Disadvantages of Unit Banking

Following are the main disadvantages of unit banking:

1. No Economies of Large Scale: Since the size of a unit bank is small, it cannot reap the advantages of large scale viz., division of labor and specialization.

2. Lack of Uniformity in Interest Rates: In unit banking system there will be large number of banks in operation. There will be lack of control and therefore their rates of interest would differ widely from place to place. Moreover, transfer of funds will be difficult and costly.

3. Lack of Control: Since the number of unit banks is very large, their co-ordination and control would become very difficult.

4. Risks of Bank’s Failure: Unit banks are more exposed to closure risks. Bigger unit can compensate their losses at some branches against profits at the others. This is not possible in case of smaller banks. Hence, they have to face closure sooner or later.

5. Limited Resources: Under unit banking system the size of bank is small.

Consequently its resources are also limited. Hence, they cannot meet the requirements of large scale industries.

6. Unhealthy Competition: A number of unit banks come into existence at an important business centre. In order to attract customers they indulge in unhealthy competition.

7. Wastage of National Resources: Unit banks concentrate in big metropolitan cities whereas they do not have their places of work in rural areas. Consequently there is uneven and unbalanced growth of banking facilities.

8. No Banking Development in Backward Areas: Because of unlimited resources, Unit banks cannot afford to open uneconomic branches in smaller towns and rural areas. As such, these areas remain unbanked.

9. Local Pressure: Since unit banks are highly localized in their business, local pressures and interferences generally disrupt their normal functioning.

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Advantages of Unit Banking

Following are the main advantages of unit banking:

1. Efficient Management: One of the most important advantages of unit banking system is that it can be managed efficiently because of its size and work. Co-ordination and control becomes effective. There is no communication gap between the persons making decisions and those executing such decisions.

2. Better Service: Unit banks can render efficient service to their customers. Their area of operation being limited, they can concentrate well on that limited area and provide best possible service. Moreover, they can take care of all banking requirements of a particular area.

3. Close Customer-banker Relations: Since the area of operation is limited the customers can have direct contact. Their grievances can be redressed then and there.

4. No Evil Effects Due to Strikes or Closure: In case of there is a strike or closure of a unit, it does not have much impact on the trade and industry. Because of its small size. It does not affect the entire banking system.

5. No Monopolistic Practices: Since the size of the bank and area of its operation are limited, it is difficult for the bank to adopt monopolistic practices. Moreover, there is free competition. It will not be possible for the bank to indulge in monopolistic practices.

6. No Risks of Fraud: Due to small size of the bank, there is stricter and closer control of management. Therefore, the employees will not be able to commit fraud.

7. Closure of Inefficient Banks: Inefficient banks will be automatically closed as they would not be able to satisfy their customers by providing efficient service.

8. Local Development: Unit banking is localized banking. The unit bank has the specialized knowledge of the local problems and serves the requirement of the local people in a better manner than branch banking. The funds of the locality are utilized for the local development and are not transferred to other areas.

9. Promotes Regional Balance: Under unit banking system, there is no transfer

of resources from rural and backward areas to the big industrial and commercial centers. This tends to reduce regional imbalance.

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Meaning of Unit banking

The banking system in different countries varies substantially from one another. Broadly speaking, however, there are two important types of banking systems, viz., unit banking and branch banking.

‘Unit banking’ means a system of banking under which banking services are provided by a single banking organization. Such a bank has a single office or place of work. It has its own governing body or board of directors. 

‘Unit banking’ functions independently and is not controlled by any other individual, firm or body corporate. It also does not control any other bank. Such banks can become member of the clearing house and also of the Banker’s Association. Unit banking system originated and grew in the U.S.A. Different unit banks in the U.S.A. are linked with each other and with other financial centers in the country through “correspondent banks.”

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Sources of a bank’s Income

A bank is a business organization engaged in the business of borrowing and lending money. A bank can earn income only if it borrows at a lower rate and lends at a higher rate. The difference between the two rates will represent the costs incurred by the bank and the profit. Bank also provides a number of services to its customers for which it charges commission. This is also an important source of income.

The followings are the various sources of a bank’s profit:

1. Interest on Loans: The main function of a commercial bank is to borrow money for the purpose of lending at a higher rate of interest. Bank grants various types of loans to the industrialists and traders. The yields from loans constitute the major portion of the income of a bank. The banks grant loans generally for short periods. But now the banks also advance call loans which can be called at a very short notice. Such loans are granted to share brokers and other banks. These assets are highly liquid because they can be called at any time. Moreover, they are source of income to the bank.

2. Interest on Investments: Banks also invest an important portion of their resources in government and other first class industrial securities. The interest and dividend received from time to time on these investments is a source of income for the banks. Bank also earns some income when the market prices of these securities rise.

