- Distinguish between banking and non banking financial institutions.
- Identify the different types of bank accounts and how commercial banks reconcile liquidity and profitability security.
- Distinguish between assets and liabilities of commercial banks.
- Explain the functions, role and limitations of commercial banks in Rwanda.
- Identify the role of foreign commercial banks in Rwanda.
- State the functions of the Central Bank of Rwanda.
- Explain the objectives and tools of monetary policy.
- Give examples of non banking financial institutions in Rwanda.
- Assess the role of the different types of financial institutions in an economy.
- Examine the conflicting ideas of profitability and liquidity for commercial banks.
- Describe the process of credit creation in commercial banks.
- Examine the applicability of monetary policy tools in Rwanda.
- Describe the operation of financial markets in Rwanda.
- Recognise the role of financial institutions in economic development and be a responsible citizen in relation to financial matters.
6.1 Financial institutions
6.1.1 Meaning
Financial institutions are institutions which bring together borrowers and lenders of money. Financial intermediaries can be described as those institutions, which stand between savers and borrowers, integrating and satisfying the interest of both.
They accept time and saving deposits from customers and lend out money on a longer term basis. They transfer funds from those with surplus money balances to the would-be borrowers who wish to use these funds for investment or consumption purposes. They deal in primary and secondary securities.
Activity 1
Using photographs a, b and c in figure 1 below, identify the following:
1. What do the institutions below deal in?
2. What are financial institutions?
3. What are the functions of such institutions in Rwanda?
4. Give any other institutions that deal in such an activity in your locality.
5. Classify the various financial institutions in Rwanda.
6.1.2 Types of financial institutions
There are basically two types of financial intermediaries and these include:
1. Banking financial intermediaries such as commercial banks and the central bank; and
2. Non-banking financial intermediaries.
Functions of financial intermediaries
Specifically, financial intermediaries have vital roles to play in a modern economy which include:
• They act as a go-between savers and borrowers. They facilitate direct contact between savers and borrowers.
• They purchase government bonds and securities.
• They improve the utilisation of scarce resources by providing facilities for investment in plant, equipment, and so on,
through loans, mortgages, purchases of bonds share.
• They spread their risk between different borrowers; create financial assets and substantially add to the stock of
financial assets available to the lenders.
• They provide liquidity easily and quickly through the conversion of an asset into cash without any loss in their value.
• They maintain equilibrium between the demand and supply of financial assets, bring about stability in the capital market;
• They increase the liquidity of the financial system. Financial intermediaries increase the liquidity of the financial system
through giving out loans. They also invest the proceeds into treasury bills, bonds, business firm shares; and
• They facilitate the pooling of risks. Lending is wrought with risks. Important among these is default by borrowers.In a
situation where individual savers would have to find corresponding borrowers, the risk of one losing the savings would
be high.
6.2 Banking financial institutions
Activity 2
Using photographs a, b and c in Figure 1 on page 182-183, individually work in your exercise books.
1. What are banking financial institutions?
2. Name the examples of commercial banks you know in Rwanda.
3. What is the relationship is between photographs a b and c?
4. What are the functions of commercial banks in Rwanda?
5. Name the different accounts run by commercial banks.
6. Which account would you open up and why?
Facts
Banking financial institutions are institutions which receive deposits from the public; give loans on short-term basis and create new deposits by loaning more amounts of funds deposited by customers. They include:
1. Commercial banks
2. Central banks.
6.2.1 Commercial banks
These are financial institutions that provide retail banking services such as providing types of accounts for their customers and facilitating a payment mechanism. Examples are Fina Bank, Eco Bank; Banque Populaire du Rwanda SA (BPR), Bank of Kigali-BK, Access Bank Rwanda, Commercial Bank of Africa (Rwanda), Guaranty Trust Bank (GTB), I&M Bank (Rwanda), Crane Bank Rwanda, etc.
Functions of commercial banks
Credit creation
In this role, the commercial bank accepts deposits and lends money out (grant loans) at an interest.
Transmission of money
Commercial banks provide facilities for domestic and foreign transfer of money. Provision of such facilities can be done through issuing of cheques, credit transfer, standing order, or direct debit transfer. Banks can also transfer funds outside the country by making payments abroad on behalf of their customer thus facilitating international trade. They sell traveller’s cheques to their customers wishing to travel abroad.
Advisory services
Banks also offer advisory services to their customers usually charging for these services. The range
of such services includes: trusteeship, foreign exchange, and investment management, among others.
Other financial products Commercial Banks can offer other financial products to their customers such as mortgages
and insurance.
Provision of credit facilities
Commercial banks channel the accumulated funds or deposits received under the different accounts into productive uses
in the form of loans, advances, overdraft facilities and cash credits to their customers.
Provision of facilities for safekeeping deposits
Commercial banks provide facilities for safeguarding of valuables like jewelery and documents such as land titles. They also look after the property of dead customers and distribute their assets as laid down in their respective wills.
Open up and run different accounts
Commercial banks open up and run different accounts on behalf of their clients. These accounts include:
1. Current accounts: The opening of a current account provides the customer with the facilities of drawing cheques, arranging
for regular payments by standing orders and having payments such as salaries credited direct into the account.
2. Savings accounts: The main feature of this account is that it stipulates a minimum/maximum monthly subscription which
must be maintained for a set term usually a minimum of 12 months.
3. Fixed deposit accounts: Here the customers deposit a certain amount of money for a period of time without withdrawing
it. There is a high interest earned on this deposited money. The money is only withdrawn after a certain period of time.
Liquidity and profitability in commercial banks
Activity 3
Visit any of the nearest commercial bank branches in your locality. Research on the following:
1. How do commercial banks reconcile the conflicting objectives of liquidity and profitability?
2. What is the difference between assets and liabilities of a bank?
3. Give examples in each case.
Facts
Each commercial bank has to maximise its profits without losing sight of its liquidity. Therefore, commercial banks
must be highly efficient in their portfolio management by maintaining an optimum balance between the two conflicting
objectives of liquidity and profitability.
Liquidity: Liquidity is the bank’s ability to convert its assets into cash quickly without any loss of value. The presence of a high proportion of liquid assets in the total assets of a commercial bank is a sign of its strength. Liquid assets are assets which can conveniently, easily and quickly be converted into cash. The higher the proportion of such assets, the lower the liabilities of a commercial bank and vice versa. This partly means that the bank cannot invest most of its funds in long-term projects or securities. It also implies that the bank will be unable to earn high profits. Therefore, a commercial bank must manage its objectives of liquidity so as to gain public confidence and, therefore, the bank should keep all its deposits in cash or in a liquid form, i.e. near cash.
Profitability:Profitability is the prime goal of any commercial bank. All its operations must bring income to enable it to meet its running costs; make payments of interest to its depositors; and yield reasonable return to its owners. Therefore, the bank should manage its portfolio in such a way that it maximises its profits.
Liquidity-profitability dilemma
The objectives of liquidity and profitability are conflicting in nature. They are not compatible. A bank can either achieve the objective of liquidity or that of profitability but not both. Cash, money at call and short notice and bills are all liquid assets, in varying degrees, but they yield very low income or bring very low profits to the bank. Loans are quite profitable but are less liquid and investments fall in between these two.
