11

THE KENYAN THE KENYAN FINANCIAL SYSTEMFINANCIAL SYSTEM

The financial system facilitates the The financial system facilitates the transformation of savings into investment transformation of savings into investment & consumption. are systematically & consumption. are systematically interrelated. interrelated.

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The financial systemThe financial system consists of: consists of:

Financial assetsFinancial assets Financial intermediaries andFinancial intermediaries and Financial marketsFinancial markets

The primary function of the The primary function of the system is to allocate the capital system is to allocate the capital resources in an economy.resources in an economy.

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FINANCIAL ASSETSFINANCIAL ASSETS

If ‘A’ transfers funds to ‘B’, ‘A’ receives a If ‘A’ transfers funds to ‘B’, ‘A’ receives a financial asset, which represents a claim financial asset, which represents a claim against the income and assets of ‘B’. From the against the income and assets of ‘B’. From the point of view of ‘B’, such a claim represents a point of view of ‘B’, such a claim represents a financial liability. financial liability.

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Note:Note:

For every financial asset, there is a For every financial asset, there is a corresponding financial liability. Financial corresponding financial liability. Financial assets are the basic products of the financial assets are the basic products of the financial system. There are three broad types of system. There are three broad types of financial assets: money, debt and stock.financial assets: money, debt and stock.

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Money (notes and coins) is issued by the Money (notes and coins) is issued by the Central bank of Kenya and by Commercial Central bank of Kenya and by Commercial banks as demand deposits and debt is issued by banks as demand deposits and debt is issued by a variety of organizations, including the a variety of organizations, including the government of Kenya and its agencies. government of Kenya and its agencies.

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Equity and preference is issued by business Equity and preference is issued by business organizations.organizations.

Debt capital entails a fixed interest and Debt capital entails a fixed interest and principal repayment burden.principal repayment burden.

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Examples of financial assets (securities) are:Examples of financial assets (securities) are:

Equity (Ordinary) SharesEquity (Ordinary) Shares Preference SharesPreference Shares DebenturesDebentures Treasury bills and BondsTreasury bills and Bonds Commercial PapersCommercial Papers Company DepositsCompany Deposits

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FINANCIAL FINANCIAL INTERMEDIARIESINTERMEDIARIES

Financial Intermediaries are institutions or Financial Intermediaries are institutions or firms that mediate or stand between ultimate firms that mediate or stand between ultimate lenders and ultimate borrowers or between lenders and ultimate borrowers or between those with budget surplus and those who run those with budget surplus and those who run budget deficits. budget deficits.

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Below are examples of financial intermediaries:Below are examples of financial intermediaries:

Commercial banksCommercial banks Building SocietiesBuilding Societies Merchant BanksMerchant Banks Development BanksDevelopment Banks Post Office Savings BankPost Office Savings Bank

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Savings and Credit Co-operative Savings and Credit Co-operative

Societies (SACCOS)Societies (SACCOS) Insurance companiesInsurance companies Unit trusts (mutual funds)Unit trusts (mutual funds) Investment TrustsInvestment Trusts Investment companiesInvestment companies Pension funds e.g. N.S.S.FPension funds e.g. N.S.S.F

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Finance HousesFinance Houses Capital Markets and Nairobi Stock Exchange Capital Markets and Nairobi Stock Exchange

MarketMarket Foreign Exchange BureauxForeign Exchange Bureaux The GovernmentThe Government Acceptance HousesAcceptance Houses Stock Exchange MarketStock Exchange Market

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The central function of all financial The central function of all financial intermediaries is to collect surpluses (savings) intermediaries is to collect surpluses (savings) of other economic units and to lend them to of other economic units and to lend them to the deficit spenders. If these intermediaries did the deficit spenders. If these intermediaries did not perform this function, it would be not perform this function, it would be necessary for individual depositors to agree necessary for individual depositors to agree terms directly with individual borrowers. terms directly with individual borrowers. Although, this is a bit inconveniencing, there Although, this is a bit inconveniencing, there are some instances where it becomes necessary are some instances where it becomes necessary to do so - for example a company raising funds to do so - for example a company raising funds directly from the public.directly from the public.

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BENEFITS OR FUNCTIONS BENEFITS OR FUNCTIONS OFOF

FINANCIAL FINANCIAL INTERMEDIARIESINTERMEDIARIES

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Maturity transformationMaturity transformation

Majority of deposits is for very short-term Majority of deposits is for very short-term (Bank deposits), whereas most loans are (Bank deposits), whereas most loans are required for longer periods (mortgages are for required for longer periods (mortgages are for 20 to 25 years). Financial intermediaries are 20 to 25 years). Financial intermediaries are able to overcome this maturity mismatch by able to overcome this maturity mismatch by offering a wide range of deposit accounts, thus offering a wide range of deposit accounts, thus helping to ensure that not all the depositors’ helping to ensure that not all the depositors’ funds are withdrawn at the same time.funds are withdrawn at the same time.

