BANKING LAW

CONTENTS

1. Acknowledgment........................................................................................3

2. Introduction................................................................................................. 4

3. Definition of bank…………………………………………………………..4

4. Banking system…………………………………………………………......6

5. What is chain banking……………………………………………………..9

6. Preludeing of chain banking……………………………………………...9

7. Chain banking in current scenario………………………………………11

8. List of the advantages of chain banking…………………………………12

9. List of the disadvantages of chain banking...............................................14

10.Conclusion…………………………………………………………………17

11.Bibliography...............................................................................................18

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INTRODUCTION

The existing banking structure in India, evolved over several decades, is elaborate and
has been serving the credit and banking services needs of the economy. There are multiple layers
in today's banking structure to cater to the specific and varied requirements of different
customers and borrowers. The banking structure played a major role in the mobilisation of
savings and promoting economic development. In the post financial sector reforms (1991) phase,
the performance and strength of the banking structure improved perceptibly. Financial soundness
of the Indian commercial banking system compares favourably with most of the advanced and
emerging countries.

India cannot have a healthy economy without a sound and effective banking system. The banking
system should be hassle free and able to meet the new challenges posed by technology and other
factors, both internal and external.

In the past three decades, India's banking system has earned several outstanding achievements to
its credit. The most striking is its extensive reach. It is no longer confined to metropolises or
cities in India. In fact, Indian banking system has reached even to the remote corners of the
country. This is one of the main aspects of India's growth story.

The government's regulation policy for banks has paid rich dividends with the nationalization of
14 major private banks in 1969. Banking today has become convenient and instant, with the
account holder not having to wait for hours at the bank counter for getting a draft or for
withdrawing money from his account.

Definition of Bank

Section 5(b) defines bank as accepting for the purpose of lending or investment of
deposits of money from the public, repayable on demand or otherwise and withdrawal by
cheque, draft, and order or otherwise. Section 49A of the Act prohibits any institution other than
a banking company to accept deposit money from public withdrawal by cheque. Students may
note that the essence of banking business is the function of accepting deposits from public with
the facility of withdrawal of money by cheque. In other words, the combination of the functions

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of acceptance of public deposits and withdrawal of the money by cheques by any institution
cannot be performed without the approval of Reserve Bank.

A bank is an institution which deals in money and credit. Thus, bank is an intermediary which
handles other people's money both for their advantage and to its own profit. But bank is not
merely a trader in money but also an important manufacturer of money. In other words, a bank is
a factory of credit.Let us see the definitions of bank and banking, given by various authorities.

Crowther defines a bank as, "one that collects money from those who have it to spare or who are
saving it out of their income and lends the money so collected to those who require it".

Dr. L. Hart, says that the bankers are "one who in the ordinary course of business; honours
cheques drawn upon him by persons from and for whom he receives money on current
accounts"1.

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Banking System

The structure of banking system differs from country to country depending upon their economic
conditions, political structure and financial system. Banks can be classified on the basis of
volume of operations, business pattern and areas of operations. They are termed as system of
banking. The commonly identified systems are,

1. Unit banking
2. Branch Banking
3. Correspondent Banking System
4. Group Banking
5. Chain Banking
6. Pure Banking
7. Mixed Banking
8. Relationship banking
9. Narrow Banking
10. Universal Banking
11. Retail Banking
12. Wholesale Banking
13. Private Banking:
Unit banking: Unit banking is originated and developed in U.S.A. In this system, small
independent banks are functioning in a limited area or in a single town i.e., the business of each
bank is confined to a single office, which has no branch at all. It has its own board of directors
and stockholders. It is also called as "localized Banking"

Branch Banking: The Banking system of England originally offered an example of

the branch banking system, where each commercial bank has a network of branches spread
throughout the country.

Correspondent Banking: Correspondent banking system is developed to remove the

difficulties in unit banking system. It is the system under which unit banks are linked with bigger
banks. The big correspondent banks are linked with still bigger banks in the financial centers.

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The smaller banks deposit their cash reserve with bigger banks. The bigger banks with whom
such deposits are so made are called correspondent banks.

Therefore, correspondent banks are intermediaries through which all unit banks are linked with
bigger banks in financial centers. Through correspondent banking, a bank can carry-out business
transactions in another place where it does not have a branch.

Group Banking: Group Banking is the system in which two or more independently
incorporated banks are brought under the control of a holding company. The holding company
may or may not be a banking company. Under group banking, the individual banks may be unit
banks, or banks operating branches or a combination of the two.