Banks must be prepared to make payments to its customers as and when they are needed by maintaining a high degree of liquidity, that is, it should have all its funds as cash reserves. However, this will not bring any profits to the bank. On the other hand, banks want to maximise profits by investing their funds in long-term assets, with high profitability but less liquidity. Thus the Liquidity-profitability dilemma.
How commercial banks balance liquidity and profitability
Given the conflicting nature of the above objectives, the bank has to act very carefully to strike an optimum balance.
To solve this conflict, the bank does the following:
• Maintains a certain percentage of deposits in cash form (cash reserve ratio) to cater for the withdraw needs of customers –
This maintains liquidity while the lent out amount caters for the profitability interests of the bank.
• Maintains reserves at the central bank so that in case it is unable to meet the liquidity needs of depositors, it may make use
of such reserves.
• The bank may invest in security and other assets in an effort to make profits. However, the bank should make sure that while
it invests for profits, it invests in liquid assets which can easily be turned into cash in case need arises for liquidity, thus striking
a balance between liquidity and profitability.
• As commercial banks lend out money in form of loans, it advances them in such a way that they receive repayments more
regularly, e.g. advancing both short-term, medium-term and long-term loans to ensure a regular and constant payment system.
• Commercial banks set a minimum deposit balance on the customers’ account below which customers are not allowed to draw.
This maintains sufficient liquidity since accumulated balance cannotbe withdrawn, pool up to a large sum that can meet the
liquidity needs of depositors.
• Commercial banks borrow from the central bank, as a lender of the last resort, in situations where they are unable to meet
the daily needs of its customers.
• Commercial banks invest in non-banking activities such as transport, buildings, industries, etc. so as to maintain profitability
through earning extra money to supplement bank activity-generated revenue.
• Commercial banks charge a fee for the services they provide as a means of raising more revenue to increase profitability and
liquidity e.g. bank statements, ledger fee cheques clearing, ATM withdrawals, storage of valuables, etc.
• Commercial banks discount bills of exchange and earn a profit at the maturity of the bills, i.e. buy the bills from holders at
less than their value of maturity, thus achieving profitability.
• Paying low interest to depositors and charging a high interest on borrowers, thus making profits and bringing in cash.
• Demanding collateral security to avoid loss of money.
Assets and liabilities of commercial banks
Assets
These are possessions of the bank plus its claims on other financial institutions and clients. They include:
• Cash in hand and reserves with the central bank;
• Deposits with other banks and non-banks;
• Loans advanced and overdrafts to customers; and
• Fixed assets and long-term investments.
Liabilities
These are claims by the outside world. Or they are properties that belong to the people but not the bank. They include:
• Money on fixed, current and saving accounts;
• Deposits by other banks and non-banks; and
• Government deposits in the bank.
Credit creation by commercial banks
Activity 4
Visit any nearest commercial bank branch in your locality. Research on the following:
1. What is meant by credit creation?
2. How do commercial banks create credit?
3. What are the factors that determine ability of commercial banks to create credit?
4. Analyse the difficulties met in the process of credit creation by commercial banks in Rwanda.
Facts
Credit creation is the process by which commercial banks create credit by lending out money using cheques.
OR It is the process by which commercial banks create additional deposits by way of extending loans to borrowers.
The volume of money accumulates with time basing on the interest charged.
Commercial banks are required to keep a certain amount of money to meet the daily requirements of its customers
and this is known as cash ratio.
Assumptions of credit creation
• Assumes one bank with many branches which have cooperation among themselves;
• A certain cash ratio is given and maintained;
• All banks are willing to advance loans to the borrowers who meet the minimum conditions for borrowing;
• All payments are made through the banks using cheques;
• The money that the bank loans out is deposited back in the same bank or another bank;
• The public is willing to borrow from banks; and
• There should be no government interference.
Example
Assume a single bank with an initial deposit of 10,000 FRW with a cash ratio of 20% and 4 people A, B, C and D.
(a) Describe the process of credit creation.
(b) Find the rate of credit multiplier and final deposit.
Customer A deposited 10000 FRW to the bank. The bank kept 20 %( 2000) as cash ratio and lent out 80 % (8000) to customer B. Customer B deposited the same cheque in the same bank. Out of 8000 FRW, the bank kept 20% (1600) as cash ratio and loaned out 6400 to customer C. The process continues until no further loans are available for lending out.
Note The number of times initial deposit multiplies itself to give a final depositis called credit multiplier (cm).
Exercise
Work out, and interpret the following in your exercise books:
1. Given a cash ratio of 20% and an initial deposit of 10,000.Calculate the credit multiplier and final deposit.
2. Given that the initial deposit in the bank is 20,000 FRW and the total credit created amounts to 100,000 FRW.
Calculate the credit multiplier.
3. Given that the final deposit is 80.000 FRW, and cash ratio is 20%, calculate the initial deposit. Given the initial deposit
of 20.000 FRW and credit multiplier of 4, calculate the total credit created.
Determinants of commercial banks’ ability to create credit
Deposits make loans and loans make deposits. Nevertheless, commercial banks do not have limitless powers to create credit. The ability to create credit is thus determined by many factors which include the following:
Conditions of trade and business in the economy
During times of business prosperity when opportunities for profitable investments are greater, there is a high demand for bank loans from individuals and businesses, thus banks are better positioned to create more credit. Contrariwise, during periods of recession, because of the limited scope of profitable investments, the demand for credit is low, thus the powers to create credit are diminished.
Banking habits of individuals (Whether people believe in the use of cheques or cash)
The power of a commercial bank is reduced if people are accustomed to the use of cash in their transactions. On the other hand, the power of a bank to create credit is harnessed if there is increased use of cheques.
Availability of good securities
If there is availability of adequate amounts of valuable collateral, for instance stocks, bill, bonds and shares, commercial banks can expand their lending activities and hence their powers to create credit are augmented. And if securities are not available in adequate amounts, then their powers for credit creation are limited.
Willingness to deposit (propensity to deposit)
If individuals are willing to deposit, then credit creation will be high and vice versa.
Cash reserves
The power of commercial banks to create credit depends on the cash reserves. The larger the cash reserves,
the greater the credit creation and vice versa.
Cash ratio
Cash ratio is the proportion of cash kept by commercial banks to meet the daily requirements of the customers. If the cash ratio is high, there will be less credit creation and vice versa.
Propensity to demand loans
If the propensity to demand loans is high, then credit creation will be high and vice versa.
The country’s monetary policy
If the country pursues an expansionary monetary policy, credit creation is likely to be high. However, if the country is pursuing a restrictive monetary policy, credit creation will be limited.
Limitations of commercial banks to create credit in Rwanda
• Difficulty in mobilising savings because of widespread poverty among the people and this reduces money available to
lend out.
• Illiteracy of the people who do not keep their money in banks and do not know the operations of the banks.
• Too much government interference in the activities of the banks makes it hard for them to carry out their activities.
• Existence of a large subsistence sector which does not generate enough incomes to the people necessary to save
in the banks.