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Financial Intermediaries also have Financial Intermediaries also have access to access to wholesale money marketswholesale money markets such as the inter- such as the inter-bank market, where they can raise short-term bank market, where they can raise short-term finance should they encounter some shortage.finance should they encounter some shortage.

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Risk TransformationRisk Transformation Individual depositors are generally reluctant to Individual depositors are generally reluctant to

lend all their savings to other individuals or lend all their savings to other individuals or companies, principally because of the risk of companies, principally because of the risk of default or fraud. Intermediaries effectively default or fraud. Intermediaries effectively enable lenders to spread this risk over a wide enable lenders to spread this risk over a wide variety of borrowers. Intermediaries also have variety of borrowers. Intermediaries also have the experience and the skills needed to improve the experience and the skills needed to improve credit management. Transformation of risk can credit management. Transformation of risk can also be referred to as also be referred to as Risk reductionRisk reduction..

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AggregationAggregation

The majority of retail deposits are relatively The majority of retail deposits are relatively small, averaging under sh. 20,000.00, while small, averaging under sh. 20,000.00, while loans are typically larger, with mortgages loans are typically larger, with mortgages being for sh. 500,000.00 and above. Financial being for sh. 500,000.00 and above. Financial intermediaries can overcome this size intermediaries can overcome this size mismatch by aggregating small deposits, and, mismatch by aggregating small deposits, and, if necessary, by accessing the wholesale if necessary, by accessing the wholesale money markets for funding.money markets for funding.

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Geographic LocationGeographic Location

A further difficulty that individual depositors and A further difficulty that individual depositors and individual borrowers might experience is the simple individual borrowers might experience is the simple problem of locating one another within their own area or problem of locating one another within their own area or their own circle of contacts. A depositor, for example, in their own circle of contacts. A depositor, for example, in Nairobi is unlikely to know of the existence of a likely Nairobi is unlikely to know of the existence of a likely borrower in Eldorate. Intermediaries overcome these borrower in Eldorate. Intermediaries overcome these search and location problems through their national search and location problems through their national branch network, and more recently by the introduction of branch network, and more recently by the introduction of telephone banking.telephone banking.

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Induce SavingsInduce Savings

Savers require store of value to hold their Savers require store of value to hold their savings in. Financial intermediaries, assisted by savings in. Financial intermediaries, assisted by the financial markets, promote savings by the financial markets, promote savings by providing a wide range of financial assets as providing a wide range of financial assets as store of value. For savers (wealth holders), this store of value. For savers (wealth holders), this offers ample choice of portfolios with attractive offers ample choice of portfolios with attractive combinations of income, safety, yield, etc.combinations of income, safety, yield, etc.

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Law of Large NumbersLaw of Large Numbers The economic basis of financial institutions lies in the The economic basis of financial institutions lies in the

economy of large scale in portfolio management and in economy of large scale in portfolio management and in the law of large numbers. Banks, insurance companies, the law of large numbers. Banks, insurance companies, unit trusts and other financial institutions operate on unit trusts and other financial institutions operate on the assumption, supported by statistical law of large the assumption, supported by statistical law of large numbers that not all creditors (depositors) will numbers that not all creditors (depositors) will withdraw their deposits at the same time, and that while withdraw their deposits at the same time, and that while others are withdrawing, others (new or old) are others are withdrawing, others (new or old) are depositing or paying in cash. These intermediaries are depositing or paying in cash. These intermediaries are therefore able to make liabilities that are more liquid.therefore able to make liabilities that are more liquid.

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Professional ManagementProfessional Management The large size of assets portfolios that financial The large size of assets portfolios that financial

intermediaries have allows them to employ intermediaries have allows them to employ professional managers, who are well-versed in the professional managers, who are well-versed in the complexities of modern finance, in appraising loan complexities of modern finance, in appraising loan proposals, evaluating investment opportunities, proposals, evaluating investment opportunities, monitoring loans and investments, analysis the market monitoring loans and investments, analysis the market and other developments etc. this is important as and other developments etc. this is important as individual owners (savers) cannot afford the cost of individual owners (savers) cannot afford the cost of professional management and other support staff. They professional management and other support staff. They do not in general also have the knowledge, time or do not in general also have the knowledge, time or desire to manage on their own. desire to manage on their own.

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FINANCE HOUSESFINANCE HOUSES

These are basically lending organizations. These are basically lending organizations. They are known for smaller-scale lending on They are known for smaller-scale lending on consumer goods, but many also offer corporate consumer goods, but many also offer corporate loan packages. Their activities are sometimes loan packages. Their activities are sometimes referred to as the secondary banking sector.referred to as the secondary banking sector.