Chain Banking: Chain banking is a system of banking under which a number of

separately incorporated banks are brought under the common control by a device other than
holding company. This may be:

(a) Through some group of persons owning and controlling a number of independent banks.
(b) Each bank retains its separate identity.
(c) Each one carries out its operations without the intervention of any central organization.
Pure Banking and Mixed Banking: On the basis of lending operations of the bank, banking is
classified into:

(a) Pure Banking

(b) Mixed Banking

(a) Pure Banking: Under pure Banking, the commercial banks give only short-term
loans to industry, trade and commerce. They specialize in short term finance only. This type Of
banking is popular in U.K.
(b) Mixed Banking: Mixed banking is that system of banking under which the
commercial ban s perform the dual function of commercial banking and investment banking, i.e.,
it combines deposit and lending activity with investment banking. Commercial banks usually

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offer both short-term as well as medium term loans. The German banking system is the best
example of mixed Banking.
Relationship banking: Relationship banking refers to the efforts of a bank to promote
personal contacts and to keep continuous touch with customers who are very valuable to the
bank. In order to retain such profitable accounts with the bank or to attract new accounts, it is
necessary for the bank to serve their needs by maintaining a close relationship with such
customers.

Narrow Banking: A bank may be concentrating only on collection of deposits and lend
or invest the money within a particular region or certain chosen activity like investing the funds
only in Government Securities. This type of restricted minimum banking activity is referred to
'Narrow Banking’.

Universal Banking: As Narrow Banking refers to restricted and limited banking activity
Universal Banking refers to broad-based and comprehensive banking activities. Under this type
of banking, a bank will deal with working capital requirements as well as term loans for
developmental activities. They will be dealing with individual customers as well as big corporate
customers. They will have expanded lines of business activity combining the functions of
traditional deposit taking, modern financial services, selling long-term saving products,
insurance cover, investment banking, etc.

Regional banking: In order to provide adequate and timely credits to small borrowers in
rural and semi-urban areas, Central Government set up Regional Banks, known as Regional
Rural Banks all over India jointly with State Governments and some Commercial Banks. As they
are permitted to operate in particular region, it may help develop the regional economy.2

Local Area Banks: With a view to bring about a competitive environment and to
overcome the deficiencies of Regional Banks, Government has permitted establishment of a one
type of regional banks in rural and semi-urban centers under private sector known as “Local Area
Banks”

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Wholesale Banking: Wholesale or corporate banking refers to dealing with limited large-sized
customers. Instead of maintaining thousands of small accounts and incurring huge transaction
costs, under wholesale banking, the banks deal with large customers and keep only large
accounts. These are mainly corporate customer.

Private Banking: Private or Personal Banking is banking with people — rich individuals
instead of banking with corporate clients. Private or Personal Banking attends to the need of
individual customers, their preferences and the products or services needed by them. This may
include all round personal services like maintaining accounts, loans, foreign currency
requirements, investment guidance, etc.3

Retail Banking: Retail banking is a major form of commercial banking but mainly targeted to
consumers rather than corporate clients. It is the method of banks' approach to the customers for
sale of their products. The products are consumer-oriented like offering a car loan, home loan
facility, financial assistance for purchase of consumer durables, etc. Retail banking therefore has
large customer-base and hence, large number of transactions with small values. It may therefore
be cost ineffective in a highly competitive environment. Most of the Rural and semi-urban
branches of banks, in fact, do retail banking. In the present day situation when lending to
corporate clients lead to credit risk and market risk, retail banking may eliminate market risk. It
is one of the reasons why many a wholesale bankers like foreign banks also prefer to go for
consumer financing albeit for marginally higher net worth individual.

What is Chain Banking?

Chain Banking is a form of banking when a small group of individuals control three or more
banks which are independently chartered. Individuals secure enough stocks to get the controlling
interest in the banking corporations involved. The management can also be established via a
board of directors that can effectively create a network and undertake supervision of banking
activities. Chain banking systems took shape in USA around 1925 when 33 chains were co-

3
Avlonitis, G. J. and P. Papastathopoulou (2000) “Chain banking and its applicability ,” International Journal
of Bank Marketing , 18(1): 27-41.