3. Discounts: Commercial banks invest a part of their funds in bills of exchange by discounting them. Banks discount both foreign and inland bills of exchange, or in other words, they purchase the bills at discount and receive the full amount at the date of maturity. For instance, if a bill of Rs. 1000 is discounted for Rs. 975, the bank earns a discount of Rs. 25 because bank pays Rs. 975 today, but will get Rs. 1000 on the due date. Discount, as a matter of fact, is the interest on the amount paid for the remaining period of the bill. The rate of discount on bills of exchange is slightly lower than the interest rate charged on loans and advances because bills are considered to be highly liquid assets.

4. Commission, Brokerage, etc.: Banks perform numerous services to their customers and charge commission, etc., for such services. Banks collect cheques, rents, dividends, accept bills of exchange, issue drafts and letters of credit and collect pensions and salaries on behalf of their customers. They pay insurance premiums, rents, taxes etc., on behalf of their customers. For all these services banks charge their commission. They also earn locker rents for providing safety vaults to their customers. Recently the banks have also started underwriting the shares and debentures issued by the joint stock companies for which they receive underwriting commission.

Commercial banks also deal in foreign exchange. They sell demand drafts, issue letters of credit and help remittance of funds in foreign countries. They also act as brokers in foreign exchange. Banks earn income out of these operations.

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Importance of capital market

An efficient capital market is an essential pre-requisite for industrial and commercial development of a country. An organized and well-developed market operating in a free market economy ensures the best possible co-ordination and balance between the flow of savings on the one hand and the flow of investment leading to capital formation on the other. It also directs the flow of savings into most profitable channels and thereby ensures optimum utilization of financial resources.

The importance of capital market in the process of economic development of a country can be described as below:

1. Mobilizing Savings: The capital market plays a vital role in mobilizing savings to put it in productive investment, so that the development of trade, commerce and industry could be facilitated. In this process the capital market helps in the process of capital formation and hence the economic development. The capital market acts as a bridge, between savers and investors.

2. Stability in Value: In case of a developed capital market, the experts in banking and non-banking intermediaries put in every effort in stabilizing the values of stocks and securities. This process is facilitated by providing capital to the needy at a lower rate of interest and by cutting down the speculative and unproductive activities.

3. Encouragement to Economic Growth: The process of economic growth is made easier through the capital market. The various institutions of the capital market give quantitative and qualitative direction to the flow of funds. The proper flow of funds leads to the development of commerce, trade and industry.

4. Inducement to Savings: Savings are the backbone of any nation’s economic development. If capital markets are developed in less developed areas, people will get induced to save more because savings are facilitated by banking and non-banking financial intermediaries.

Thus, it is clear that the capital market is the life-blood of economic development of a country. If the capital market is not developed, it will lead to misuse of financial resources. The capital market plays a significant role in diverting the wrongful use of resources to their rightful use.

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Meaning of Capital Market

The term “Capital Market” is used to describe the institutional arrangements for facilitating the borrowing and lending of long-term funds. Usually, stress is laid on the markets for long term debt and equity claims, government securities, bonds, mortgages, and other instruments of long-term debts. Thus, the capital market embraces the system through which the public takes up long-term securities, either directly or through intermediaries. It consists of a series of channels through which the savings of the community are mobilized and made available to the entrepreneurs for undertaking investment activities.

Conventionally, short-term credit contracts are usually classified as money market instruments, while long-term debt contracts and equities are regarded as capital market instruments. In practice, however, there is a thin line of demarcation between the money market and the capital market, because quite often, the same institutions participate in the activities of both the markets, and there is flow of funds between the two markets.

The major functions performed by a capital market are as follows:

(a) Mobilization of financial resources on a nation-wide scale.

(b) Securing the foreign capital and know how to fill up the deficit in the required resources for economic growth at a faster rate.

(c) Effective allocation of the mobilized financial resources by directing the same to projects yielding highest yield or to the projects needed to promote balanced economic development.

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Forms of Lending/ Advances by the Bank

Banks lend for working capital requirements in the form of:

1. Loans

2. Cash credit

3. Overdraft

1. Loans: This is the oldest and very popular form of lending by the banks. In case of loans, financial assistance is given for a specific purpose and for a fixed period. The customer can withdraw the entire amount of loan in a single installment. As such, interest is payable on the entire amount. In case he needs the funds again, he has to make a fresh application for a new loan or renewal of the existing one. Ordinarily, the loans are repayable in one installment. However, a customer may return the loan in more than one installment also.

2. Cash Credit: Cash credit is the most popular method of lending by the banks in India. It accounts for more than two third of total bank credit. Under cash credit system, a limit, called the credit limit is specified by the bank. A borrower is entitled to borrow up to that limit. It is granted against the security of tangible assets or guarantee. The borrower can withdraw money, any number of times up to that limit. He can also deposit any amount of surplus funds with him from time to time. He is charged interest on the actual amount withdrawn and for the period such amount is drawn.

3. Overdraft: One of the main advantages of a current account is that, its holder can avail of the facility of overdraft. An overdraft facility is granted to a customer on a written request. Sometimes, it may be implied where a customer overdraws his account and the bank honors his cheques.

The bank should obtain a written request from the customer. He should also settle the terms and conditions and the rate of interest chargeable. It is usual to obtain a promissory note from the customer to cover the overdraft.

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