October 19, 2021

Role of Central Bank of Kenya The roles are outlined in the CBK Act of 1966 and the banking Act of 1968 The Act give CBK the powers to ensure financial soundness of the economy this is through issuing of currency, and Control of money supply in the economy. The banking Art allows CBK to operate on commercial basis and offers such services as currency notes to commercial banks, and discounting securities. a) Issuing of currency and control of money supply This is the most important role of CBK and calls for a high degree of efficiency and trust. CBK is allowed to print money to match the resources accumulated by different sectors of the economy. This means that there is a strong correlation between the money supply in the economy and the resources in the economy. It is always kept as top secret in order to avoid speculation. CBK maintains some resources to back the Kenyan currency. They are referred to as reserves and they are in form of Gold, silver, and other strong foreign currencies. b) Adviser to the Government On economic policies necessary at any one point in time to stimulate economic development of various sectors Ways of raising finance e.g. best sources of finance and best cost of the interest to be paid on such finances Best means of managing the private sector from the financial management point of view. In particular it advices on which projects the public sector and which the Government is to finance Gives advice on ways and means of controlling inflation Means and ways of boosting purchasing power of the people in order to uplift their standards of living c) Banker to the Government Undertakes all government transactions e.g. different government ministries will draw cheque on it for payment for different services and goods the ministry has purchased Receives various payments on behalf of Government e.g. tax payments are deposited in the consolidated account maintained by CBK, foreign aid and other funds received by Government It also pays foreign loans on behalf of the Government thus it keeps foreign exchange reserves for this purpose It advances loans to the Government both short term and long term to finance Government projects d) Management of public debt Public debt is that finance which Government borrows from its citizens and foreigners through Government securities such as treasury bonds and stocks. Finances from these securities are received by CBK on behalf of the Government to finance deferent economic activates. CBK will receive the finance from the securities and also undertakes to pay interest and principle to the public or foreigner when they fall due. Advice the Government the rate of interest the securities will carry. Advice the Government to what conditions will be ideal to sell Treasury bill or Government stocks e) Banker to commercial banks Acts as the clearing house where it acts as a middle man in settlement of debt by or to any commercial bank in Kenya It is the sole custodian of reserve deposits which by law commercial banks are required to maintain with CBK  Acts as a source of short term finance to commercial banks e.g. when commercial banks are faced with short term liquidity problems they borrow from CBK It acts as an arbitrator in disputes between commercial banks e.g. financial expansion disputes It is authorised by commercial banks to sell or discount promissory notes, bill of exchange or any other documentary instalment maturing within 180 days f) Financial controller of all commercial banks Commercial banks are required to be guided in their activities by CBK in the following areas:- Areas in which investments are a priority to Government investment plans Submit periodic reports from which important statistics used to gauge the financial soundness of the economy are prepared e.g. savings accumulated over a period of time or investments made over a period of time Advice commercial banks in matters of financial planning Advice commercial banks in their process of credit creation g) Lender of last resort If circumstances warrant or dictate CBK may act as lender of last resort in the following circumstances Under high inflationary circumstances where the general public looses confidence in money and prefers to invest in real estates A commercial bank may fail to raise the finance necessary to undertake a given investment, either due to high capital investment or due to liquidity constraints thus forcing it to turn to CBK for financing h) Foreign exchange administration The county earns through sale of goods and services to the foreign countries. This finance is usually in form of money such as dollars, euro, Japanese yen, sterling pound, douche mark etc. These currencies make up the special exchange rate in the international trade. The process of management of international trade is aimed at ensuring that there is a balance between inflows from abroad and outflows out of the country. For this reason CBK will allow as little money as possible to live the economy but to allow as march as possible to enter the economy. In its control of forex, CBK is the sole seller of foreign currency in Kenya. Commercial banks can do this with approval from CBK