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Wholesale FinanceWholesale Finance

Finance houses fund their operations mainly Finance houses fund their operations mainly through the wholesale finance market rather through the wholesale finance market rather than their attracting deposits from the general than their attracting deposits from the general public. Funds are placed with Finance houses public. Funds are placed with Finance houses on unsecured basis for periods from three to on unsecured basis for periods from three to six months.six months.

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Finance houses offer more or less the same Finance houses offer more or less the same services offered by other financial institutions like services offered by other financial institutions like commercial banks, building societies, etc. The commercial banks, building societies, etc. The services of Finance houses are:services of Finance houses are:

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Unsecured LoansUnsecured Loans

These are usually fixed-rate loans for terms of These are usually fixed-rate loans for terms of one to five years, which can be used for any one to five years, which can be used for any purpose – holiday, building or buying a house, purpose – holiday, building or buying a house, business, agriculture, etc. These services are business, agriculture, etc. These services are provided through agencies with sales outlets.provided through agencies with sales outlets.

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Secured LoansSecured Loans

Finance houses also provide secured loans for Finance houses also provide secured loans for home improvement & other purposes.home improvement & other purposes.

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Hire PurchaseHire Purchase A hire purchase company (hiree) gives goods on hire A hire purchase company (hiree) gives goods on hire

to a user (hirer) who pays periodic hire purchase to a user (hirer) who pays periodic hire purchase installments. On payment of final hire purchase installments. On payment of final hire purchase installment, the ownership of the goods is transferred installment, the ownership of the goods is transferred to the hirer from the hiree. Typically, in a hire to the hirer from the hiree. Typically, in a hire purchase transaction, the hiree charges interest on a purchase transaction, the hiree charges interest on a flat rate basis. This means that interest is charged on flat rate basis. This means that interest is charged on the amount financed in the beginning and not on the the amount financed in the beginning and not on the diminishing balances. Under this system of purchase, diminishing balances. Under this system of purchase, the goods belong to the lending institution until they the goods belong to the lending institution until they are fully paid for.are fully paid for.

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LeasingLeasing

This is a method of acquiring a physical asset This is a method of acquiring a physical asset for a fixed period and is commonly used by for a fixed period and is commonly used by businesses for acquiring company vehicles and businesses for acquiring company vehicles and expensive items of equipment such as expensive items of equipment such as photocopiers. The lending organization retains photocopiers. The lending organization retains the ownership of the item, receives payments the ownership of the item, receives payments over a specified period (say 3 years) and then over a specified period (say 3 years) and then takes back the item to sell to recoup takes back the item to sell to recoup outstanding cost, sometimes to the person who outstanding cost, sometimes to the person who has been leasing it.has been leasing it.

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FactoringFactoring Some Finance houses provide factoring Some Finance houses provide factoring

services to businesses. So they manage a services to businesses. So they manage a company’s invoices and debtors and collect company’s invoices and debtors and collect (and retain) the money owed to the company. (and retain) the money owed to the company. The factor (Finance house) buys trade debts The factor (Finance house) buys trade debts from its clients at a discount and makes profit from its clients at a discount and makes profit when the debts are realized.when the debts are realized.

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MERCHANT BANKSMERCHANT BANKS

Merchant Banks are also known as wholesale Merchant Banks are also known as wholesale banks or investment banks. They are banks or investment banks. They are specialized banks concern with the specialized banks concern with the arrangement of finance and in investment arrangement of finance and in investment management, for large corporate clients in a management, for large corporate clients in a big way.big way.

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They are often involved in advising companies They are often involved in advising companies on the issuing of new share or loan capital, and on the issuing of new share or loan capital, and many Merchant banks are also active in the many Merchant banks are also active in the field of pension fund management.field of pension fund management.

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Origins of Merchant BankingOrigins of Merchant Banking

The origins of Merchant Banking lie – as the The origins of Merchant Banking lie – as the name suggests – in the financing of name suggests – in the financing of international trade. Their earliest business was international trade. Their earliest business was acceptance, which started when early merchant acceptance, which started when early merchant bankers accepted bills of exchange (basically bankers accepted bills of exchange (basically promising to pay internationally traded goods promising to pay internationally traded goods and services).and services).

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Services offered by Merchant Services offered by Merchant BanksBanks

They accept, discount and purchase genuine They accept, discount and purchase genuine trade bills with emphasis on the international trade bills with emphasis on the international trade i.e. they give acceptance credit.trade i.e. they give acceptance credit.

They provide import/export advice to business They provide import/export advice to business engaged in international trade.engaged in international trade.

