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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Meaning of security

A security is a document that is an evidence of specific claims on a stream of income and/or the particular assets. Debt securities include bonds and mortgages. Ownership securities include common stock certificates and the title to marketable assets. In addition, preferred stock is a hybrid security which entitles its owner to a mixture of both ownership and creditor ship privileges.

A good security should have the following characteristics:

1. Free from encumbrances

2. Easy marketability

3. Easy storability

4. Durability

5. Free from price fluctuations

6. Easy ascertainment of value

7. Earning of income

8. Free from heavy cost of handling

9. Free from disabilities

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Central Bank is a Banker to Commercial Banks

Broadly speaking, the central bank acts as the banker’s bank in three different capacities:

(a) It acts as the custodian of the cash reserves of the commercial banks

(b) It acts as the lender of the last resort

(c) It is the bank of central clearance, settlement and transfer.

We shall now discuss these three functions one by one.

(a) It acts as the custodian of the cash reserves of commercial banks: Commercial banks keep part of their cash balances as deposits with the central bank of a country known as centralization of cash reserves. Part of these balances are meant for clearing purposes, that is, payment by one bank to another will be simple book entry adjustment in the books of the central bank. There are many advantages when all banks keep part of their cash reserves with the central bank of the country. In the first place, with the same amount of cash reserves, a large amount of credit creation is possible. Secondly, centralized cash reserves will enable commercial banks to meet crises and emergencies. Thirdly, it enables the central bank to provide additional funds to those banking institutions which are in temporary difficulties. Lastly, it enables the central bank to influence and control the credit creation of commercial banks by making the cash reserves of the latter more or less.

(b) Lender of the last resort: As the banker’s bank, the central bank can never refuse to accommodate commercial banks. Any commercial bank wanting accommodation from the central bank can do so by re discounting (selling) eligible securities with the central bank or can borrow from the central bank against eligible securities.

By lender of the last resort, it is implied that the latter assumes the responsibility of meeting directly or indirectly all reasonable demands for accommodation by commercial banks in times of difficulties and crisis.

(c) Clearing agent: As the central bank becomes the custodian of cash reserves of commercial banks, it is but logical for it to act as a settlement bank or a clearing house for other banks. As all banks have their accounts with the central bank, the claims of banks against each other are settled by simple transfers from and to their accounts. This method of settling accounts through the central bank, apart from being convenient, is economical as regards the use of cash. Since claims are adjusted through accounts, there is usually no need for cash. It also strengthens the banking system by reducing withdrawals of cash in times of crisis.

Furthermore, it keeps the central bank of informed about the state of liquidity of commercial banks in regard to their assets.

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Usefulness of a Developed Money Market

The money market is an important institution in a modern economy and it has influenced profoundly industrial and commercial developments:

(a) In Financing Industry and Commerce: In the first place, the money market is of very great help in financing industry and commerce. Industries are helped in their working capital requirements through the system of finance bills, commercial paper, and so on. It has played a very important part in the financing of trade and commerce. Both internal as well as international trade is normally financed through the system of bills of exchange which are discounted by the bill market.

(b) Investment of Short-term Funds: The money market plays a very important role in providing necessary assets for the investment of short-term funds of commercial banks. Commercial banks find such assets in the call money market as well as in the bill market. Thus, the money market offers the commercial banks a very good means of temporarily employing their funds in liquid or near-money investments.

(c) Help to the Central Bank: The money market is of great help to the central bank of the country. For one thing, the money market and short-term rates of interest which prevail there serve as a good barometer of monetary and banking conditions in the country and thus provide a valuable guide to the determination of central banking policy. For another, the developed money market being a highly integrated structure enables the central bank to deal with the most sensitive of the sub-markets so that the influence of the operation of the central bank may spread to other sections also.

(d) Help to the Government: Lastly, the money market helps the government. The money market supplies the government with necessary short-term funds through the treasury bills.

Thus, a developed money market is of great assistance to industry and commerce, to the commercial banking system, to the central bank of the country and to the government.

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Financial Institutions of the Money Market

The money market may also be analyzed on the basis of the different institutions engaged in lending and borrowing short-term funds. The nature of these institutions may differ from country to country. The same institutions may also function both as borrower and as lender in the market. The lenders are:

1. The Central Bank: It is the lender of last resort. It lends money to commercial banks when they approach for financial assistance.

2. Commercial Banks: They form the most important class of lenders in the money market. They also borrow from the central bank directly or indirectly. The money that they lend comes from the public in the form of deposits repayable on demand. These funds are invested in various forms of assets. These assets which are considered the secondary reserve for the bank are closely linked with the money market.