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existing having ownership of 933 banks. The purpose was to maximise profit and goodwill in the
market. The banks which entered into chains within a community, had little scope of competition
from other banks operating in the same area. The investors ensured that each bank in the chain
catered to the interests of different segments in the market so that there was no overlapping of
interests and the returns were not compromised. There is generally no holding company to
control the interests of banks. Thus, the underlying principles of chain banking are:4

1. A small group of persons own and control a number of independent banks

2. Each bank carries its operations independently without any external interference by any
holding company.

3. Every member of the chain retains its independent identity.

Key Features and relevance of Chain Banking

Chain banking at the time of its growth and emergence offered amazing services to the customers
due to targeted approach, to the investors in form of consistent returns and complete control.
The investors made sure that there was an optimum utilization of resources which will maximise
the profits and potential. It provided for quick decision-making due to centralised and unified
control which trickled down to customers in form of efficient service. However, the system lost
significance with the introduction of more liberal banking laws as the banks which were part of
chains opened more to offer more services to their customers. On the other hand, chain banking
introduced non-flexible controls and risk of speculations. There were cases of maladministration
and frauds.

The characteristic form of chain banking is ownership of stock in a number of banks by one
individual, or one family, or by a small group of persons, such as the officers of a particular
bank. The inter relationship may be tennous , such as an interlocking of directorates ,with no real
attempt to control ,ownership being a matter of investment only, or it may be a majority or
complete ownership of stock ,with the purpose of control of operations. The ususlly accepted
distinction between chain banking and group banking , as more recently developed, is that of

4
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personal ownership of stock as opposed to corporate ownership. Several of the present group
bank organizations had their origin in chain .Groups and chains, however, merge into one another
, in a manner that makes absolute distinctions difficult to establish.

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Preludeing of chain banking

Chain banking occurs when there is a small group of individuals who control a minimum of 3
banks which are chartered independently. These individuals must secure enough stock in the
banks to gain a controlling interest in the corporations involved.As an alternative, management
may also be established by creating a majority on the corporate Board of Directors responsible
for the supervision and oversight of the banking institutions.Chain banking is a process which
began to form in the United States in the 1920s. By 1925, there were 33 chains which co-existed
to control over 900 banks. The goal of this system was to maximize profits and improve
goodwill within the marketplace.5

Chain banking in current senario

Conceptually, chain banking is a form of bank governance that occurs when a small group of
people control at least three banks that are independently chartered. In general, the controlling
parties are majority shareholders or the heads of interlocking directorates. Chain banking as an
entity has declined along with the surge in interstate banking.

BREAKING DOWN 'Chain Banking6'

Chain banking is not like branch banking, which involves conducting banking activities (e.g.
accepting deposits or making loans) at facilities away from a bank's home office. Branch banking
has gone through significant changes since the 1980s. It also differs from group banking.

In group banking, several affiliate banks exist under a single bank holding company. In chain
banking, three or more banks function independently without the traditional obstacles of
a holding company. A bank holding company is a parent corporation, limited liability company
or limited partnership that owns enough of the original bank’s voting stock to control its policies

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https://brandongaille.com/15-chain-banking-advantages-and-disadvantages/

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https://www.investopedia.com/terms/c/chain-banking.asp

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and management. The activities of separate banks within chain banking don't overlap (as
occasionally occurs in a holding company) so that the revenue is maximized as much as possible.

Chain Banking Versus Interstate Banking

Interstate banking grew significantly in the mid-1980s, a time during which state legislatures
passed new laws that allowed bank holding companies to acquire out-of-state banks on a
reciprocal basis with other states. As noted above, the rise in interstate banking has correlated
with a decline in chain banking.

Interstate banking grew in three phases. The first began in the 1980s with regional banks, which
formed when smaller, independent banks merged to create larger banks. Following this the
Reigle-Neal Interstate Banking and Branching Efficiency Act allowed banks which met capital
requirements to acquire banks in any other state after Oct. 1, 1995. These legislative acts resulted
in the onset of nationwide interstate banking.

Chain Banking and Investment Banking

Chain banking is distinct from investment banking in that investment banks create capital by
underwriting new debt and equity securities, aid in the sale of securities, and facilitate mergers
and acquisitions, reorganizations and broker trades, along with providing guidance to issuers
regarding the issue and placement of stock. Investment banks are by nature interstate (and
international), given that many deals, which investment banks broker, include investors
worldwide.

Many investment banking systems are subsidiaries of bulge bracket firms like Goldman Sachs,
Morgan Stanley, JPMorgan Chase, Bank of America Merrill Lynch and Deutsche Bank.

