionary.
EXPANSIONARY MONETARY POLICY
This is a monetary policy that aims to increase the money supply in the economy by decreasing
interest rates, purchasing government securities by central banks, and lowering the reserve
requirements for banks. An expansionary policy lowers unemployment and stimulates business
activities and consumer spending. The overall goal of the expansionary monetary policy is to fuel
economic growth. However, it can also possibly lead to higher inflation.
CONTRACTIONARY MONETARY POLICY
The goal of a contractionary monetary policy is to decrease the money supply in the economy. It
can be achieved by raising interest rates, selling government bonds, and increasing the reserve
requirements for banks. The contractionary policy is utilized when the government wants to
control inflation levels.

19. 6.0 NATURE OF LENDING AND DECOMPOSITION OF LENDING
In finance, a loan is the lending of money by one or more individuals, organizations, or other
entities to other individuals, organizations etc. The recipient (i.e., the borrower) incurs a debt and
is usually liable to pay interest on that debt until it is repaid as well as to repay the principal amount
borrowed. Lending (also known as "financing") occurs when someone allows another person to
borrow something. Money, property, or another asset is given by the lender to the borrower, with
the expectation that the borrower will either return the asset or repay the lender. In other words,
the lender gives a loan, which creates a debt that the borrower must settle
In relation to banks, lending or giving out of loan is one of the major reasons why bank exists and
its one of the core functions of a bank. No bank survives without giving out loan because its one
of the financial intermediation processes. Banks receive deposits from households, firms and
government (surplus side of the economy) and give it to the deficit side of the economy
(households, firms and government) as loans in from of capital for acquisition of resources which
in turn lead to economic growth and development. Also, banks do keep part of the deposit received
in form of CRR (Cash reserve ratio) with the regulatory authorities (central bank). The CRR serves
as one of the measures used by the central banks to control money supply in the economy. For a
bank to survive, there must be a very strong lending or credit policy framework with a strong will
from the management of the institution based on the following principles:
 Safety
 Liquidity
 Spread
 Purpose
 Security
 Policy validation
 Profitability
Also, before loan can be given out, there are some principles that borrower must have. The
principles are known as 5C of credit

20.  Character
 Capacity
 Capital
 Collateral
 condition
Lending can equally be categorized into the following
 Secured lending
 Unsecured lending
 Syndicated lending