• Lack of credit worthiness among borrowers – Some people take loans from the banks and fail to pay back hence banks
get losses.
• Too much liquidity preference. People prefer to hold money in cash rather than depositing it. This reduces the money
available with the commercial banks to lend out.
• Low demand for loans because of lack of collateral security such as land, and other property.
• Inflation which limits saving because money may have lost value so people prefer to invest than saving.
• High competition for customers because most of them are located in urban centres and this leads to low deposits; and
• Poor infrastructure characterised by poor roads, telecommunication all limiting the activities.
Role of commercial banks in Rwanda
Activity 5
1. Analyse the role of commercial banks in the development process of Rwanda.
2. State the problems that hinder the smooth operation of commercial banks activities in Rwanda.
3. Suggest measures that can be taken by the government of Rwanda to boost the banking sector.
Facts
In addition to the services that commercial banks provide to the public, they play a big role in fostering the economic development of Rwanda as below:
• They advance short-term and long-term loans to the business community. This facilitates new investment and expansion
of the existing ones, thus promoting economic growth and development.
• They also offer loans to customers to improve their standards of living, e.g. to purchase houses, and other expensive
consumer goods that they otherwise could not afford.
• They create employment opportunities by employing people as auditors, accountants, managers, tellers, drivers, security
guards, cleaners, etc. This helps solve the unemployment problem in Rwanda.
• They mobilise savings from the public by paying interest on deposits. This encourages flow of funds from savers to borrowers,
therefore, encouraging productive investment activities that promote economic growth and development in the country.
• Commercial banks provide technical and professional advice to customers, i.e. investors and business people, which helps
them make sound investment decisions, e.g. on best projects to
be financed and efficient running of companies, thus creating
a healthy and efficient economy.
• Commercial banks pay taxes to the government from their profits made, of which revenue is used to finance various
government expenditures.
• Commercial banks facilitate international and domestic trade by making available foreign exchange, letters of credit and
money transfer services. This increases the flow of
technology, ideas and skills and other resources in the country that
facilitates increase in the productive capacity of Rwanda.
• Commercial banks act as agents of the central bank to implement monetary policy since they deal directly with the public.
This enables the government through the central bank to regulate economic activities within the economy and achieve specific
development goals, for example, controlling inflation in Rwanda
• They receive payments for their customers, for instance, salaries which promotes effective and efficient planning by
consumers and producers.
• Commercial banks facilitate quick and easy means of payments through use of cheques and standing orders. This helps to
create money in the public without the central bank having to print more currency.
• They help keep valuable documents and articles of customers such as marriage certificates diplomas, wills, etc.
• They manage the property of the deceased customers and distribute assets as laid down in the will. This avoids conflict and
social tension among the public, thus bringing about peace and harmony that is necessary for a conducive investment climate
in an economy.
• They help in transforming the economy from a subsistence economy to a monetary economy especially in rural areas
through advancing loans to the public for productive activities. This calls for the establishment of banks in most rural
areas, thus promoting development.
• They promote technology in the economy, for example through the use of ATMs, SMS banking, all which bring about
economic development of the country.
• They facilitate the process of capital formation through the promotion of savings and investment. This, therefore,
expands productivity in the economy and breeds economic growth and development.
Limitations of commercial banks in Rwanda
Much as the banking business in Rwanda provides a lot of benefits to the Rwandan economy, it is faced with many problems which limit its operation and they include, among others, the following:
High liquidity preference among the public
Many people in Rwanda prefer to hold wealth in cash than depositing it with the commercial banks. This reduces the volume of transactions the commercial banks handle, thus reducing their would-be profit earnings to sustain their activities.
Unfavourable policies against private commercial banks
In Rwanda, there is a rate of taxes charged on commercial banks which reduces their profit margin, thus adversely affecting their operation.
Lack of well qualified, competent and trustworthy employees for commercial banks
The qualified personnel at times tend to be corrupt and end up misusing the banks’ resources.
Stiff competition in the banking business
This has led some banks to reduce on the interest rate on loans, increase interest on deposits and introduce very many services. This has increased operating costs, reduced profit and in some cases, banks have even failed to meet running costs, leading to their closure.
Low savings
In Rwanda, due to massive poverty, the level of savings and deposit is low. This has greatly affected the commercial bank in sustaining its operations due to insufficient deposits.
The subsistence nature of most Rwandan societies
This, together with ignorance of most people in Rwanda, has greatly affected the banking activities in Rwanda.
The prevalent fear of borrowing and loaning culture
Many people in Rwanda are unwilling to go for loans due to limited investment opportunities. This greatly affects the lending potential of commercial banks thus lowering their profits as well.
Poor communication network in form of roads, telephone system and internet connections
This makes the flow of information and transactions difficult between or among the commercial bank branches countrywide.
Bureaucracy, inefficiency and arrogance by some bank officials
This has scared away the would-be customers in some commercial bank branches in the country, thus hindering their operation as well.
Banking conditions
Some commercial bank conditions tend to discourage the would-be customers who may wish to open up accounts with commercial banks, for example, a high minimum initial deposit.
High marginal propensity to consume ( MPC)
In Rwanda, there is a high MPC implying a low MPS, thereby limiting commercial banks capacity to mobilise adequate savings.
High government interference
The government of Rwanda at times has fixed high interest rates in order to fight inflation, as opposed by commercial banks, thereby discouraging people from getting loans from commercial banks.
Insecurity
In most LDCs and Rwanda inclusive, there is political insecurity which has always scared people from depositing their money in the banking system thus reducing on operations of commercial banks.
The role of foreign commercial banks in Rwanda
Activity 6
Using the photographs in Figure 2 below, identify and explain the following:
1. What name would you give to such institutions?
2. Give other examples of such banks in your locality or country.
3. Through a whole class debate, examine and present the role of such institutions to the development process of Rwanda.
Facts
Foreign commercial banks are banks which have headquarters in outside countries, but have several branches in different countries. Banks incorporated in Rwanda include:
• Kenya Commercial Bank (KCB),
• Eco Bank,
• Equity Bank,
• Guaranty Trust Bank,
• Crane Access, Etc.
Foreign commercial banks have both positive and negative role in the development process of Rwanda as explained below.
Positive role
• They attract foreign investors through transferring their money easily and safely from their countries of origin. This gives
foreign investors confidence about the security of their investments.
• They increase foreign exchange necessary for facilitating international trade, i.e. foreign commercial banks are able to bring
foreign exchange into the country from their home country which makes it easy for importers to access it at favourable rates.
• They promote increased efficiency through competition among the local banks. Thus better services and products produced
by foreign commercial banks have been extended to local ones, for example use of ATMs, Internet banking, etc.
• They provide employment opportunities to local professionals such as managers, accountants, loans officers, auditors,
supervisors,tellers, drivers, etc. which increases their
experience and soon or later use such skills/experience in
managing/operating local commercial banks.
• They promote international understanding among countries through movement of staff from one country to another,
soliciting aid and loans from home countries. This, therefore, promotes
cooperation and mutual understanding among
countries in which they operate.