List of the Advantages of Chain Banking

1. It limits risks for a community, making it possible to expand local needs for credit.
In 1921, before the creation of chain banks occurred in the United States, there were over $1
billion in losses experienced by depositors within the unit-based banking system. Many banks
found themselves going out of business because the structures of that system failed. By

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spreading out the risks between multiple small banks instead of making every individual bank
assume all risks, it became possible to offer more credit or lending products to communities
where it may not have been possible to do so before.

2. This system makes it possible to access banking facilities when limited resources are present.
When there is little financial capital available in a community, then the limited resources restrict
the number of banking facilities which can be supported. Some small communities, before the
creation of chain banks, may not have been able to support a local bank at all. Because the nature
of chain banking creates a centralized structure where common management tendencies and risk
handling are present, more people can access banking facilities because more can be done with
their limited resources.

3. It provides an efficient system of management for better financial control.

Chain banking is more efficient than the unit-based model because there is one core group of
stakeholders who are organizing structures for multiple banks. It limits the number of executive
management decisions which must be made at the local level because the stakeholders make the
same decisions for multiple banks. Even when chain banking involves multiple Boards or
officers which serve with one another, the similarities and cooperation involved in management
create efficiencies for each banking system. This creates better financial controls for everyone
involved.

4. Chain banking systems rarely take on unnecessary risks.

The system of chain banking was created to avoid risks in the first place. It is a structural
response to the numerous losses that were experienced by depositors leading up to, and then
during, the period of the Great Depression. Instead of taking risks with deposits in an effort to
grow profits exponentially, the goal of this structure is to manage funds in a way that makes them
accessible and useful to individuals without the same threats of loss. Although this process limits
overall profitability, it does provide a safer place for people to keep their money until they need
to have it at a later time.

5. It is an affordable system of banking.

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Because there are fewer risks involved with chain banking from a consumer standpoint, it
becomes affordable to use banking tools and products. Individuals have more access to credit,
which allows them to start businesses, expand inventory, build new structures, or even purchase
a new home. The goal of chain banking is to create as many efficiencies within the system as
possible, which leads to better decisions on how finances are managed at all levels within the
organization.

6. Chain banking stops unhealthy competition.

Healthy competition occurs when 2+ organizations are competing for the same customers by
offering innovative or differential products at a price that is similar. Unhealthy competition
occurs when an organization is willing to undercut its profits to gain a bigger market share. That
action creates a race to the bottom for all companies involved, as profits are slashed to maintain a
market presence. By instituting a system of chain banking, the unhealthy competition that can be
seen in some communities is much more difficult to implement.

7. It avoids the need for a merger.

When chain banking systems are implemented, the stakeholders do not merge their operating
companies with a parent company. The banks are still operated as if they are an independent
entity, even though they fall under the general control of parental stakeholders. This gives each
location the advantages of having a large-scale organization, while keeping their separate entities
and ability to provide localized support.

8. Individual entities benefit from purchases of scale.

Because a common set of stakeholders is involved in the chain banking process, each individual
location gets to benefit from an economy of scale that they wouldn’t be able to access without a
parent company or stakeholder oversight. That creates lower operational costs, which improves
the bottom line of each location over time.

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List of the Disadvantages of Chain Banking7

1. It limits overall profitability.

Profits occur when risks are taken within the financial sector. Risks may also lead to steep losses,
which chain banking cannot afford to take. For that reason, banks managed in this fashion often
take a very conservative approach to investing. They create small gains for their members or
customers, with only small losses the potential risk being faced. This creates an environment
where the primary challenge is to have the investment gains be greater than the rate of inflation,
which does not always happen.

2. There is little engagement regarding the social welfare needs of the community.
Many banks use their profits in a way that betters the welfare needs of their local communities.
Because there are fewer profits available within the system of chain banking, these institutions
are rarely active in social improvement activities. Their focus is to maintain the status quo, create
profits where possible, and effectively manage themselves in communities where there m ay be
limited resource availability.

3. It creates a centralized structure where one person may control the wealth.
Many chain banking systems create a centralized structure where one entity, or even one person,
pulls the strings of wealth management for a series of banking locations. Even if multiple banks
are managed by multiple Boards or offices, the President or central figure within the organization
is often tasked with leadership decisions for it. At the local level, that means the decisions made
for all banks may not be the best possible solution for a specific local bank.