Merchant banks give short term and medium Merchant banks give short term and medium term loans to companies.term loans to companies.

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They arrange lease and hire purchase finance to their They arrange lease and hire purchase finance to their customers.customers.

They finance property development (mortgages).They finance property development (mortgages). They manage investment funds, with their main They manage investment funds, with their main

clients being pension funds and insurance companies.clients being pension funds and insurance companies. Merchant banks act as underwriters for businesses Merchant banks act as underwriters for businesses

going public or floating such shares.going public or floating such shares.

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Difference between Merchant Banks Difference between Merchant Banks and Commercial Banksand Commercial Banks

Merchant BanksMerchant Banks Commercial BanksCommercial Banks

Undertake wholesale banking Undertake wholesale banking Banking Undertake retailBanking Undertake retail

Usually do not provide personal Usually do not provide personal accounts to small depositorsaccounts to small depositors

Usually offer different accounts even to Usually offer different accounts even to small depositorssmall depositors

Their customers are usually big Their customers are usually big companiescompanies

Their customers are usually small savers Their customers are usually small savers & a few big companies& a few big companies

Merchant banks offer leasing & hire Merchant banks offer leasing & hire purchase facilities for heavy purchase facilities for heavy equipments and machineryequipments and machinery

Commercial Banks do not usually offer Commercial Banks do not usually offer leasing and hire purchase facilities leasing and hire purchase facilities except under special circumstancesexcept under special circumstances

Merchant banks lend on long-term Merchant banks lend on long-term basis because they also borrow longbasis because they also borrow long

Commercial Banks usually lend short-Commercial Banks usually lend short-term because they mostly accept demand term because they mostly accept demand depositsdeposits

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DEVELOPMENT BANKSDEVELOPMENT BANKS

These are specialized financial institutions, These are specialized financial institutions, which perform the twin functions of providing which perform the twin functions of providing medium and long-term finance to private medium and long-term finance to private entrepreneurs and of performing various entrepreneurs and of performing various promotional roles conducive to economic promotional roles conducive to economic development.development.

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As the name suggests, they are development-As the name suggests, they are development-oriented banks and therefore as banks they oriented banks and therefore as banks they provide finance. They are different from provide finance. They are different from commercial banks in the following ways:commercial banks in the following ways:

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Development BanksDevelopment Banks Commercial BanksCommercial Banks

Do not seek or accept deposits of Do not seek or accept deposits of money from the general publicmoney from the general public

Accept deposits of money from the Accept deposits of money from the general publicgeneral public

Specialize in providing medium and Specialize in providing medium and long-term financelong-term finance

Specialize in providing short-term Specialize in providing short-term financefinance

Main objective is to promote Main objective is to promote economic development by economic development by promoting investment and enterprisepromoting investment and enterprise

Main objective is to accept deposits Main objective is to accept deposits of money from the general public of money from the general public for lending & investmentfor lending & investment

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The development promotional roles The development promotional roles may take the following forms:may take the following forms:

Provision of risk capitalProvision of risk capital Underwriting of new issuesUnderwriting of new issues Arranging for foreign exchange loansArranging for foreign exchange loans Identification of investment projects and Identification of investment projects and

opportunitiesopportunities

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Provision of technical adviceProvision of technical advice Provision of both local and foreign market Provision of both local and foreign market

informationinformation Evaluation of project reportsEvaluation of project reports

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THE FINANCIAL MARKETS IN THE FINANCIAL MARKETS IN KENYAKENYA

The financial market can be defined as the sum The financial market can be defined as the sum total of all capital, money and security market total of all capital, money and security market institutions operating in an economy. This also institutions operating in an economy. This also include individuals, companies, institutions and include individuals, companies, institutions and government, who buy (borrow) and sell (lend) government, who buy (borrow) and sell (lend) money to different parties at a price (interest or money to different parties at a price (interest or dividend) determined by the market forces of dividend) determined by the market forces of demand and supply of money. demand and supply of money.

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THE MONEY MARKETTHE MONEY MARKET

This is a market for short-term funds This is a market for short-term funds (instruments), i.e. finance for business for (instruments), i.e. finance for business for about 2 years. Examples are:about 2 years. Examples are:

Bank OverdraftsBank Overdrafts Short Term LoansShort Term Loans Promissory NotesPromissory Notes Bills Of ExchangeBills Of Exchange

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Trade CreditTrade Credit Guilt Edged Securities (Govt. Securities)Guilt Edged Securities (Govt. Securities) Bankers’ Certificate Of DepositsBankers’ Certificate Of Deposits Commercial PapersCommercial Papers

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Financial Institutions or Intermediaries Financial Institutions or Intermediaries that sell short-term funds are: that sell short-term funds are:

