CHAPTER 2
LITERATURE REVIEW
In this section of our work; we are concerned with coming
along with all necessary theories that suggest the possibility of the existence
of a relationship between risk management and the risk reduction strategy of
financial institutions in Cameroon. Here we are making a survey of borrowed
academic materials, which might help us in better understanding the core issue
of our research project.
A general understanding of the concept of financial
institutions
2.1 DEFINITION OF FINANCIAL INSTITUTION
According to Millard F. Long (1919), financial institutions
make use of a widely accepted medium of exchange which reduces the cost of
transaction, facilitate trade and encourage specialisation as well as
production efficiency. In addition, Ndenka Aaron (2005) add by saying that
financial institutions or financial intermediaries are simply economic units
whose main function is to handle the financial assets of the households and
firms in our society.
In other words, they are business entities that specialises in
managing deposits from savers or depositors and give these deposits out as
loans to borrowers. Their main tool of raising financial profits is through
credit, which is the process by which loanable funds are allocated to borrowers
from lenders. The use of credit by financial institutions that enters in a
legal course of action, of course, need or necessitate the establishment of
legal instruments called credit instruments. The most commonly used credit
instruments are of two types: promises to
pay and order to pay. They include
letter of credit, bills of exchange, cheques, bonds, stocks and securities.
Furthermore, credit instrument confer to its owner the three
following characteristics that are a yield, liquidity and safety (Aaron Ndenka,
2005).
The following diagram represents a summary of the functioning
of financial institutions in their lending process.
FIGURE 1: THE LENDING PROCESS OF FINANCIAL
INSTITUTIONS
ULTIMATE
LENDER
ULTIMATE
BORROWER
Direct
borrowing
Direct
lending.
Indirect lending
FINANCIAL
INTERMEDIARY
Money
Money
Evidence of debt
evidence of debt
Source: Foundations of Banking and Finance, 2005.
2.2 TYPE OF FINANCIAL INSTITUTION AND THEIR ASSOCIATED
FUNCTIONS
The term financial institutions can be applied to a variety of
institution some of which are:
2.2.1 THE CENTRAL BANK
The central bank is the most important institutions in a
financial system. It occupies a unique position in the monetary and banking
system of the country in which it operates. The central bank is always inspired
by the principle of national welfare and in order to achieve this it must be
done not under the influence of government, the reason being that the economy
problem of the country cannot be satisfactorily solved without the fullest
co-operations between the central bank and the government (Foundations of
banking, 2005)
The central bank should under no circumstances compete with
other banks that is receiving deposits from the public or extending loans to
needy borrowers. If it competes with other banks, this will conflict with its
important function of being the bankers' bank, controller of credit and lender
of last resort (comparative banking systems, 2005).
Furthermore, the special powers of the central bank are
designed to help it to control the volume and availability of currency and
demand deposit in the best interest of the economic life of the nation. The
group of special powers comprises the power to issue legal tender currencies,
to control the volume of reserves available at the commercial banks and to cat
as the principal financial adviser to the national government (Ndenka Aaron,
2005).
Kaufman George, Larry Mote and Harvey Rosenblum stated during
a conference in 1982 in Chicago that the means as tools used by central banks
in carrying out their duties in order to control the money in circulation can
include the granting or refusing to grant loans to the commercial banks. This
will affect their reserve requirements and therefore the credit. Secondly, by
presenting a reserve ratio, a central bank can influence the amounts of
reserves available to commercial banks. Thirdly, by buying and setting
securities in an open market operation (OMO). The central bank can also affect
the size of reserves of commercial banks. Here heavy reliance is put on loans
to commercial banks because of the narrowness of financial markets.
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