• They have a responsibility by which they help the disadvantaged groups, protect environment, promote sports,
education and health through their various programmes such as sponsoring students, donating scholastic materials,
computers, building hospital wards, and giving relief supplies during times of hardships to people.
• They contribute revenue to the government through taxation especially large-scale operations which pay a lot of taxes
to the government.
• They increase the level of savings as they mobilise savings from both rural and urban population.
• They improve technology with their sophisticated equipment. Thus, they may encourage development of indigenous
technology.
• They facilitate international trade through providing documentary credit, bank drafts, telegraphic transfers, etc.
• They contribute to the expansion and extensive modernisation of the existing infrastructure such as roads, communication
networks, power, etc.
• They help in monetising the economy by reducing the subsistence sector through extension of credit facilities to the local
population to engage in economic activities.
Negative role
• Foreign commercial banks worsen the unemployment problem of local skilled manpower because they tend to
employ people from their countries of origin at the expense of local manpower for top management, leaving citizens for
low level jobs.
• They are discriminative towards individuals and firms from the home country of the banks in their service rendering
for example, giving letters of credit, charging different interest rates and general attention and services at the bank counters.
• They are mostly urban-based thus leading to regional imbalances, i.e. urban against rural areas.
• Foreign commercial banks repatriate their profits to their home countries which deprives the host countries of the
already scarce financial resources which limits domestic investments.
• They enhance rural urban migration since they are mostly located in urban areas. Local people will, therefore, move
to enjoy their better and efficient facilities and services offered in urban areas. This deprives the rural areas of development
opportunities.
• They mostly follow policies and guidelines from their headquarters, of which policies normally conflict with the host
government’s policies especially in implementing monetary policies.
• They outcompete the local commercial banks, through more resources, skilled manpower, funds and better technology.
Such stiff competition may result into failure to attract new clients and retain the old ones thus ending up closing down.
This also causes unemployment and discourages further entrepreneurship in the local investors.
6.2.2 Central bank Activity 7
Visit the library or Internet, basing on the photographs in figure 3 on page 202.
1. What is a central bank?
2. The Central Bank of Rwanda is called:
(a) Bank of Kigali (c) Bank Populaire
(b) National Bank of Rwanda (d) coins and notes
3. Explain the functions of the Central Bank of Rwanda.
4. Distinguish between commercial banks and the central bank.
Facts
A central bank may be defined as that central monetary institution responsible for the management of the monetary system
of the country. It is an institution, which controls all other banks in the country. A central bank is an institution formed by the government with wide ranging powers including the issue of currency and control of other financial institutions in the country. NBR is the central bank of Rwanda.
Functions of central banks
Most central banks perform various functions which include the following:
Acts as government banker, fiscal agent and advisor
Central Banks in all countries act as the fiscal agent, banker and advisor on all important financial matters to governments
of their countries. It conducts the banking accounts of government departments and enterprises; is financial advisor to the government; manages the national debt; and conducts transaction on behalf of the government involving the purchases or
sales of foreign currencies.
Banker’s bank
A central bank accepts deposits from commercial banks and will, on order, transfer them to the account of another bank. In this way, the central bank provides each commercial bank with the equivalent of a checking account and with a means of settling debts to other banks.
It acts as a banker to overseas central banks and international financial institutions, for example, the World Bank, the IMF, etc.
Issue of the country’s currency
A central bank enjoys the monopoly of the issue of a country’s currency. No bank other than the central bank is authorised by law to print currency notes. This allows the central bank to have control over the excessive credit expansion by commercial bank and allows for the issuance of uniform currency, thereby achieving the homogeneity characteristic.
Lender of last resort
Acts as a lender of last resort to commercial banks and other financial institutions when they run out of cash. In its capacity as the lender of the last resort, the central bank meets all reasonable demands from commercial banks by providing temporary liquidity to commercial banks by making short-term loans to them.
Keeps a nation’s foreign exchange reserves
A central bank performs this function in order to keep a favourable balance of payments and to maintain a stable exchange rate. It maintains the stability of internal and external value of the currency.
Controller of credit
This is one of the major functions of a central bank. The central bank controls credit by means of various monetary policy instruments such as open market operations, bank rate, legal reserve requirements, moral suasion, selective credit control
and special deposit. This is done by supervising the activities of commercial banks and other financial institutions.
Bank of central clearance, settlement and transfer
Central clearance implies that it settles the differences of a financial nature between the various commercial banks by making transfers of accounts at the central bank since commercial banks keep their surplus cash reserves with the central bank. It is easier to clear and settle claims between them by making transfer entries in their accounts maintained with the central bank than if each commercial bank entered into separate clearance and settlement transactions with other banks individually.
Differences between a central bank and commercial banks
• A central bank is established for public service. Its operations are not basically guided by the profit motive. A commercial
bank is guided by the profit motive.
• A central bank is responsible to the government whereas a commercial bank is responsible to its shareholders.
• A central bank controls other banks while a commercial bank does not. I.e. the central bank has a supervisory role
over commercial banks.
• A central bank is the only body legally permitted to issue a nation’s currency. Commercial banks are not permitted.
• A central bank does not compete with commercial banks for business and will usually maintain the governments account.
• A central bank generally does not deal directly with the public. It deals with the public indirectly through commercial banks.
Commercial banks deal directly with the public.
• A central bank acts as a lender of last resort to commercial banks when they are in liquidity problems.
• A central bank can formulate and execute a monetary policy whereas a commercial bank does not.
• A central bank is exclusively owned by the government, and it has a special relationship with the government of the country.
A commercial bank can be owned by the government or individuals.
• A central bank deals directly in the foreign exchange market. All foreign exchange earnings are submitted to it and it then
meets the foreign exchange requirements of individuals, firms
and commercial banks. Commercial banks do not deal directly
in the foreign exchange market. If they want to transfer money to foreign countries, they do so through the central bank.
• A central bank is a banker’s bank unlike a commercial bank.
Role of central banks
Activity 8
Examine the role of the Central Bank of Rwanda in the development process of the economy.
Facts
In addition to its traditional functions, the central bank plays crucial roles in development. These include:
• The central bank helps the government in the economic planning process. It provides the necessary financial economic
data which greatly facilitates government in its planning process.
• The central bank develops the financial sector for example, it encourages the development of commercial banks which
tend to extend credit to stimulate rural activities for the mobilisation of domestic capital required for economic development.
• The central bank through its monetary policy tools, such selective credit control, helps channel credit to the priority areas
aimed at improving productivity and investment.
• It regulates and controls the supply and demand for money with the objective of attaining high growth rates in GDP,
adequate employment opportunities, price stability, etc.
• Through favourable rate policies aimed at foreign exchange stability, both the public and private sectors are encouraged
to save and invest, thus promoting economic growth and development.
• It educates and trains bankers which increases efficiency in the banking sector.
Monetary policy
Activity 9
Visit the school library or the Internet and research on the following:
1. What is monetary policy?
2. Explain the objectives of monetary policy in Rwanda.
3. Explain the monetary policy tools that the Central Bank of Rwanda has used in attaining the monetary
policy objectives stated in (2) above.
