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 deposits 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 less chances of fraud and irregularities under the 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.
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 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:
Unit bank has another disadvantage 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 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 at other towns, it has to depend upon the correspondent banks for remittance of funds. This is very expensive. These demerits have led to 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:
The 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 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 investment 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:
The branch banking has its critics who point towards a number of disadvantages of this system.
They are discussed as under:
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 monopoly in the banking industry.
Funds tend to concentrate in a few banks. It may further lead to 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 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 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 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 wastage of national resources.
Despite demerits, the branch banking system is preferred to the unit banking in developing countries like India. In poor countries, the unit banking cannot be successful. There is need to develop agriculture, industry and trade which is only possible through the branch banking system with its large financial resources.
Further, for a balanced regional development, it is through branch banking that funds can be utilised from branches in developed regions to backward regions.
However, the disadvantages of the. branch banking can be avoided through their proper regulation by the central bank of the country. If the banks fail to follow the central bank, they can be nationalized by the government. This is what has been done in India and a few other developing countries.
System # 3. Group Banking:
Group banking is part of the USA banking system. It is a type of multiple office banking consisting of two or more banks under the control of a holding company, which itself may or may not be a bank. The term “bank holding Company” is based on 25 per cent ownership or control of two or more banks.
The holding company is called the parent company and the banks under the parent company are called operating companies. The parent company controls and manages the operating banks under the group but each bank continues to keep its separate entity or name. The parent company may also be an operating bank.
Merits of Group Banking:
The group banking system has certain advantages:
1. Pooling of Resources:
The parent company pools the resources of the group and helps the group banks to provide large loans and advances.
2. Do not need large Cash Reserves:
The banks in the group need not keep large cash reserves for they can transfer funds to each other when the need arises.
3. Increase in Efficiency:
The efficiency of the group increases when the parent company provides such specialised services as research, advice on investments, loans and legal matters to all the banks in the group.
4. Economies of Large Operations:
The group also gains from the economies of large scale banking operations when the parent company advertises, makes bulk purchases, and hires the services of experts on behalf of the banks in the group.
5. No Mergers:
As already noted above, under the group banking system the operating companies do not merge with the parent company and continue to keep their separate entities but benefit from all the advantages of a large scale organisation.
6. No Unhealthy Competition:
Group banking avoids unhealthy competition among banks when they are under one holding company.
Demerits of Group Banking:
Despite the above merits, the group banking system suffers from certain disadvantages:
1. Monopoly Banking:
The group banking system is a step towards monopoly banking which is not healthy from the economic view-point.
2. Inefficient System:
The operating banks may not follow the guidelines and policies laid down by the parent company from time to time. This may lead to inefficiency.
3. Chain Reaction:
If the business of one member declines, it may adversely affect the business of other members of the group.
4. Diversion of Funds:
If the parent company is not an operating banking company, it may divert the funds of the group in furthering its own interests. This may prove harmful for the entire operating group which may be starved of funds and ultimately bring disaster to the group.
System # 4. Chain Banking:
Chain banking is also a USA banking system. It is a banking system where the same individual or group of individuals controls two or more banks, as against control by a holding company under group banking. This is done by stock ownership in two or more banks.
Stockholders directly or through their nominees exercise control of competing banks. The chain banking system possesses almost the same advantages and disadvantages as that of the group banking discussed above.
System # 5. Mixed Banking:
The mixed banking system is one in which the commercial banks advance both short-term and long- term loans to commerce and industry. Under the British banking system, the commercial banks give short- term loans to commerce and industry.
But in other European countries like Germany, the Netherlands, Hungary and Belgium, the mixed banking system operates whereby the commercial banks lend money to meet the short-term and long-term requirements of industry and commerce. Mixed banks perform the usual banking functions and also provide industrial finance.
Merits of Mixed Banking:
The mixed banking system has some advantages which the British type “pure” banking system lacks. They are as follows:
1. Provide Initial Capital:
The mixed banks help the establishment of industries by providing them initial capital for long-term.
2. Underwrite Shares and Debentures:
They undertake to underwrite the equity shares and debentures of industries and thus help them in mobilising public savings for capital formation.
3. Higher Profits:
The profits of the commercial banks increase when they themselves invest in the long- term securities of industries. For they earn high interest rates on them.
4. Help in Feasibility Reports:
The industries stand to gain when such banks render expert advice in preparing feasibility reports and in financial matters.
