Traditional Financial Institutions: Definition, Functions, Pros & Cons

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What is Financial Institutions?

Financial institutions are business organizations which deal in money, though some may deal in other financial assets such as shaves, letters of credit, bills of exchange etc. With the exception of the Central Bank, they make profits by trading in money; that is, through the process of accepting deposits in several ways e.g. offering technical advice etc.

Traditional Financial Institutions
Traditional Financial Institutions

What is Traditional Financial Institutions?

Before the advent of modern financial institutions, existing side-by-side with them in modern times, there are some traditional institutions which perform the basic banking iimctions. They still work hand in hand.

  • In the traditional setting, there are ‘money lenders’ who make profits by charging interest on money lent to people. Money lenders have surplus funds for lending and they usually charge very high interest rates.
  • There is a traditional banking system (‘Local Bank’) which is called various name in various languages. In some cases the members contribute an agreed sum of money into a Fund on a regular basis such as on Sundays, the market day of the area, or month ending. The contributions can be on a daily, weekly or monthly basis. From the fund, money can be lent to members or other persons and interest is charged. At an agreed period (say during festivals, end of year, etc) the members are re-paid their money together with their share of the interest or profit.

On the other hand, the members may pay various sums of money into the fund, each according to his ability.

  • There is another variation of the ‘Local Bank’ in which members of the organization contribute agreed sums of money which are given to the members in turns.

The order is arrived at by various means e.g. balloting, by consensus, etc. This type is common among workers (especially the low income earners) in various organizations. It is a means of raising relatively large sums of money which could be channelled into meaningful projects.

Advantages of Traditional Financial Institutions

  • These traditional financial institutions encourage their members to form the habit of saving money.
  • They encourage their members to invest the big sum of money they have saved.
  • They lend money to their members.
  • They save their members the pains of going to banks to borrow money with their embarrassing collateral securities.
  • They inculcate the principles of democracy in their members.

They discourage their members from being extravanant in their spending so that they can save money.

Disadvantages of Traditional Financial Institutions

  • These traditional financial institutions experience high embezzlement rates.
  • They have weak management because, they are managed by those who lack administrative and managerial acumen.
  • The institutions lack effective means of recove loan granted to their members tthey default In re-payment.
  • They have tow financial resources at their disposal as a result of Inability of some of their members to make their contributions.
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