4. To what extent are the monetary policy tools applicable in Rwanda?
Facts
Monetary policy is the management of demand and supply of money together with the rate of interest in order to influence the level of economic activities. Monetary policy as an instrument of economic stabilisation has been used by various countries to manage their economies. Monetary policy is exercised by the central bank through various tools of monetary authority.
Objectives of the monetary policy
• To maintain domestic price stability;
• To influence the level of employment and attain full employment;
• To influence the balance of payment position of the country;
• To ensure stability of foreign exchange in the country;
• To influence the nature and levels of investment in the country;
• To encourage growth of the financial sector;
• To achieve economic growth;
• Ensure that government deficits are financed at low interest rates;
• Create a broad and continuous market for government securities;
• Maintain a continuously low structure of interest rates;
• Encourage the public to save a larger fraction of its real income; and
• Provide credit at differential interest rates.
Tools/instruments of monetary policy
The central bank has a number of instruments, which can be used to control credit.
The following are some of the tools/ instruments of monetary policy:
1. Bank rate/discount rate
This is the interest rate at which the central bank advances money to commercial banks whose reserves are temporarily below the required level. To lower the amount of money in circulation, the central bank increases the rate, therefore, increasing the rate at which banks give loans to the people. To increase money in circulation, the central bank lowers the rate and also the commercial banks lower the lending rate for people who borrow.
2. Open market operations (OMO)
This involves buying and selling of treasury bills and bonds to the general public. This is done in order to curb deflationary and inflationary pressures in the economy. When the government wants to increase money in circulation, it buys securities from the people while selling the securities to the people will reduce money from circulation.
3. Legal reserve requirement (LRR)
This is the amount of money which by law is supposed to be kept by commercial banks in the central bank. When the central bank wants to reduce money in circulation, it increases the legal reserve requirement, while reducing the legal reserve requirement will increase the money available to lend out.
4. Special deposits
The central bank may require commercial banks to create special deposits over and above the reserve requirements. This will reduce the amount of money available to lend to the people, hence reducing money in circulation. This is done during inflation.
5. Moral suasion
This is the issuing of persuasive instructions by the central bank to commercial banks soliciting their co-operation in making its monetary and credit policy successful. The central bank informally asks the commercial banks to contract credit during inflation, and to expand credit during a slump. Although not backed by law, commercial banks will always agree.
6. Selective credit control
The central bank can instruct commercial banks to favour or disfavour certain sectors to control the flow of credit into different activities in the economy. It aims at encouraging certain productive activities and discouraging others. The central bank issues directives to commercial banks to give or not to give loans for any specific purposes.
7. Marginal reserve requirement (MRR)
This is collateral security (requirement) needed by the commercial banks before giving out loans. When the banks want to increase money in circulation, it sets a lower requirement while to reduce the amount of borrowing, the bank asks for a high margin requirement.
8. Currency reform
This is the last policy carried out when all others have failed to reduce money in circulation. Here the central bank introduces a new note (currency) to replace the worn out notes or (money that has lost value). One single note will be equal to large sums of currency which has lost value. People are required to take back the old notes for new currencies.
Applicability of monetary policy tools
Some monetary policy tools have efficiently helped in achieving monetary policy objectives in Rwanda. This is seen below;
1. Open market operations
This consists of the BNR intervention on the money market to mop up or to inject liquidity in the banking system and keep
the reserve money on the desired path.These open market operations include notably repos or reverse repos operations, treasury bills issuance, standing deposits facility and standing lending facility and refinancing window.
2. Reserve requirements
Depository institutions (commercial banks) are obliged to hold minimum reserves against their liabilities, predominantly in the form of balances at the central bank. There are three reasons for imposition of reserve requirements (RR): monetary control, liquidity management and prudential. The current reserve requirement ratio is 5% . Changes in reserve requirements affect the liquidity of the banking system and its capacity to create loans.
3. Foreign exchange intervention
The National Bank of Rwanda intervenes in the foreign exchange market, among other reasons, in order to defend the exchange rate and to achieve a desired amount of international reserves. The intervention in the foreign exchange market directly affects reserve money and hence has a direct impact on overall liquidity in the economy and the stance of monetary policy.
Limitations of monetary policy in Rwanda
The implementation of monetary policies in Rwanda has not been very successful
due to many reasons which include some of the following:
• Existence of large subsistence sector which limits the operation of the monetary policy, since most transactions are
still carried out through barter exchange.
• Most commercial banks in Rwanda are foreign-owned or act as branches of other banks abroad. This means that
their liquidity needs are addressed by their mother banks abroad which make implementation of monetary policies difficult.
• Corruption and lack of self-commitment among bankers which makes some monitory policy tools ineffective,
for example selective credit control, as loans go to non-priority sectors.
• High rate of liquidity preference among people due to ignorance and or general lack of confidence in the banking sector,
thus making it difficult to implement the monetary policy tools.
• Lack of collateral security by most people in Rwanda to act as guarantee for loan acquisition hence few qualify for loans.
Therefore, even if the central bank wanted commercial banks to
increase the level of lending, many people will not qualify
for bank loans since they lack collateral security.
• Limited investment opportunities together with an unconducive investment climate that discourages people from
getting loans, for example, high interest rates on business loans, high taxes on investors, etc. which make monetary
policy tools ineffective.
• Poorly developed money markets which renders some tools ineffective such as Open Market Operation (OMO),
therefore there will be no buying and selling of securities and thus the central bank cannot use such a policy to regulate
the amount of money in circulation.
• Most people in Rwanda prefer investing their money in real assets such as land, cattle, houses, etc. than saving it
with banks. This is due to low interest given to depositors thus discouraging them from saving and thus affecting the
operation of monetary policy tools.
• Conflict between political interest and monetary policy. The government in most cases wants to increase wages of
workers, increase prices of agriculture products, etc. However, such policies may conflict with the existing monetary policy.
• Insufficient supervisory capacity of central bank over commercial banks that leads to excess liquidity with commercial
banks thus ending up giving excess credit than what the central bank would wish to.
• Existence of insecurity which leads to high economic uncertainties and thus reducing deposits with the commercial
banks, therefore, affecting the success of monetary policies.
• Poor infrastructure in some parts of the country which reduces the bank services thereby reducing savings mobilisation
in rural areas; and
• Foreign interference that affects the smooth operation of central bank and execution of monetary policies as exemplified by
conditions from the World Bank, the IMF and other donor agencies.
6.3 Non-banking financial institutions (NBFIs)
Activity 10
Visit the library or Internet. Using photographs in Figure 4 below, identify and explain:
1. The name given to such institutions.
2. Give other examples of such institutions in your locality and Rwanda in general.
3. What are the functions of such institutions?
Facts
Non-banking financial institutions (NBFIs) are financial institutions that accept deposits from people but do not create credit.
They include development banks, for example Banque Rwandaise de Development (BRD), insurance companies, cooperatives, post office savings bank, housing and building societies, credit and savings societies, discount houses, and development housing companies, for example Housing Bank of Rwanda.
These institutions operate in all sectors of productive investment in the economy of Rwanda, for example agriculture and livestock, manufacturing industry, education and health, ICT, transport and related facilities, micro finance, etc.
