Definition

Different Types of Banking System

With development of banking institutions, various systems of banking have come into existence. Generally most of the people refer banking system to the foundation of banking institutions classified on the basis of functions namely, central bank, commercial banks, and development finance institutions and so on.

But according to the Encyclopedia Britannica, the structure of banking system is defined on the basis of organizational characteristics and techniques or functions of the system.

Following is the structure of Banking System:

Banking system based of organizational characteristics:

  1. Branch banking
  2. Unit banking
  3. Chain banking
  4. Holding Company/group banking

Banking system based of techniques/functions:

  1. Deposit banking
  2. Investment banking
  3. Merchant banking
  4. Mixed banking

Whereas chain banking and group banking is associated with Unit Banking.

These modern banking systems had evolved through a historical process depending on socio economic, political and geographical factors. Since historical experience varied from one country to another. It is observed that Branch banking originated in the United Kingdom whereas the United States of America is the home of Unit banking. On the other hand, the mixture of the two or hybrid system is found to be in operation in many countries of Asia and Africa, more particularly in India and other countries of the Far East.

 

Banking system based of organizational characteristics:

1. Branch banking

Branch banking is a system where the banking business is carried on by single bank with a network of branches throughout the length and breadth of the country. The bank will have a head office in one town and branches in different parts of the country. The branch manager in accordance with the regulations and policies of the head office directs the affairs of the branch. Each bank is a single entity owned by a group of shareholders and controlled by a group of directors.

A bank may decide to establish a branch banking organization, when regulation permit, particularly if it serves a rapidly growing region and finds itself under pressure either to follow its business and household customers as they move into new areas or lose them to more conveniently located competitors.

2. Unit Banking

In the unit banking system, the banking operations are carried through a single office and confined to a particular area. The banks maintain no branches. Unit Banks, offer all their services from one office, though a small number of services (such as taking deposits or casing checks may be offered from limited service facilities, such as drive in windows, automated teller machines, and retail store pint of sale terminals that are linked to the bank’s computer system. These organizations are common in U.S. banking today.

Correspondent banking system is a feature of unit banking system.

The unique feature of unit banking system is the correspondent banking system. This is an arrangement with which banks carry account with banks in the neighboring cities and these banks in turn have accounts with the large cities like New York. Banks in New York have correspondent bank relation with many branches throughout the country. The small bank in the small community, which holds deposits with the city bank, is the responded bank while the city bank holding the deposits for the small bank is the correspondent bank.

The major service of correspondent bank is clearing of cheques and movement of funds from one place to another. Another valuable service rendered by the bank is strengthening the financial resources of banks during tight money periods. It also acts as source of information and helps in various banking operations.

3. Chain banking:

Chain banking refers to the system where one or few individuals control two or more banking companies or by the same group of persons through purchase of shares of such banks.

The main difference between the two systems is that in case of group banking, the affairs of the group are controlled by the holding company, whereas in case of chain banking system has more or less the same advantages and disadvantages of the group banking system.

4. Group Banking:

Group banking is a system where a group of banks are brought under the control of a holding company. The holding company controls the affairs of all units in the group. But each bank in the group maintains its separate identity. The purpose of group banking is to unify the management of banks, to achieve economies of large-scale operation and to grab more power.

The chief advantage of this system is that each bank need not carry large cash reserve; such cash reserves are concentrated in one or few member banks of the group. In times of need the bigger banks will help the smaller banks. Secondly, economies of large-scale production can be achieved by cutting down operating cost, by purchasing supplies in bulk and improving the efficiency of management.

Under group banking system, both banking and non-banking companies are referred to as affiliated banks. The group banking and chain banking systems are found in the United States.

 

Banking system based of techniques/functions:

1. Deposit banking

Receiving deposits and making advances for short period is called deposit banking. The underlying principle of this system is that banks cannot lock up their deposits in long-term investment, as the deposits are repayable on demand. Banks were custodians as well as trustees to keep safe the deposits of the public. This principle made them completely free from supplying fixed capital requirement of industries.

Pure deposit banking has its origin in England. Banks in England were only confined to accepting deposits and lending for short periods to industries and trade.

2. Investment Banking

During the second half of the 19th century the industrialization of Germany was made possible only by the investment banks. When Germany wanted to industrialize the country, it did not have adequate funds, secondly, moneyed people were unwilling to finance industries on their own. There was an imperative need for an agency which would pool the resources and divert to the promotion and development of industries. This necessitated the evolution of investment banking in Germany. The banks did varied services like granting short and long term loans, subscribing to shares and debentures, drawing and accepting bills etc.

The banks not only financed but also helped the promotion of new companies. The method of promoting a company could be described as follows: whenever a proposal to start a company was put forward, it was examined by experts of the bank. On its approval, a syndicate or Consortium was formed, comprising a number be of joint stock banks and private men. Its members promised to subscribe a portion of the capital of the proposed company. The bank which created consortium became the agency to sell the shares. Subsequently the shares were brought before the public. The consortium arranged for listing securities in the stock exchange also. The Consortium was generally formed for a specific period after which it might be either dissolved or extended. On dissolution, the profit or loss and unsold securities were shared between members in proportion to their participation.

3. Mixed Banking

The banking system that combines deposit banking with investment banking is known as Mixed Banking. The mixed bank receives deposits from public and provides short term, medium term and long term loan to industries. Mixed banking system refers to that banking system under which the commercial banks make long term loans to industry. In England, commercial banks are mainly concerned with supplying the short-term credit requirements of trade and commerce. Generally, the commercial banks refrain from supplying the long-term credit to the industry. In short, the British commercial banking system keeps aloof from financing the long-term credit requirements of industries. As against this British trend, the commercial banks in Germany, Belgium, Hungary and the Netherlands have greatly assisted in the industrial development of these countries by giving long-term loans to industries.

In mixed banking, the commercial banks promote the industrialization of their country and come forward to provide the initial capital to the newly started industries. Alongside the task of providing capital to industries, mixed banks also perform the functions of deposit banks. To the extent commercial banks in India have come forward to provide long-term capital to small and medium-sized industries they can be said to perform the function of mixed banks.

 

Other Banking System:

Retail banking:

Generally banking firms that provide banking services to individuals and small business, is called retail bank. Households are the most important sources of collecting deposit in any country. Retail banks collect deposit from households and provide services of checking account; bill payment, opening new account, and consumer were transfer, investment services loan application and approval, credit card issue, car loan etc.

“Retail banking means transactions with customers of smaller means, i.e. small checking account, consumer credit, holding of saving deposits, or sale of certificate of deposit in small holding of individuals.”

 -- L.M. Bhole

Universal Banking:

Universal bank is the bank that provides all rages of financial services. It is the combination of commercial banking and investment banking.

“Banking that involves not only services related to loans and savings but also those involved in making investments in companies is called universal banking”

      -- Oxford dictionary of business

Under the Second Banking Directive of 1963, the term banking was defined in one way across the whole community, so that all European banks can offer a common set of services referred to a Universal banking. These common services include deposit taking, lending, financial leasing, payments services, supplying guarantees and credit commitments, trading in money market instruments, securities currencies, financial futures, options, and other interest bearing, or interest rate hedging instruments, aiding issuers of new securities, advising on acquisition and mergers, brokering funds, granting portfolio advice and management services, supplying safe keeping services, and providing credit references.

 

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