The GovernmentThe Government Commercial BanksCommercial Banks Acceptance HousesAcceptance Houses Discounting HousesDiscounting Houses Merchant BanksMerchant Banks

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Buyers of such finances are:Buyers of such finances are:

IndividualsIndividuals CompaniesCompanies GovernmentGovernment Financial InstitutionsFinancial Institutions

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Characteristics of the Money MarketCharacteristics of the Money Market

The market provides short-term finance onlyThe market provides short-term finance only The securities bought and sold in this market are highly The securities bought and sold in this market are highly

negotiable as they can be bought and sold easilynegotiable as they can be bought and sold easily The finance in this market is usually not secured and The finance in this market is usually not secured and

depends on the goodwill of the borrower or buyerdepends on the goodwill of the borrower or buyer This finance is used to solve liquidity problems of the This finance is used to solve liquidity problems of the

concerned partiesconcerned parties

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This finance is very expensive as compared to This finance is very expensive as compared to other sourcesother sources

It is not a perfect market because the demand It is not a perfect market because the demand for such finance far exceeds its supply for such finance far exceeds its supply

This market brings together the buyers and This market brings together the buyers and sellers of the short-term securitiessellers of the short-term securities

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THE CAPITAL MARKETSTHE CAPITAL MARKETS

The markets are for long-term funds i.e. finances that The markets are for long-term funds i.e. finances that are available over 2 years. This market is not well are available over 2 years. This market is not well developed in Kenya. This market is divided into two.developed in Kenya. This market is divided into two.

The security market is a market for long term The security market is a market for long term securities like equity shares, preference shares, securities like equity shares, preference shares, debentures and govt. stocks.debentures and govt. stocks.

The long-term loan market is a market for long-term The long-term loan market is a market for long-term loans, mortgage finance, lease finance and higher loans, mortgage finance, lease finance and higher purchase finance.purchase finance.

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Financial institutions (intermediaries) that sell Financial institutions (intermediaries) that sell Long-term funds (Participants in the Capital Long-term funds (Participants in the Capital Market) are:Market) are:

The Government of KenyaThe Government of Kenya The Stock ExchangeThe Stock Exchange Investment BanksInvestment Banks Investment CompaniesInvestment Companies

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Insurance CompaniesInsurance Companies Pension FundsPension Funds Commercial BanksCommercial Banks Hire Purchase CompaniesHire Purchase Companies

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Services Rendered by the Capital Services Rendered by the Capital MarketMarket

They offer They offer long-term financelong-term finance to the to the businesses, which is used to acquire fixed businesses, which is used to acquire fixed assets.assets.

They They encourage foreignencourage foreign investments in the investments in the securities of the quoted companies.securities of the quoted companies.

They They facilitate the purchase and salefacilitate the purchase and sale of of shares and other securities. shares and other securities.

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The market provides The market provides permanent financepermanent finance necessary for a strong financial base of going necessary for a strong financial base of going concerns, e.g., equity share capital, concerns, e.g., equity share capital, irredeemable preference shares, convertible irredeemable preference shares, convertible debentures and convertible preference shares.debentures and convertible preference shares.

The market provides useful information and The market provides useful information and advice to investors.advice to investors.

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The market enables individuals and companies The market enables individuals and companies to obtain long-term finance, which they can to obtain long-term finance, which they can sell in the money market in form of short-term sell in the money market in form of short-term loans.loans.

The market is responsible for an orderly The market is responsible for an orderly secondary market, which facilitates the secondary market, which facilitates the liquidation of long-term investments.liquidation of long-term investments.

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It promotes the culture of thrift or savings. The fact It promotes the culture of thrift or savings. The fact that institutions exist and that there is some returns that institutions exist and that there is some returns expected from investments, encourages savings.expected from investments, encourages savings.

The stock exchange assists in the transfer of savings The stock exchange assists in the transfer of savings to investment in productive enterprises as an to investment in productive enterprises as an alternative to keeping the savings idle.alternative to keeping the savings idle.

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It assists in the rational and efficient allocation It assists in the rational and efficient allocation of capital, which is a scarce resource.of capital, which is a scarce resource.