4. Chain banking concentrates control of credit authorization.

The goal of chain banking is to expand opportunities for the average person to use financial tools
and lending products. When banks are controlled by a common set of stakeholders, however, this
structure also concentrates who is in control of credit line authorizations. That makes it easier for
stakeholders to discriminate against certain groups of people if they desire to do so. Instead of

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being restrained by local interest controls, stakeholders are only accountable to themselves and
the profitability they are able to achieve.

5. It creates a system which looks to create a monopoly.

Although the banks are technically independent within a chain banking system, they are still
controlled by the same group of stakeholders. That allows the stakeholders to manage rates,
products, and systems within the communities they control because they are in control of bank
access. When there is no competition available within a community, then the consumers are at a
disadvantage because they are forced to use the banking tools that are available to them from the
one association.

6. Chain reactions create declines for everyone.

The reason why chain banking tends to be a popular structure is that when one bank creates
gains, the others benefit through a chain reaction process. The gains filter down to each satellite
within the established chain. The opposite is also true, however, which is why chain banking can
be problematic. If one chain experiences dramatic losses, then the other chains experience that
loss as well.

7. There can be rebellion within the system.

In a chain banking system, a centralized core of leadership directs operations from their parent
location. These stakeholders may wish to see certain policies enacted at the local level because it
improves the bottom line of the banks. If local managers disagree with these decisions, they may
choose to not follow the policies or guidelines that were outlined to them. Unless the
stakeholders come to the individual location, they may not realize their systems were not
implemented. That process creates inefficiencies within the system which may affect other
locations as well.

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Conclusion

Banking systems have been with us for as long as people have been using money. Banks and
other financial institutions provide security for individuals, businesses and governments, alike.
Let's recap what has been learned with this tutorial. In general, what banks do is pretty easy to
figure out. For the average person banks accept deposits, make loans, provide a safe place for
money and valuables, and act as payment agents between merchants and banks. Banks are quite
important to the economy and are involved in such economic activities as issuing money,
settling payments, credit intermediation, maturity transformation and money creation in the
form of fractional reserve banking.
To make money, banks use deposits and whole sale deposits, share equity and fees and interest
from debt, loans and consumer lending, such as credit cards and bank fees .In addition to fees
and loans, banks are also involved in various other types of lending and operations including,
buy/hold securities, non-interest income, insurance and leasing and payment treasury services.

History has proven banks to be vulnerable to many risks, however, including credit, liquidity,
market, operating, interesting rate and legal risks. Many global crises have been the result of
such vulnerabilities and this has led to the strict regulation of state and national banks. Other
financial institutions exist that are not restricted by such regulations. Such institutions include:
savings and loans, credit unions, investment and merchant banks, shadow banks, Islamic banks
and industrial banks.
These chain banking advantages and disadvantages show us that when resources are limited,
and risks could be devastating, it is a feasible solution which brings financial tools to small
communities. It may also limit the amount of profits available within the community, while
focusing on the preferences of a few to manage the needs of the many.

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BIBLIOGRAPHY

Books:

 Boni, K.; Tsekeris, C. (2015): “Electronic Banking”, in Ritzer, G. (ed.), Blackwell

Encyclopedia of Sociology, Blackwell.

 Gandy, T. (2014): “Banking in e-space”, The banker, 145 (838), pp. 74–76.

Article:

 Arora, Anjali(2000), “The chin banking and its origin ,” The Standard, March
27Security Flaws in Online Banking Sites Found to be Widespread Newswise.

 Nair, A (1999), “Chain banking,” Asia Internetnews, May 12th Geyer J. (2015),
“Adoption of e-Finance Research Note SPA-1200-101,” ,

 Hertzum, M., N.C. Juul, N. Jørgensen, and M. Nørgaard (2004), “Effect of chian
Banking,” Technical Report.Mishra, A. K. (2011), “Internet Banking in India,”
BanknetIndia

 Avlonitis, G. J. and P. Papastathopoulou (2000) “An evolution of chain

banking ,” International Journal of Bank Marketing , 18(1): 27-41

 Avlonitis, G. J. and P. Papastathopoulou (2000) “Chain banking and its

applicability ,” International Journal of Bank Marketing , 18(1): 27-41.

 Geyer J. (1997), “Adoption of Chain Banking ,” Gartner Group,

Website

 gktoday.in

 brandongaille.com

 shodhganga.in

 investopedia.com

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