Types of banking systems & their relative merits and demerits.

Types of banking systems & their relative merits and demerits.

All of us well realize to what extent banks are important in our lives. They serve the financial requirements of different categories of people in different fields like agriculture, business, and more. There are various types of Banking System

Types of Banking System

1- Group Banking

Banking system is designed to be used by groups rather than individuals. A common example is a company plan offered to employees. Group banking members may have access to lower interest rates, lower fees, discounts and other perks not available to regular account holders.

Group banking can also provide a more personalized banking relationship for the members if the bank designates one representative, who is generally more knowledgeable about the group’s needs, as the point of contact for all the members of the group.

2- Chain Banking

Chain banking is a situation in which three or more banks that are independently chartered are controlled by a small group of people. It refers to a form of bank governance that occurs when a small group of people controls at least three banks.

Usually, the controlling parties are majority shareholders or the heads of interlocking directorates. Chain banking as an entity has declined with the surge in interstate banking.

The concept of chain banking is different from group banking, in that the entities involved in the chain bank arrangement remain autonomous and are not owned by a single holding company. By contrast, the group banking model requires a holding company to own all the banks involved, effectively creating an umbrella under which all the banks operate.

3- Mixed Banking

Mixed banking is a system of banking where a bank combines both deposit banking as well as investment banking. In other words, the bank will provide short-term loans for commerce and trade and long-term finance for industrial units.

While this type of banking promotes rapid industrialization, the mixed banking system reduces the liquidity of funds of commercial banks. it difficult to pay back the borrowed funds of customers whenever they make a demand because funds get blocked when the bank gives long-term loans to industries.

4- Branch Banking

Branch banking refers to a single bank that operates through various branches in a city or in different locations or out of the cities. It offers a wide array of face to face services to its customers. Services provided by a branch include cash withdrawals and deposits from a demand account with a bank teller, financial advice through a specialist, safe deposit box rentals etc.

5- Unit Banking

Banking systems encourage either small, independent banks or banks that are theoretically independent but are in fact owned by a bank holding company.

 

The following points highlight the six main systems of banking. The systems are 1. Unit Banking, 2. Branch Banking, 3. Group Banking, 4. Chain Banking, 5. Mixed Banking, 6. Correspondent Banking.

System  1. Unit Banking:

Unit banks are independent, one-office banks. Their operations are confined in general to a single office. The existence of unit banking in the USA is due to legal restrictions which prevent the growth of monopoly in banking. Some unit banks have grown to large sizes but they operate under severe restrictions which limit or prohibit the establishment of branches.

The unit banks operate in small towns and cities and are called country banks and city banks respectively. All unit banks are linked together by a correspondent bank relationship. A country bank has deposited in city banks, and city banks have deposits in branch banks in the same and other big cities like New York and Chicago.

Merits of Unit Banking:

The unit banks, being independent and one-office banks, possess certain advantages:

1. Efficient Working:

A unit bank works very efficiently and provides prompt service to its customers. For, like a departmental store in a locality, it has competitors in other unit banks.

2. Personal Relations:

Since its organisers and other staff are generally local people, they have personal relations which help in mobilising larger resources for the bank.

3. Quick Decisions:

They are able to meet the financial requirements of the people promptly and efficiently. There is always on-the-spot decision-making by the bank management.

4. Less Irregularities:

There are fewer chances of fraud and irregularities under unit banking because of the close supervision and control of the management.

5. Local Utilisation of Deposits:

Local deposits are utilised by a unit bank on the development of the same locality and they are not to be transferred to other towns as is done under branch banking.

6. Economies:

The unit banking operations being on a small scale, they are free from the diseconomies which arise in large scale banking operations.

7. Prevention of Monopoly:

Unit banking helps in the prevention of monopoly banking.

8. Enjoy Merits of Branch Banking:

The unit banks also enjoy the advantages of branch banking as they are connected with big banks through the correspondent banking system in the USA.

Demerits of Unit Banking:

Despite these merits, unit banking suffers from certain disadvantages:

1. Failure to Spread Risks:

The unit banking system suffers from its failure to spread risks. As the unit banking operations are localised in a particular area, the failure of a big party to repay the loan in time may bring disaster to the bank.

2. Limited Resources:

The unit bank has another disadvantage in that it has limited resources at its disposal. So in the event of a financial or economic crisis, if its depositors start withdrawing their money, the bank fails. This is what actually happened in the USA during the Great Depression of the 1930s when 5000 banks failed and an additional 1200 were absorbed by larger banks.

3. Non-diversified Services:

The unit bank cannot provide diversified banking services to its customers because of its inability to establish branches and higher costs. For example, businessmen may prefer a branch of their city bank in the local business centre to facilitate their business transactions.

4. No Economies of Large Operations:

The unit banking system cannot have the advantages of a large scale banking in that it cannot recruit more efficient and highly paid staff, and cannot enjoy the economies of large scale and intensive specialisation and division of labour.

5. Lack of Fund Mobility:

An important argument against the unit banking system is that there is lack of mobility of funds within the country. The unit banks do not attract funds from outside their areas. On the other hand, there is every likelihood of local funds flowing out to the large money markets in pursuit of higher interest rates. This is because the unit banks are unable to pay high-interest rates.

6. Non-Economic Considerations:

A unit bank may not advance loans strictly on economic considerations thereby jeopardizing the interests of its depositors. It may be pressurised to give loans to a few local businessmen who may not be creditworthy.