The stock market promote higher standards of The stock market promote higher standards of accounting, resource management and accounting, resource management and transparency in the management of business transparency in the management of business

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Difference between the Money Difference between the Money Market and the Capital MarketMarket and the Capital MarketMoney MarketMoney Market Capital MarketCapital Market

11 Goodwill of borrower Goodwill of borrower qualifies him for the qualifies him for the financefinance

Goodwill of the borrower is not Goodwill of the borrower is not important, but his ability to important, but his ability to raise securities is what mattersraise securities is what matters

22 Finance is usually Finance is usually obtained in cashobtained in cash

Finance is usually obtained in Finance is usually obtained in kind, e.g. in form of assetskind, e.g. in form of assets

33 Finance is expensiveFinance is expensive Finance is usually cheapFinance is usually cheap

44 This market does not This market does not deal with the foreign deal with the foreign exchange for exchange for investment reasonsinvestment reasons

It is a channel through which It is a channel through which foreign investments come into foreign investments come into the countrythe country

55 Finance here is Finance here is usually unsecuredusually unsecured

Finance here is usually secured Finance here is usually secured against fixed assetsagainst fixed assets

66 Finance takes a short Finance takes a short time to raisetime to raise

Finance takes a long time to Finance takes a long time to raise due to a lot of formalitiesraise due to a lot of formalities

77 Funds here are Funds here are highly negotiablehighly negotiable

Funds here are not highly Funds here are not highly negotiablenegotiable

88 It is open to all companies It is open to all companies and businesses regardless and businesses regardless of their sizeof their size

It serves big companies more It serves big companies more than small companiesthan small companies

99 Not much influenced by Not much influenced by the central bank through the central bank through selective credit control and selective credit control and credit squeezecredit squeeze

The central bank controls these The central bank controls these markets through selective credit markets through selective credit control and credit squeezecontrol and credit squeeze

1010 No intermediaries neededNo intermediaries needed Calls for intermediaries like Calls for intermediaries like brokers and dealersbrokers and dealers

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THE STOCK EXCHANGE THE STOCK EXCHANGE MARKETMARKET

The Stock Exchange Market is a place where The Stock Exchange Market is a place where securities are bought and soldsecurities are bought and sold

It is usually a building or part of the same where It is usually a building or part of the same where members of the exchange, acting as brokers or members of the exchange, acting as brokers or dealers buy or sell securities.dealers buy or sell securities.

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This is an organized capital market for securities This is an organized capital market for securities inform of shares, preference shares, debentures etc.inform of shares, preference shares, debentures etc.

The stock exchange deals primarily in the The stock exchange deals primarily in the secondary issues (second hand securities)secondary issues (second hand securities)

Not all companies or businesses can have their Not all companies or businesses can have their securities traded in the stock exchange market, securities traded in the stock exchange market, unless they are members i.e. listed or quoted in the unless they are members i.e. listed or quoted in the marketmarket

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Unlike other markets, one is not permitted to buy Unlike other markets, one is not permitted to buy and sell shares directly in the stock exchange and sell shares directly in the stock exchange market. According to the rules, you can only do market. According to the rules, you can only do your buying and selling through a licensed your buying and selling through a licensed member of the stock exchange market called a member of the stock exchange market called a ‘stockbroker’ or a ‘share broker’.‘stockbroker’ or a ‘share broker’.

Stockbrokers are the only ones authorized to buy Stockbrokers are the only ones authorized to buy

and sell securities on behalf of others for some and sell securities on behalf of others for some commission. This commission is a fee called commission. This commission is a fee called brokerage and is fixed by the Stock exchange brokerage and is fixed by the Stock exchange market.market.

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THE ROLE OF THE STOCK THE ROLE OF THE STOCK

EXCHANGEEXCHANGE

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Raising Capital for BusinessesRaising Capital for Businesses

The Stock Exchange provides The Stock Exchange provides companiescompanies with the facility to raise with the facility to raise capitalcapital for expansion for expansion through selling through selling sharesshares to the to the investinginvesting public. public.

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Mobilizing Savings for InvestmentMobilizing Savings for Investment

When people draw their savings and invest in shares, When people draw their savings and invest in shares, it leads to a more rational allocation of resources it leads to a more rational allocation of resources because funds, which could have been consumed, or because funds, which could have been consumed, or kept in idle kept in idle depositsdeposits with with banksbanks, are mobilized and , are mobilized and redirected to promote redirected to promote businessbusiness activity with benefits activity with benefits for several economic sectors such as for several economic sectors such as agricultureagriculture, , commercecommerce and and industryindustry, resulting in a stronger , resulting in a stronger economic growtheconomic growth and higher and higher productivityproductivity levels. levels.

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Facilitate Company GrowthFacilitate Company Growth

Companies view acquisitions as an Companies view acquisitions as an opportunity to expand opportunity to expand product linesproduct lines, increase , increase distribution channels, hedge against volatility, distribution channels, hedge against volatility, increase its increase its market sharemarket share, or acquire other , or acquire other necessary business necessary business assetsassets. A . A takeovertakeover bid or a bid or a mergermerger agreement through the agreement through the stock marketstock market is is one of the simplest and most common ways to one of the simplest and most common ways to company growing by acquisition or fusion.company growing by acquisition or fusion.