The role of Stock Exchange in economic development 1. It provides a ready capital market in which buyers and sellers of securities conclude their deals and make investment liquid. 2. The stock market through market forces of demand and supply determine price of different securities. 3. The stock market is a barometer of the economy. The stock exchange shares prices move with the general trend in the economy, mostly they follow the economic cycle. 4. They improve corporate governance. The stock market improves management standards and efficiency in order to satisfy the demand of shareholders. 5. The stock market provides a medium through which the government can absorb excess liquidity in the economy by issuing securities at favorable interest rates and hence reduce inflation. 6. The government can raise capital for development project. 7. The government and local authorities may decide to borrow money in order to finance projects such as roads construction or housing., these projects are usually funded by bonds. 8. When the government or local authority issues bonds, it may reduce the need to tax people in order to finance development. 9. The stock market index is an important indicator of economic performance. 10. Stock market is used to mobilize saving for investment i.e stock exchange is important in any economy because it acts as channel through which savings are invested to reduce income inequalities. Reasons why many firms are not quoted in stock exchange market 1. Most companies operating in Kenya are owned by families who value their control such cannot go public as this dilutes their ownership. 2. Going public entails a lot of secrecy to the public because such companies are required to publish annual financial statements and also allow shareholders to inspect statutory books, list of shareholder, list of directors, creditors etc. 3. Going public is expensive as means of raising finance because of floating cost. Which include under writing, advertising, brokers commissions, legal fee for receiving banks etc 4. Some companies in Kenya are subsidiaries of multinational whose parent companies are quoted in other stock markets. 5. Going public entails a lot of formalities on the part of companies concerned. These formalities include the a. Capital market formalities b. preparing a prospector c. Arranging & paying auditors d. Compiling the companies five years audited Profit & loss accounts 6. Some firms avoid stock market because of the rigid rules and regulations 7. A highly profitable company may want to retain profits for expansion while public as shareholders may demand dividends. 8. Most companies in Kenya do not maintain proper book of accounts and as such cannot convince the public to buy their shares if their performance is questionable.

The Five Parts of the Financial System 1. Money: Anything generally accepted as a means of payment or medium of exchange. It’s useful because you can exchange goods or services with it, either now or later (non-perishable, store of wealth. Contrast with, say, fish). 2. Financial Instruments: A written legal obligations of one party to transfer something of value to another party at some future date under certain conditions. These obligations usually transfer resources from savers to investors. Examples: Stocks, bonds, insurance policies. 3. Financial Markets: Places or networks where financial instruments are sold quickly and cheaply Examples: New York Stock Exchange, Chicago Board of Trade and Nairobi Stock exchange. 4. Financial Institutions: Firms that provide savers and borrowers with access to financial instruments and financial markets. Among other services, they allow individuals to earn a decent return on their money while at the same time avoiding risk. Exs.: banks, insurance companies, mutual funds, brokerage houses 5. Regulators: Government entity which monitors the state of the economy and conducts monetary policy. Example: central Bank of Kenya. Flow of funds in a Financial system;- Financial system ensure flow of funds through two mechanisms;- i) Direct finance ii) Indirect finance Direct finance: – Borrowers borrow directly from lenders in financial markets by selling to them securities (financial instruments) shares, bonds, debentures Financial markets are critical for producing an efficient allocation of capital which contribute to higher production Indirect finance: – Ensures movement of funds from lenders to borrows through financial intermediaries. Financial intermediaries These are Financial institution (such as a bank, credit union, finance company, insurance company, stock exchange, brokerage company) which acts as the ‘middleman’ between those who want to lend and those who want to borrow.  Importance of financial intermediaries a) Reduction of transaction cost They reduce transaction cost by taking advantage of economies of scale and expertise’s (skills in financial management). They ensure flow of funds from borrows to lenders at low cost. They provide customers with services hence making it easier for customers to conduct transaction i.e. commercial bank facilities transactions in any given economy b)Risk sharing Uncertainly due to variation in the returns of investment Financial intermediary through a process known as risk sharing ensure return in investment and also ensure diversification of portfolio. The process of risk sharing ensures that there is low risk on investors’ assets. This process of risk sharing is sometimes known as assets transformation. This is because risky assets are transformed into safer assets for investors. c) Information Asymmetry Financial intermediaries in any given economy ensures that investors have information that enables them to make accurate decisions, however there can be cases of individuals and firm having more information than other. This is known as information asymmetry Lack of adequate information created by information asymmetry causes two problems in financial systems 1 Adverse selection Problem created by asymmetric information before a transaction occurs, which makes potential borrows not to pay back the loan hence increasing credit risk. This makes lenders avoid lending even to credit worth customers. Adverse selection makes the financial market to be inefficient 2 Moral hazard It’s the problem created by information asymmetry after the transaction has occurred. Moral hazard in financial market is the risk that the borrower may engage in activities in order to avoid paying back the loan i.e. selling the collateral.