7. Backward Areas:

Since a unit bank has limited resources at its disposal, it cannot be opened in backward towns. As a result, such areas continue to remain backward.

8. Unhealthy Competition:

As every company starts a unit bank in a large town, it leads to unhealthy competition among different unit banks with the result that very few survive in the long run.

9. Remittance of Funds:

As a unit bank has no branches in other towns, it has to depend upon the correspondent banks for remittance of funds. This is very expensive. These demerits have led to the modification of the banking laws in the USA whereby branch banking has been permitted in a number of states, though branch banking across state boundaries is still prohibited.

System # 2. Branch Banking:

Branch banking is the most prevalent banking system in the majority of countries. Under this system, a big bank has a number of branches in different parts of the country and even many branches within a cosmopolitan city like Mumbai, Kolkata, Chennai or New Delhi.

Small commercial banks also carry on branch banking operations within a state or region. In the USA, branch banking is confined to the states. Accordingly, a number of banks have merged under a holding company to carry on branch banking business efficiently and profitably.

Merits of Branch Banking:

The branch banking system has many advantages which make this system superior to the unit banking system.

1. Spreading of Risks:

Branch banking has the advantage of spreading risks geographically and industrially. If branches in a particular area suffer losses due to recession in industries located there, these losses can be offset by profits from prosperous areas.

2. Large Scale Organisation:

The branch banking system has the advantages of large scale organisation because a large bank is able to recruit efficient and trained staff and pay better than the unit banks. It can thus realise the advantages of intensive specialisation and division of labour by carrying out separate banking operations under different staff.

3. Economy in Reserves:

The branch banking system helps in economising the use of cash reserves. It can move cash reserves from one branch where they are less needed to the other where they are more required in times of necessity.

4. Advances on Merits:

Under this system, loans are advanced on merits than on personal or local considerations. There are set rules under which loans are advanced to customers.

5. Diversification of Operations:

Under the branch banking system, there is diversification of banking operations. Big banks can provide banking facilities to trade, industry, businessmen and the common man at cheaper rates and more efficiently than unit banks because they possess larger financial resources.

6. Equitable Distribution of Funds:

As a corollary to the above, big banks can provide banking facilities throughout the length and breadth of the country, whether it is a small village or a big city, and a backward or a prosperous area. It is in this way that branch banking also helps in the equitable distribution of funds within the country.

7. Proper Utilization of Funds:

A big bank with the large number of bank branches is able to utilise its funds most profitably. It can carry out its banking operations with lower cash reserves in each branch and lend the remaining amount to its customers. In case the need arises for excess cash in one branch, it can be met by transferring funds from some other branch.

Thus the commercial banks earn larger profits under branch banking than under unit banking.

8. Remittance Facilities:

With its network of branches spread in all parts of the country, a big bank can provide cheaper and better remittance facilities to its clients than under the unit banking system having correspondent banking relations.

9. Large Investments:

Under the branch banking system, a big bank with large financial resources is in a better position to choose securities and make large investments in keeping with the principles of safety and liquidity.

10. Effective Central Bank Control:

The central bank of the country can control the banks more effectively under the branch banking system than under the unit banking. It is easier to control the credit policies of a few large banks than those of numerous unit banks.

Demerits of Branch Banking:

Branch banking has its critics who point towards a number of disadvantages of this system.

They are discussed as under:

1. Bureaucratisation:

Under the branch banking system, there is bureaucratisation and the management of all the branches is under the control of the head office, this leads to delay in taking, prompt decisions by the branch managers. They have to refer all cases above a certain limit for advances to the head office.

2. Do not meet Local Needs:

The branch managers are not able to meet the borrowing needs of the local business community as efficiently and sympathetically as the unit banks. This is because the branch bank managers stay in one locality only temporarily and have to operate under rules set by the head office.

3. Monopoly Banking:

The branch banking system leads to the establishment of monopoly banking in the country. When a few big banks open branches in all parts of the country, they limit competition in banking and ultimately lead to the establishment of a monopoly in the banking industry.

Funds tend to concentrate in a few banks. It may further lead to the concentration of economic power in industry and even to political power by such financially powerful banks.

 

 

 

4. Lax Supervision:

As big bank has a number of branches spread throughout the country, it is difficult to manage and supervise them efficiently. Control becomes lax, the banking services suffer and the clients are hit hard.

5. Transfer of Funds:

Another disadvantage of branch banking is that deposits of one area may be used for financing business and industry in other areas where the banks expect to earn more by lending. This may adversely affect the former area if it is already backward.

6. Fear of Loss:

If branch banking spreads on a large scale, some of the branches may run under losses due to bad debts and low mobilisation of deposits. Such a situation may lead to a huge loss to the bank thereby leading to its failure.

7. Unhealthy Competition:

Branch banking leads to competition among different banks in establishing branches at various places. This tendency leads to an unnecessary increase in expenses. The usual practice is for the different commercial banks to open branches in the same locality in big towns and cities.

This leads to the concentration of branches, thereby resulting in unhealthy competition and rivalry. Sometimes, the banks give inducements in the form of gifts and provide free outstation services to attract customers. Such devices increase bank expenses and lead to the wastage of national resources.

Conclusion:

Despite demerits, the branch banking system is preferred to the unit banking in developing countries like India. In poor countries, unit banking cannot be successful. There is a need to develop agriculture, industry and trade which is only possible through the branch banking system with its large financial resources.

Further, for balanced regional development, it is through branch banking that funds can be utilised from branches in developed regions to backward regions.