3. Institutional Investors: They include savings banks, insurance companies, trust companies and investment trusts. The portion of their funds kept invested in liquid assets finds its way into the money market.

4. Private Individuals, Partnerships and Companies: Normally this group may not be interested in short-term funds. If the interest rates become attractive, they may divert a portion of their surplus funds to the money market.

The borrowers in the money market must satisfy certain conditions regarding the paper they offer for discounting. “The paper must be absolutely liquid, easily realizable and short of maturity.” These conditions are satisfied by bill brokers and dealers in stock exchange.

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Composition of the Money Market

The money market is composed of several financial agencies that deal with different types of short-term credit. We may describe the following important components of the money market:

1. Call Money Market: It is a market for short-period loans. Bill brokers and dealers in stock exchange require financial accommodation for very short periods. Money may be lent for periods not exceeding seven days. Sometimes money is lent only overnight. These loans are called call loans or call money as the banks recall these loans at very short notice. The banks prefer this kind of investment for two reasons.

Firstly, call loans can be treated almost like cash and they form the second line of defence for the banks after cash. Secondly unlike cash, the call loans earn some income, in the form of interest, for the banks. The commercial banks are the lenders and the bill brokers and dealers in stock exchange are the borrowers in the call money market. The call money market is an important section of the money market.

2. Collateral Loan Market: When loans are offered against collateral securities like stocks and bonds, they are called ‘collateral loans’ and the market is known as the collateral loan market. This market is geographically most diversified.

3. Acceptance Market: It refers to the market for bankers acceptances which arise out of trade-both inland and foreign. When goods are sold to anyone on credit, the buyer accepts a bill. Such a bill cannot be discounted anywhere easily. The banker adds his credit to the bill by accepting it on behalf of his customer who has purchased the goods. Such bills can be discounted anywhere. In London, there are specialist firms called acceptance houses which accept bills drawn on them by traders. They are well known all over the world. In the past, the acceptance market was a prominent section of London money market. Its importance has declined considerably in recent years. The function of the acceptance houses is being performed by the commercial banks is several countries.

4. Bill Market or Discount Market: It refers to the market where short-dated bills and other paper is discounted. Before the First World War the most important paper discounted in the London money market was the commercial bill which was used to finance both inland and foreign trade. During the inter-war period the importance of the commercial bills declined. This place has been taken by treasury bills. The treasury bills are promissory note of the government to pay a specified sum after a specified period, generally 90 days. The treasury bills are purchased by the investors and when necessary they are discounted in the discount market.

These markets are not water-tight compartments. They are related to one another.

The borrowers in the call money market deal in treasury bills which are discounted with them. Acceptance houses accept bills which are later discounted in the discount market. Thus, the various sections of the money market are intimately related to and are dependent on one another.

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Functions of Money Market

A well-organized and developed money market can help a country to achieve economic growth and stability. It performs a diversity of functions in the banking structure of the economy. They are:

(a) Money market provides outlets to commercial banks, non-banking financial concerns, business corporations and other investors for their short-term funds. It enables them to use their excess reserves in profitable investment.

(b) Money market also provides short-term funds to businessmen, industrialists, and traders etc. to meet their day-to-day requirements of working capital. Money market plays a crucial role in financing both internal as well as international trade.

(c) Money market provides short-term funds not only to private businessmen but also to government and its agencies.

(d) Money market enables businessmen, with temporary surplus funds, to invest them for a short period.

(e) Money market serves as a medium through which the central bank of the country exercises control on the creation of credit.

(f) Money market is also of great help to the government.

The functions of the money market are virtually the same in all the countries of the world. But the institutions, instruments and modes of operation are different in different money markets.

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Meaning of Money Market

The money market concerns trading in money instruments involving borrowing and lending for short periods. It is part of the securities market. The other part is capital market which deals with long-term instruments like equity or shares, debentures and bonds. It provides long-term finance to the government and firms, mostly large ones.

Money Market is a short-term credit market. It is the centre in which short-term funds are borrowed and lent. It consists of borrowers and lenders of short-term funds. The borrowers are generally merchants, traders, brokers, manufacturers, speculators and Government. The lenders are commercial banks, insurance companies, finance companies and the central bank. The money market brings together the lenders and the borrowers. It does not deal in cash or money. It deals in trade bills, promissory notes and government papers or bills, which are drawn for short-periods.

Dr. S.N. Sen defines money market as “the organisation for the lending of short-term funds, through the use of such instruments as commercial bills of exchange, short-term government securities and bankers acceptances.”

The Reserve Bank of India describes money market as “the centre for dealings, mainly of a short-term character, in monetary assets, and it meets the short-term requirements of borrowers and provides liquidity or cash to lenders.”

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