Examples of non-banking financial institutions
Development Bank of Rwanda, commonly known as Banque Rwandaise de Development (BRD)
The Development Bank of Rwanda began its operation in 1967, as a long-term financial service provider, with the financing geared towards national development projects.
As of April 2011, the total assets valuation was approximately 72 billion, FRW with shareholders’ equity of approximately 25 billion FRW. The BRD has undergone re-structuring, re-Organisation and re-capitalisation, to repair the damage incurred during the 1994 Rwanda genocide. It has also financed rural development projects, since almost 90% of the population live in rural areas.
Insurance companies
These are business institutions that provide coverage, in form of compensation resulting from loss, damages, injury, treatment, or hardship in exchange for premium payments. They pool clients’ risks to make payments affordable for the insured. The role of the insurance companies has been very remarkable in mobilisation of savings and investments in the social sector for so many years. They also offer various types of services ranging from life, retirement fund and medical fund, automobile, to property coverage
There are many insurance companies in Rwanda for example La Rwandaise d’Assurance Maladie (RAMA), SONARWA SA, SORAS SA, Phoenix, AAR Health Services, Military Medical Insurance (MMI), Prime Life Ltd, etc.
Savings and credit co-operatives organisations (SACCOS)
These are co-operatives formed to mobilise savings from members and lend some of the savings to members. Members normally make deposits on a weekly or monthly basis. They provide financial services to their members particularly facilities for saving and borrowing. Because the SACCOs are owned by the members, they are able to charge a lower rate of interest than the commercial banks. In many cases, members must be from a specific geographical location or working in the same industry for example Umurenge SACCO, Umwalimu SACCO, etc.
Microfinance institutions (MFI)
Micro means very small. Micro-finance or micro lending is defined as the provision of credit to people who are unable to obtain loans or credit from commercial banks because their only security is the fact that they have a regular source of income.
In Rwanda, there are many microfinance entities varying from moneylenders,merchants, pawn brokers, loan brokers, burial societies, and savings groups to the more complicated rotating savings and credit associations. All these are run on a very small scale compared to the bigger financial institutions in terms of the amount they handle. Examples of microfinance institutions in Rwanda include:
• AB Bank Rwanda, • Zigama CSS,
• Agaseke Bank, • Goshen, and
• Unguka Bank,
• Urwego Opportunity Bank,
• Vision Finance Company, etc.
Characteristics of MFIs
• They are not deposit taking institutions and are, therefore, self-funding, unlike the formal banks.
• Interest rates charged are high compared to formal banks because the average value of the loans is low while costs
of granting and administering are high and fixed and a higher incidence of bad debts because of the target market’s
higher risk profile.
• MFIs operate out of low cost, unsophisticated branches. Customers do not feel intimidated to walk into a branch and
are served by tellers who speak their language.
Functions special to NBFIs
• Brokers of loanable funds: They intermediate between savers and investors. They sell indirect securities to the savers and
buy primary securities from investors. They thus take risk on themselves and reduce the risk of the lenders because low
returns on some assets are offset by high returns on others.
• Mobilisation of savings for the benefit of the economy: By providing expert financial services such as easy liquidity,
safety of the principal amount and ready divisibility of savings into direct securities of different values, they mobilise more
funds and attract a larger share of the public’s savings.
• Direct funds into investment channels: By mobilising the general public’s savings, NBFIs channel them into productive
investments and this directs public savings into investment, aids capital formation and economic growth.
• Stabilisation of capital markets: NBFIs trade in the capital market in a variety of assets and liabilities and in turn equilibrate
the demand for and supply of assets. By functioning within a legal framework and rules, they protect the savers’ interests and
create stability in the capital market.
• Provision of liquidity: NBFIs provide liquidity and they do this by advancing short-term loans and financing them by
issuing claims against themselves for long periods and diversifying loans among different types of borrowers.Role of
non- banking financial institutions
Activity 11
Visit the school library or Internet and research about different non-banking financial institutions in Rwanda.
Explain:
1. The role of non-banking financial institutions in the development of Rwanda.
2. Identify the challenges faced by these institutions in their operations.
Facts
• Provision of employment opportunities to the nationals through setting up banks and people are employed as
accountants, managers, loans officers, etc.
• Provision of security to property and people’s lives, for example insurance companies;
• They act as intermediaries between potential savers and investors which creates assets and liabilities.
• They give or offer loans to development production ventures such as small scale industries, agriculture, etc. which
commercial banks are reluctant to support.
• They act as avenues through which the donor, government and non-governmental organisations channel their funds
to facilitate development programmes.
• They help in transformation of the rural sector from subsistence to monetary economy.
• Non- banking financial institutions are spread all over the country, for instance credit unions, development banks,
insurance companies, thus helping in mobilisation of savings which are then channelled to local rural-based projects.
• They help in indiginisation of the economy, i.e. they advance loans to local entrepreneurs, women groups, the youth, etc.
who are neglected by commercial banks.
• They expand government revenue through paying taxes, on which government can invest in development programmes.
Challenges of non-banking financial institutions in Rwanda
• Corruption, mismanagement and lack of self-commitment among employees which makes some non-banking
financial institutions ineffective.
• Lack of credit worthy customers who normally fail to pay back in time or even completely fail to pay back.
• High illiteracy and ignorance levels among the majority of the population, thus not able to save with non-banking
financial institutions and at times are not aware of services rendered by such institutions.
• Government influence through high taxes, interest rate determination, all which do not favour these financial institutions.
• Low savings among the population due to poverty among the majority of the population in Rwanda.
• Existence of insecurity which leads to high economic uncertainties and thus reducing activities of non-banking
financial institutions, therefore, affecting the successful operation.
• Poor infrastructure in some parts of the country which reduces the bank services thereby reducing savings mobilisation
in rural areas.
• High marginal propensity to consume ( MPC): In Rwanda, there is a high MPC implying a low MPS thereby limiting
the capacity of non-banking financial institutions to mobilise adequate savings.
• Existence of large subsistence sector which limits the operation of non-banking financial institutions,
since most transactions are still carried out through barter exchange.
• High competition from banking financial institutions and non-banking financial institutions themselves.
• Foreign influence especially from the International Monetary Fund (IMF) and the World Bank.
• The prevalent fear of borrowing and loaning culture: Many people in Rwanda are unwilling to go for loans due to
limited investment opportunities. This greatly affects the lending potential of non-banking financial institutions,
thus lowering their profits as well;
• Lack of well qualified, competent and trustworthy employees for non-banking financial institutions.
The qualified personnel at times tend to be corrupt and end up misusing the banks resources.
6.4 Financial markets
Activity 12
Basing on photographs below, visit the school library or the Internet, make research and respond to the following:
1. What do the institutions in the photographs deal in?
2. What are financial markets?
3. How are they classified and give examples in each.
4. Identify and distinguish the different terms used in financial markets.
Facts
A financial market is an arrangement of possible buyers and sellers of financial securities such as bonds and treasury bills, commodities, and other fungible items (items that can be substituted for something of equal value or utility).
The term “financial markets” is often used to refer solely to the markets that are used to raise finance. They deal in stocks/ shares, bonds, bills of exchange, foreign currency etc. Examples of financial markets include capital markets, derivative markets, money markets, and currency markets.