The role of financial system in the economy The financial sector provides six major functions that are crucial for the survival and efficient operation of any given economy. These functions are outlined below: 1. Providing payment services. It is inconvenient, inefficient, and risky to carry around enough cash to pay for purchased goods and services. Financial institutions provide an efficient alternative. The most obvious examples are personal and commercial checking and check-clearing and credit and debit card services; each are growing in importance, in the modern sectors at least, of even low-income countries. 2. Matching savers and investors. Although many people save, such as for retirement, and many have investment projects, such as building a factory or expanding the inventory carried by a family micro enterprise, it would be only by the wildest of coincidences that each investor saved exactly as much as needed to finance a given project. Therefore, it is important that savers and investors somehow meet and agree on terms for loans or other forms of finance. This can occur without financial institutions; even in highly developed markets, many new entrepreneurs obtain a significant fraction of their initial funds from family and friends. However, the presence of banks, and later venture capitalists or stock markets, can greatly facilitate matching in an efficient manner. Small savers simply deposit their savings and let the bank decide where to invest them. 3. Generating and distributing information. One of the most important functions of the financial system is to generate and distribute information. Stock and bond prices in the daily newspapers of developing countries are a familiar example; these prices represent the average judgment of thousands, if not millions, of investors, based on the information they have available about these and all other investments. Banks also collect information about the firms that borrow from them; the resulting information is one of the most important components of the capital of a bank although it is often unrecognized as such. In these regards, it has been said that financial markets represent the brain of the economic system. 4. Allocating credit efficiently. Channeling investment funds to uses yielding the highest rate of return allows increases in specialization and the division of labor, which have been recognized since the time of Adam Smith as a key to the wealth of nations. 5. Pricing, pooling, and trading risks. Insurance markets provide protection against risk, but so does the diversification possible in stock markets or in banks’ loan syndications. 6. Increasing asset liquidity. Some investments are very long-lived; in some cases – a hydroelectric plant, for example- such investments may last a century or more. Sooner or later, investors in such plants are likely to want to sell them. In some cases, it can be quite difficult to find a buyer at the time one wishes to sell – at retirement, for instance. Financial development increases liquidity by making it easier to sell, for example, on the stock market or to a syndicate of banks or insurance companies.

FINANCIAL INSTITUTIONS AND CAPITAL MARKETS Introduction The economic development of any country depends, upon the existence of a well organised financial system. It is the financial system which supplies the necessary financial inputs for the production of goods and services which in turn promote the well being and standard of living, of the people of a country. Thus, the ‘financial system’ is a broader term which brings under its fold the financial markets and the financial institutions which support the system. The major assets traded in the financial system are money and monetary assets. The responsibility of the financial system is to mobilise the savings in the form of money and monetary assets and invest them to productive ventures. An efficient functioning financial system facilitates the free flow of funds to more productive activities and promotes investment. Thus, the financial system provides the intermediation between savers and, investors and promotes faster economic development. 1. Financial System a) Finance Finance is a branch of economics concerned with resource allocation as well as management, acquisition and investment. b) System A group of interacting, interrelated, or interdependent elements forming a complex whole. c) Financial system A financial system comprises financial institutions, financial markets, financial instruments, rules, conventions, and norms that facilitate the flow of funds and other financial services within and outside the national economy. It can be described as a whole system of all institutions, individuals, markets and regulatory authorities that exist and interact in a given economy. The institutions, government and individuals form the participants in various markets; money markets (including foreign exchange) and capital markets (including security) markets. The participant buy (borrow) and sell (lend) money to different parties at a price (interest or dividend) within the market, which is determined by the forces of demand and supply. Financial systems are crucial to the allocation of resources in a modern economy. They channel household savings to the corporate sector and allocate investment funds among firms; they allow inter-temporal smoothing of consumption by households and expenditures by firms; and they enable households and firms to share risks. Since these functions take place in a market oriented environment, there is a need for an independent party to enforce rules and contracts and this is the regulator. The main regulatory authorities of the financial institutions that constitute the financial system of a given economy are the Central Bank and Capital Market Authority.

