CHAPTER II. LITERATURE
REVIEW
2.1. Introduction
This chapter presents a review of the research literature
already carried out in the field under study. It is a reflection of what
economic theory reveals about the topic under study and also what different
researchers have come up with as empirical findings in their different studies.
This review helps to understand the topic under study and also identifies
different gaps of further research. Unfortunately, as shall be noticed, little
has been researched in Rwanda relating to the topic under study.
2.2. Development
Development has been defined by many writers (scholars) in
different ways; some argue that development involves growth of per capita
income which others based on the view of improving living conditions by
reducing inequality of income distribution.
According to Kocher (1973: 4), the term development is defined
as the process of a general improvement in levels of living together with
decreasing of inequality of income distribution and the capacity of sustaining
continuous improvements overtime.
Todaro (2000: 56) defines development as a multi-dimension
process involving the reorganization and the reorientation of the entire
economic and social systems. He further argues that development of physical
reality and a state of mind in which society has, through some combinations of
social, economic and political process secured the way of obtaining better
life.
2.3. Financial
institutions
There are different definitions with respect to financial
institutions. According to Collins (1993: 193), financial institutions are
institutions that act primarily as a financial intermediary in channeling funds
from lenders to borrowers (e.g commercial banks and building societies), or
from savers to investors (e.g pension funds, insurance companies).
Financial institutions are institutions that move funds from
people who save to people who have investments opportunities (mishkin, 2001:
179).
Financial institutions are business firms whose principal
assets are financial assets or claims (stocks, bonds, loans, etc) and make
loans to customers or purchase investment securities in the market place and
offer other financial services (Rose et al, 1993: 11).
2.4. Financial institutions
and financial system
Financial intermediaries and other financial institutions are
part of a vast financial system that serves the public. The financial system is
composed of a network of financial markets, institutions, businesses,
households, and governments that participate in that system and regulate its
operation. That system today knows no geographic or political boundaries, but
girdles the globe, marking loans, issuing securities, and proving outlets for
the public's savings 24 hours a day. (Rose: 1993, 6)
2.5. Functions of
financial system
The basic function of the financial system is to transfer
loanable funds from lenders or savings surplus units to borrowers or savings
deficit units. These funds are allocated by negotiations and trading in wide
web of financial markets that bring together individuals and institutions
supplying funds with those demanding funds. Most savings flowing through the
financial system come from households: the principal borrowers in the financial
system are business firms and the government. (Rose (1993))
Rose, Kolari and Fraser (1993) further reveal that the
financial system is one of the most important components of the global economy.
It provides essential services without which a modern economic system could not
function, thus presenting us with some roles of financial intermediation. Among
these roles we analyze the important ones: credit, payments, money creation
and savings.
2.5.1. Credit:
the financial system supplies credit to support purchases of goods and services
and to finance capital investments , construction of buildings, highways,
bridges, and other structures, and the purchase of machinery and equipments.
Investment increases the productivity of society's resources
and makes possible a higher standard of living for individuals and families.
(Rose et al, 1993: 7)
2.5.2.
Payments: the financial system supplies mechanisms for making payments
in the forms of currency, checking accounts and other transactions media. In
recent years institutions operating in the financial system have developed many
new payment services, including money market and NOW accounts and share draft
(all types of interest- bearing checking accounts), telephone bill- paying
services, and electronic machines that accept deposits and dispense cash.( Rose
et al, 1993: 7)
2.5.3. Money creation:
through the services of supplying credit providing a mechanism for
making payments, the financial system makes possible the creation of money.
Although several different definitions and forms of money are in use today, all
forms of money serve as medium of exchange for purchasing goods and services.
(Rose et al, 1993: 7)
2.5.4. Savings:
finally, the financial system provides a profitable outlet for
savings. Both individuals and institutions save today to be able to consume
more goods and services tomorrow. Saving performs an essential economic
function because it releases scarce resources from producing goods and services
for current consumption in order to produce investment goods (buildings,
equipments, etc). (Rose et al, 1993: 8)
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