Types of financial markets
There are basically two types of financial markets:
1. Capital markets; and
2. Money markets.
1. Money markets
This is a financial market that gives investors access to short-term debt instruments such as treasury bills for less than one year. Money markets are, mainly accessible for large corporations and financial institutions.
2. Capital markets
Capital marketsare markets in which long-term financial securities are traded. These may take mostly above two years to clear. Stock markets and bond markets are two types of capital markets that provide financing through the issuing of shares of stock or the issuing of bonds, respectively. Capital markets provide companies and governments access to long-term funding for expansion and development. Under capital markets, we can further see two different types namely:
(a) Primary markets: These are markets that deal in newly formed or issued securities.
(b) Secondary markets: These are markets that deal in providing a continuous and regular market for the buying and
selling of securities. In other words, it is a market that deals in securities that have been on the market for some time.
Terms used in money markets
1. Bank overdraft
This is an extension of credit from a lending institution when an account reaches zero. An overdraft allows the individual to continue withdrawing money even if the account has no funds in it. Basically, the bank allows people to borrow a set amount
of money.
2. Short-term loan
This is a loan that is scheduled to be repaid in less than a year. When your business does not qualify for a line of credit from a bank, you might still have success in obtaining money from them in the form of a one-time, short-term loan (less than a year) to finance your temporary working capital needs.
3. Promissory note
This is a financial instrument that contains a written promise by one party to pay another party a definite sum of money either on demand or at a specified future date. A promissory note typically contains all the terms pertaining to the indebtedness by the issuer or maker to the note’s payee, such as the amount, interest rate, maturity date, date and place of issuance, and issuer’s signature.
4. Bill of exchange
This is a written, unconditional order by one party (the drawer) to another (the drawee) to pay a certain sum, either immediately (a sight bill) or on a fixed date (a term bill), for payment of goods and/or services received. The drawee accepts the bill by signing it, thus converting it into a post-dated cheque and a binding contract.A bill of exchange is also called a draft but, while all drafts are negotiable instruments, only “to order” bills of exchange can be negotiated.
5. Trade credit
This is an agreement where a customer can purchase goods on account (without paying cash) and he or she pays the supplier at a later date. Usually, when the goods are delivered, a trade credit is given for a specific number of days, say 30, 60 or 90.
6. Certificate of deposit (CD)
This is savings certificate entitling the bearer to receive interest. A certificateof deposit bears a maturity date, a specified fixed interest rate and can be issued in any denomination. Certificate of deposits are generally issued by commercial banks.
7. Banker
This is an individual who is engaged in the business of banking especially as an executive or any other official.
An investment bankeris an individual who works in a financial institution that is in the business primarily of raising capital for companies, governments and other entities. This is often carried out in an investment bank.
8. Treasury bill
This is a short-term government security with maturities ranging from a few days to 52 weeks. Bills are sold at a discount
from their face value.
Terms used in capital markets
1. Equity
This means net worth of a person or company computed by subtracting total liabilities from the total assets. In case of cooperatives, equity represents members’ investment plus retained earnings or minus losses. Or it can be defined as, ownership interest or claim of a holder of common stock (ordinary shares) and some types of preferred stock (preference shares) of a company. On a balance sheet, equity represents funds contributed by the owners(stockholders) plus retained earnings or minus the accumulated losses.
2. Stocks
This is a combination of several shares of a company held by an individual or group. Corporations raise capital by issuing stocks and entitle the stock owners (shareholders) to partial ownership of the corporation. Stocks are bought and sold on what is called a stock exchange market.
3. Bonds
A bond,also known as a fixed-income security, is a debt instrument created for the purpose of raising capital. They are essentially loan agreements between the bond issuer and an investor, in which the bond issuer is obligated to pay a specified amount of money at specified future dates. A bond is normally issued for a period of more than one year and may mature after 30 years.
4. Debenture
This is a corporate bond that is not secured by specific property (collateral security). Most bonds issued by corporations are debentures, which are backed by their reputation rather than by any collateral, such as the company’s buildings or its inventory.
In case of bankruptcy, the holder of a debenture becomes a general creditor and, therefore, is less likely than the secured creditors to recover in full. Because of their high risk factor, debentures pay higher rates of interest than secured debt of the same issuer.
5. Balanced schemes
These are schemes that aim at providing both growth and income by periodically distributing a part of the income and capital gains they earn. These schemes invest in both shares and fixed income securities, in the proportion indicated in their offer documents (normally 50:50).
6. Collective investment schemes
This is a fund that is operated by a trust company or a bank and handles a pooled group of trust accounts. Collective investment funds combine the assets of various individuals and organisations to create a larger, well-diversified pool.
Functions of financial markets
Activity 13
Through the research made in Activity 11, identify the following:
1. What is the function of financial markets in Rwanda?
2. What hinders smooth operation of financial markets in Rwanda?
Facts
1. Financing trade
Money market plays a crucial role in financing both internal as well as international trade. Commercial finance is made available to the traders through bills of exchange, which are discounted by the bill market. The acceptance houses and discount markets help in financing foreign trade.
2. Financing industry
Money market contributes to the growth of industries in two ways:
(i) Money market helps the industries in securing short-term loans to meet their working
capital requirements through the system of financebills, commercial papers, etc.
(ii) Industries generally need long-term loans, which are provided in the capital market. However,
capital market depends upon the nature of and the conditions in the money market.
3. Profitable investment
Money market enables the commercial banks to use their excess reserves in profitable investment. The main objective of the commercial banks is to earn income from its reserves as well as maintain liquidity to meet the uncertain cash demand of the depositors. In the money market, the excess reserves of the commercial banks are invested in near-money assets (e.g. short-term bills of exchange) which can be easily converted into cash, thus, the commercial banks earn profits.
4. Self-sufficiency of commercial bank
Developed money market helps the commercial banks to become self-sufficient. In the situation of emergency, when the commercial banks have scarcity of funds, they need not approach the central bank and borrow at a higher interest rate. On the other hand, they can meet their requirements by recalling their old short-run loans from the money market.
5. Help to central bank
Although the central bank can function and influence the banking system in the absence of a money market, the existence of a developed money market smoothens the functioning and increases the efficiency of the central bank. Money market helps the central bank in two ways:
(i) The short-run interest rates of the money market serves as an indicator of the monetary
and banking conditions in the country and, in this way, guide the central bank to adopt
an appropriate banking policy,
(ii) The sensitive and integrated money market helps the central bank to secure quick
and widespread influence on the sub-markets, and thus achieve effective implementation
of its policy.
6. Mobilising savings
Capital markets help in mobilising savings and channelling them into productive investments. Consequently, it encourages capital formation and promotes the economic growth of the country.
7. Promotes economic growth
This is through the rational allocation of resources. The various constituents of the capital market direct funds into productive investment channels. When the capital market is underdeveloped, surplus funds are generally used for wasteful and unproductive purposes.
8. The capital market
brings together the savers as lenders and investors as borrowers who are respectively known as surplus spending units and deficit spending units.