Co-operative Accounting and Audit Toolkit Introduction Co-operatives are owned and controlled by their members and members are individuals, families and other co-operatives who trade with the co-operative. Members receive dividends from the net profit and have a vote in general meetings about any issues that are raised. The impact co-operatives have on their local communities and local economy is far greater than that of private business. Because the members receive the bulk of net profits it is much more widely distributed than the profits from a private business that are just distributed to a few people and often not spent locally. The multiplier effect of profits being distributed by co-operatives to local members/residents means that the impact a co-operative has is felt more acutely than a private business that is why co-operatives should measure and account for their impact more rigorously. The Co-op Accounting and Audit has been designed as a ‘light touch’ approach to what can sometimes be a complex and complicated process for members of small scale co-operatives and provides a way of engaging members more fully in the affairs of the co-operative. All co-operatives should have a Co-operative Business Plan describing what the co-operative does, how it is managed and what the plans are for the future. Co-op Accounting and Audit will measure against this plan. For further information on how to develop your business plan please see our Co-operative Management and Planning Toolkit1 or see your local National Registrar of Co-operatives in the country for advice they should also be able to assist you with developing the plan. The Co-op Accounting and Audit method uses a poster on which all the information is displayed and where progress is written up as it happens. This enables members to write in their thoughts, comments and ideas about the co-operative and how it might be improved. The Co-op Accounting and Audit poster is a tool to use in creating good governance – openness is a key operational principle for good governance. The poster is a way of starting to gather data on a regular and systematic basis, which can be extended over time. Most of the data is already known and most is already collected, however it is often recorded in different forms and can be difficult to bring it all together. The poster is designed to be a single record of the relevant information to help the management and members of co-operatives understand what the plans are for the year and how the co-operative is performing in relation to the plans. Triple Bottom Line The triple bottom line is described using different terminology by different business sectors and agencies; however there are three core elements in common. Social Audit uses the heading commercial, social, and environmental; the UN uses profit, people, and planet; and in this Toolkit the headings of Strong Co-operatives, Strong People, and Strong Communities are used. These headings fundamentally underpin the same inclusive approach, where the interdependence of the parts combine in creating a more responsible and sustainable system of organisational performance and measurement. Co-operatives need to be able to plan and manage these three key parts of a good organisation. Commercial functions need to be profitable but also of good and honest quality; social wealth needs to be developed through common ownership and the members and employees participating in the co-operative, and the opportunities the co-operative provides; and, community and environmental responsibility should be a result of the way the co-operative looks to mitigate their environmental cost to society in the way they operate their processes, package and transport goods, and produce and use energy, and in the effects on the community as a result of the co-operatives’ actions. Co-operative Accounting and Audit is designed to bring together the three dimensions of performance, the triple bottom line, that combine to form best operational practice and good governance: financial, social and environmental, and which provide the foundation for self-assessment. For a fuller description of the triple bottom line please go to Annex 1. Finance Private sector businesses report to their shareholders on their financial performance. Co-operatives report to their members on their financial performance but also need to report on the achievement of social and environmental plans. Shareholders are often removed from the businesses and are unaffected by operational performance, while members of co-operatives are intimately associated with the operations of their co-operatives and as local residents are affected by their impact. It is suggested that the Co-op Accounting and Audit is used at the same time as the financial audit; providing a full picture of performance. The financial audit provides information relevant for shareholders, while social accounting and audit provides information relevant for society.