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Redistribution of WealthRedistribution of Wealth

By giving a wide spectrum of people a chance By giving a wide spectrum of people a chance to buy shares and therefore become part-to buy shares and therefore become part-owners (owners (shareholdersshareholders) of ) of profitableprofitable enterprisesenterprises, the stock market helps to reduce large income , the stock market helps to reduce large income inequalities. Both casual and professional inequalities. Both casual and professional stock investorsstock investors through through stock pricestock price rise and rise and dividendsdividends get a chance to share in the profits get a chance to share in the profits of promising business that were set up by other of promising business that were set up by other people.people.

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Corporate GovernanceCorporate Governance By having a wide and varied scope of owners, companies generally tend to By having a wide and varied scope of owners, companies generally tend to

improve on their management standards and efficiency in order to satisfy improve on their management standards and efficiency in order to satisfy the demands of these shareholders and the more stringent rules for public the demands of these shareholders and the more stringent rules for public corporations by public stock exchanges and the government. corporations by public stock exchanges and the government. Consequently, it is alleged that public companies (companies that are Consequently, it is alleged that public companies (companies that are owned by shareholders who are members of the general public and trade owned by shareholders who are members of the general public and trade shares on public exchanges) tend to have better management records than shares on public exchanges) tend to have better management records than privately-held companies (those companies where shares are not publicly privately-held companies (those companies where shares are not publicly traded, often owned by the company founders and/or their families and traded, often owned by the company founders and/or their families and heirs, or otherwise by a small group of investors). However, some well-heirs, or otherwise by a small group of investors). However, some well-documented cases are known where it is alleged that there has been documented cases are known where it is alleged that there has been considerable slippage in corporate governance on the part of some public considerable slippage in corporate governance on the part of some public companies (e.g. Enron Corporation, MCI WorldCom, Pets.com, Uchumi).companies (e.g. Enron Corporation, MCI WorldCom, Pets.com, Uchumi).

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Creates Investment Opportunities for Creates Investment Opportunities for Small InvestorsSmall Investors

As opposed to other businesses that require As opposed to other businesses that require huge capital outlay, investing in shares is open huge capital outlay, investing in shares is open to both the large and small stock investors to both the large and small stock investors because a person buys the number of shares because a person buys the number of shares they can afford. Therefore the Stock Exchange they can afford. Therefore the Stock Exchange provides an extra source of income to small provides an extra source of income to small savers.savers.

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Government Raises Capital for Government Raises Capital for Development ProjectsDevelopment Projects

The Government and even local authorities like The Government and even local authorities like municipalities may decide to borrow money in order municipalities may decide to borrow money in order to finance huge infrastructure projects such as to finance huge infrastructure projects such as sewerage and water treatment works or housing sewerage and water treatment works or housing estates by selling another category of securities estates by selling another category of securities known as bonds. These bonds can be raised through known as bonds. These bonds can be raised through the Stock Exchange whereby members of the public the Stock Exchange whereby members of the public buy them. When the Government or Municipal buy them. When the Government or Municipal Council gets this alternative source of funds, it no Council gets this alternative source of funds, it no longer has the need to overtax the people in order to longer has the need to overtax the people in order to finance development.finance development.

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Barometer of the economyBarometer of the economy

At the stock exchange, share prices rise and At the stock exchange, share prices rise and fall depending, largely, on market forces. fall depending, largely, on market forces. Share prices tend to rise or remain stable when Share prices tend to rise or remain stable when companies and the economy in general show companies and the economy in general show signs of stability and growth. An economic signs of stability and growth. An economic recession, depression, or financial crisis could recession, depression, or financial crisis could eventually lead to a stock market crash. eventually lead to a stock market crash. Therefore the movement of share prices and in Therefore the movement of share prices and in general of the stock indexes can be an general of the stock indexes can be an indicator of the general trend in the economy.indicator of the general trend in the economy.

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Listing RequirementsListing Requirements

The listing requirements are the set of The listing requirements are the set of conditions imposed by a given stock exchange conditions imposed by a given stock exchange upon companies that want to be listed on that upon companies that want to be listed on that exchange. Such conditions sometimes include exchange. Such conditions sometimes include minimum number of shares outstanding, minimum number of shares outstanding, minimum market capitalization, and minimum minimum market capitalization, and minimum annual income.annual income.

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Requirements by stock exchangeRequirements by stock exchange

Companies have to meet the requirements of Companies have to meet the requirements of the exchange in order to have their stocks and the exchange in order to have their stocks and shares listed and traded there, but requirements shares listed and traded there, but requirements vary by stock exchange:vary by stock exchange:

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Requirements for Listing (Quoting) on Requirements for Listing (Quoting) on the Nairobi Stock Exchange Marketthe Nairobi Stock Exchange Market

The company in requiring quotation must The company in requiring quotation must register with the Registrar of companies as a register with the Registrar of companies as a limited company.limited company.