Limitations of financial markets in Rwanda
• There is a lack of coordination between the various financial institutions. They adopt different
policies and due to this, lending and borrowing become difficult. There is overlapping and delays
in creating the needs of industrial and trade sector.
• The economic policies are framed by the bureaucrats instead of technocrats, so they create
many problems. Many financial institutions are controlled by the bureaucrats and they have
no technical skill, so they lack decision making.
• The professional and skilled persons in the financial institutions are engaging more profitable
businesses and this has created a gap of talented persons in the financial institutions.
• The branches of the financial institutions are not opened in the rural areas to collect the savings
of the villages.
• In advancing loans, financial institutions compete with each other to show better performance.
Sometimes, they lend the money to those people who cannot repay. So, before advancing loans
they must be careful in checking the character and financed condition of the borrower.
• The complaints about default in loan repayments both by the public and private sector is
increasing day by day. Poor quality of manpower is employed in the financial institutions
which causes low production.
6.5 Financial sector in Rwanda
Activity 14
Visit the library or the internet and research on the state of financial sector in Rwanda.
Facts
The financial sector in Rwanda is regulated by an independent Central Bank of Rwanda (BNR). Banking service operations date back in early 1960, originating from the oldest banks of BCR and Bank of Kigali respectively. Rwanda Financial Service Sector is composed of the following institutions:
• 9 commercial banks,
• 3 microfinance banks,
• 1 development bank,
• 1 co-operative bank,
• 490 microfinance institutions of which 11 are limited companies and 479 SACCOs (including 416 UMURENGE SACCOs),
• 12 insurance companies (7 non-life insurers, 3 life insurers and 2 public insurers),
• 1 public pension fund, the Rwanda Social Security Board and around 40 private pension schemes,
• 105 operational forex Bureaus, and
• 1 stock exchange.
Forty two per cent of the Rwandan population is in the formal financial system (23% served by commercial banks and 33% served by non-bank formal institutions), and 58% use informal financial mechanisms (Source: BNR and FinScope, 2012).
The banking returns on average equal to 12.2% as of March 2013.There is an operational Capital Markets Authority (CMA)
to undertake public education and awareness and scale up financial literacy among Rwandans.
Recently, most commercial banks have centred their operations on trade finance as opposed to long-term debt financing.
This has triggered off of productive investment activity, thus there is an urgent need to focus attention on the reform and strengthening of the financial sector.
There are ready opportunities for investment in mortgage banks to enhance access to property, agricultural banks to offer agricultural credit to farmers and introduction of new financial products, including leasing and venture capital to minimise hardships of opening business as well as its continued successful operation.
The 3 largest local banks are;
• Banque de Kigali with a market share of 31% of total banking assetsand 50 % share of the total commercial bank
profitability (BK 2011).
• Banque Populaire du Rwanda (BPR): 65% cooperative members, 35% Rabobank.
• Banque Commercial du Rwanda (BCR): 80% I&M from Kenya, 20% GoR.
Eco bank, Access Bank, Equity Bank and Kenya Commercial Bank are among the large regional banks
with a presence in Rwanda.
Unit assessment
1. How important is Bank of Kigali and Bank Populaire to the development of the Rwandan economy?
2. Why has Rwanda found it necessary to create specialised institutions and development banks despite
the presence of a developed commercial banking system?
3. How has the National Bank of Rwanda (BNR) influenced the level of economic activities in Rwanda?
6.6 Glossary
- A bond: A debt instrument created for the purpose of raising capital. Or it is any evidence of debt carrying a legal obligation to pay interest and pay the principal at a stated future time.
- Assets: Possessions of the bank plus its claims on other financial institutions and clients. Or, things of value owned by a person, household, firm or other economic unit. Important examples are plant, equipment, land, patents, copyrights, goodwill, and financial assets such as money or bonds.
- Bank:A deposit-taking institution which is licensed by the monetary authority of a country to act as a repository for money deposited by the public and which undertakes to repay such deposits either immediately on demand (current accounts) or subject to due notice being given (deposit accounts).
- Bank deposit: A sum of money held on deposit with a commercial bank or a savings bank. Bank deposits are mainly of three types: demand deposits, savings deposits and time/fixed deposits.
- Bank deposit creation or credit creation: The ability of the commercial bank system to create new bank deposits and hence increase the money supply.
- Banking financial intermediaries:These are financial institutions engaged in the provision of short-term loans.
- Bill: A tradable security usually with an initial maturity of up to 6 months, which pays no explicit interest and so trades at a discount to its maturity value.
- Bills of exchange: Written orders to pay a sum of money to another person at a future date usually in exchange of the delivery of goods, widely used in the financing of international trade.
- Capital markets: Markets in which financial resources (money, bonds, and stocks) are traded.
- Cash ratio:The proportion of money which is supposed to be kept by commercial banks to meet the daily needs of the people/ customers.
- Central bank:A financial institution that is responsible for managing the central monetary system of an economy, for example, National Bank of Rwanda.
- Commercial banks: Financial institutions that provide retail banking services with an aim of making profits. Examples are Fina Bank, Eco Bank, Banque Populaire, Bank of Kigali, etc.
- Credit creation: The process by which commercial banks create credit by lending out money using cheques. The volume of money accumulates with time basing on the interest charged.
- Forex bureaus: Financial institutions whose major business activity is to buy and sell currencies, for example Red Fox Forex Bureau, Nyabugogo Forex Bureau, Ndoli Forex Bureau, etc.
- Legal reserve requirement: The amount which by law is supposed to be kept by commercial banks in the central bank.
- Liabilities: Claims by the outside world. Or, they are properties that belong to the people but not the bank.
- Maturity: The length of time until the redemption date of security such as bonds.
- Microfinance institutions (MFI): Financial institutions which provide financial services such as micro credit, micro savings, or micro insurance to basically low income earners.
- Money multiplier: The ratio of money stock to the monetary base.
- Monetary policy: The management of demand and supply of money together with the rate of interest in order to influence the level of economic activities.
- Non-banking financial intermediaries: Financial institutions that accept deposits from people and give out loans but do not create credit, for example development banks, insurance companies, cooperatives, post banks, etc.
- Reserve ratio: This is the fraction of total bank deposits that is not lent out. It includes legal reserve requirement and cash ratio.
- Savings and credit cooperatives organisations (SACCOS):Co-operatives formed to mobilise savings from members and lend some of the savings to members, for example, Umwarimu Sacco, Umurenge Sacco.
- Treasury bills: Bills of exchange sold and later bought back by the government in an endeavour to cover state spending and also regulate the amount of money in circulation.
Unit summary
• Banking financial institutions
- Commercial banks
- Central banks
• Non-banking financial institutions
• Financial markets
- Money markets
- Capital markets
Customer A deposited 10000 FRW to the bank. The bank kept 20 %( 2000) as cash ratio and lent out 80 % (8000) to customer B. Customer B deposited the same cheque in the same bank. Out of 8000 FRW, the bank kept 20% (1600) as cash ratio and loaned out 6400 to customer C. The process continues until no further loans are available for lending out.Note The number of times initial deposit multiplies itself to give a final depositis called credit multiplier (cm).