5. Help in Industrialisation:
The granting of long-term loans to industries by the mixed banks helps in the rapid industrial development of the economy.
6. Advice to Customers:
Mixed banks help customers by giving valuable advice on investments in shares and debentures of industrial concerns.
Demerits of Mixed Banking:
The mixed banking system has the following disadvantages that is why it is not practiced in England, the USA and some of the other developed countries:
1. Against the Liquidity Principle:
It is against the banking principle of liquidity of bank assets. When the bank advances long-term loans to industries, its large funds are locked up which prevent the bank to meet the short-term requirements of trade and commerce.
2. Heavy Losses:
If there is depression in economy it is not possible for industries to repay the loans. This leads to failure of the banks if they have lent vast sums to industries. This actually happened during the Great Depression of 1930s. Even a recession in industries which have borrowed capital will adversely affect the mixed banks leading to heavy losses.
3. Fear of Overinvestment:
During a boom mixed banks overinvest their funds in industries in order to earn more profits. They may also indulge in trade in securities and do speculation. Such operations may lead to huge losses if prices of securities fall suddenly.
Despite many advantages and few disadvantages of mixed banking, many banks failed in America, France, Germany and other European countries because they operated as mixed banks and industries failed to repay the loans.
System # 6. Correspondent Banking:
Correspondent banking is again an important feature of USA banking system. The USA is geographically a very big country where there are thousands of banks which operate in restricted areas. The various types of banks are able to operate efficiently through a correspondent relationship with one-another.
The country banks have deposits with city banks and city banks have deposits in state banks in the same and other cities. The centre of correspondent banking is New York city, followed by Chicago and other regional centres in big American cities. Many banks have deposits to more than one centre and correspondent banks in one centre have correspondent relations with banks in other centres.
When a small bank maintains its deposits with a big correspondent bank having a network of branches, the latter provides such services to the former as extending large credit facilities, facilitating foreign exchange transactions, cheque clearing and collection, purchase and sale of securities, etc.
It also provides a wide range of other services to small banks which include reports on the state of the economy, advice on portfolio management, borrowing from FRS in small lots, sharing computer facilities, etc.
Merits of Correspondent Banking:
This unique American banking system has certain advantages for the country (unit) banks, the city (branch) banks and for the economy.
They are as follows:
1. Rapid Movement of Funds:
Under correspondent banking, cheques of country banks are cleared and collected without much delay. Thus there is a rapid movement of funds from one area to the other. This system facilitates trade and industry.
2. Help in Dealing in Securities:
Correspondent city banks help the country banks in the buying and selling of securities.
3. Help in Providing Finance:
Such banks also help the country banks in financing loans and advances by providing them funds.
4. Help in Transfer of Funds:
They also accept or draw drafts on the country banks and thus help in transferring funds.
5. Help in Foreign Exchange Transactions:
They facilitate foreign exchange transactions of their correspondent banks.
6. Increase in Mobility of Credit:
They increase the geographical mobility of credit when business is transacted from one area to the other through these banks.
7. Render Technical Advice:
City banks also render technical advice to the country banks in installing new machines, providing legal advice, and in making investments in securities and advancing loans.
8. Provide Information:
They also provide information about the general and economic conditions of the country to the unit banks regularly.
9. Gain in Deposits and Business:
The correspondent city banks themselves gain in deposits and new business by entering into correspondent relations with the country banks. On the basis of the deposits, the city banks are able to profit more.
10. Increase in Balances:
Balances in correspondent banks tend to increase manifold which provide liquid assets with the result that they can be utilised as a ready source of funds for all banks engaged in corresponding relations. They can also be used as legal reserves with the Federal Reserve Banks and can be withdrawn in case of need.
11. Gains to the Economy:
The whole economy benefits from the correspondent banking system. There is no fear of monopoly banking. The general public can easily transfer funds from one part of the country to the other. People can use travellers’ cheques issued even by a small unit bank throughout the country. Foreign exchange business can easily be transacted and investments in stocks, shares etc. can be made even from the remotest corner of the vast American mainland through a tiny village bank. Thus the correspondent banking system facilitates ail types of transactions and helps trade and industry.
The only dement of this system is that the correspondent city banks may take excess advances on the basis of the deposits of their correspondent country banks. They may thus operate against the principles of safety and liquidity and harm not only the country banks but also the entire banking structure in the economy.