The company must have a fully paid capital The company must have a fully paid capital of not less than Ksh. 2,000,000.00 with a of not less than Ksh. 2,000,000.00 with a nominal value of between Ksh. 5.00 and nominal value of between Ksh. 5.00 and Ksh. 10.00.Ksh. 10.00.

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The company must supply the Stock Exchange The company must supply the Stock Exchange authority with details of its directors, legal authority with details of its directors, legal advisers, and company secretary and company advisers, and company secretary and company auditors.auditors.

The company must inform the stock exchange The company must inform the stock exchange authorities of its current distribution of shares.authorities of its current distribution of shares.

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The company must supply the stock exchange The company must supply the stock exchange authority with the following:authority with the following:

Audited financial statementsAudited financial statements Articles and memorandum of association Articles and memorandum of association Chairman’s reportChairman’s report

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The company must be ready to offer 20% of The company must be ready to offer 20% of its share capital to the public.its share capital to the public.

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The Capital Market Authority The Capital Market Authority (CMA)(CMA)

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The Capital market authority was established The Capital market authority was established in 1990 to stimulate the development of long-in 1990 to stimulate the development of long-term debt and equity markets. The main term debt and equity markets. The main objectives are:objectives are:

To protect the investorsTo protect the investors

To provide enough incentives for long term To provide enough incentives for long term investmentsinvestments

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To advice the government on matters To advice the government on matters concerning the development of Capital marketconcerning the development of Capital market

To license brokers, dealers, Unit Trusts, To license brokers, dealers, Unit Trusts, Investment bankers, and other participantsInvestment bankers, and other participants

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To protect and compensate any investor who To protect and compensate any investor who may suffer loss resulting from brokers or may suffer loss resulting from brokers or dealersdealers

To regulate and oversee the issue and To regulate and oversee the issue and subsequent trading both in primary and subsequent trading both in primary and secondary markets instrumentssecondary markets instruments

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The capital market Authority has established a The capital market Authority has established a trading floor in the Nairobi stock Market and a trading floor in the Nairobi stock Market and a training of staff to increase their technical training of staff to increase their technical expertise. It also has powers to control the expertise. It also has powers to control the activities of the Market.activities of the Market.

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BENEFITS BENEFITS

OF OF

INVESTINGINVESTING

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Income:Income:

This is in form of dividend equities or interest This is in form of dividend equities or interest on bonds.on bonds.

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Capital gains:Capital gains: This is in form of long-term This is in form of long-term price appreciation, shot-term price gains, and price appreciation, shot-term price gains, and bonus and rights issues.bonus and rights issues.

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Tax advantagesTax advantages

Withholding tax is usually low as compared to Withholding tax is usually low as compared to other investments.other investments.

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CollateralCollateral

Securities can be used as collateralSecurities can be used as collateral to secure to secure financing (loan).financing (loan).

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ConfidentialityConfidentiality

Financial securities are intangible and Financial securities are intangible and therefore guarantee confidentiality in therefore guarantee confidentiality in management of wealth.management of wealth.

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FlexibilityFlexibility

Shares are traded in units and lots that are Shares are traded in units and lots that are affordable by investors of different income affordable by investors of different income levels. Bonds are also fairly affordable as levels. Bonds are also fairly affordable as compared to other forms of investments like compared to other forms of investments like real estate.real estate.

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LiquidityLiquidity

Securities are easily transferable at a low Securities are easily transferable at a low transaction cost as compared to other assets transaction cost as compared to other assets such as real estate. An investor can therefore such as real estate. An investor can therefore get in and out at his convenience.get in and out at his convenience.

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Hedge Against InflationHedge Against Inflation

Share prices over a long term tend to out Share prices over a long term tend to out perform inflation. Therefore, investment in perform inflation. Therefore, investment in securitiessecurities

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Spreading of Risk & Maximization of Spreading of Risk & Maximization of ReturnsReturns

The range and variety of securities listed in the The range and variety of securities listed in the stock exchanges provide investors an stock exchanges provide investors an opportunity to minimize their exposure to opportunity to minimize their exposure to specific company risk by spreading their specific company risk by spreading their investments across a wide selection of stocks.investments across a wide selection of stocks.

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Operating ConvenienceOperating Convenience

Since investing in securities represents the Since investing in securities represents the separation of ownership from management, it separation of ownership from management, it therefore does not require personal therefore does not require personal commitment of the investor for it to give commitment of the investor for it to give return. Investors are therefore saved the return. Investors are therefore saved the occupational hazards of careers, as opposed to occupational hazards of careers, as opposed to other businesses that need the personal other businesses that need the personal presence and involvement of the entrepreneur. presence and involvement of the entrepreneur.