Commercial banking and Investment banking combined together is generally referred to as Mixed banking. Such banking of combining together the completely two different types of operations is a new development in many countries. Before this development, commercial banks were engaged in short-term financing while investment banks were engaged in long-term financing. 

The rationale of division of work was simple. Deposits of Commercial banks are of short duration and payable on demand or at short notice. Hence these banks are banks are required to keep their assets as liquid as possible so that assets always match liabilities in terms of liquidity. Any mismatch was avoided to prevent the banks from landing into liquidity troubles. On the other hand, investment bankers lent money for meeting the long-term need of the business and industry. They procured fund of longer duration to avoid any liquidity crisis. 

Separation of business between the two types of banks did not last long. At one stage, investment banks got involved into commercial banking primarily for augmenting their resources by way of mobilizing deposits to meet the growing need of industry. On the other hand, sensing market potential and being emboldened by greater resources commercial banks also did enter into the area of investment and long-term financing.

The result of mixing commercial banking with investment banking has been mixed, to say the least. Commercial banks in many countries landed into troubles and in the long run some even faced closure because of mismatch between short-term liabilities and long-term assets. In view of this new development, the desirability of mixed banking has been subjected to serious debate. Though professional bankers are found to be divided on the issue, yet majority is now found not to favor mixed banking. 

In fact, idea of mixed banking is gradually losing ground specially in view of development of different types of financial institutions to finance long term needs of the industry. Generally commercial banks now do not involve too much into term lending. Whenever they do, a limit is always drawn. As a result, the task of financing the industry is gradually shifting to investment, leasing and specialized institutions. However, recognizing the incompatibility of mixing investment banking with commercial banking, countries around the world have enacted legislation accepting the principle of bifurcation of these two systems of banking.

     

Qualities of Merchant Banker

A merchant banker must have certain qualities necessary to perform his designated functions. The essential qualities of a merchant banker are generally as follows: (a) He must have expertise, (b) He must have integrity and (c) He must be capable of building up the requisite banker-customer relationship.

Functions of Merchant Banker

A merchant banker performs many functions. Some of the important functions undertaken by a merchant banker are as follows:

• Underwriting of initial public offering of shares and debentures, 
• Appraising, promoting and financing domestic or overseas projects by raising resources in the form of equity, debenture and long-term loans;
• Extending assistance for and participating in international consortia to raise foreign currency loans;
• Taking deposits and participating in money market operations including foreign exchange dealings;
• Assisting in raising of Capital by means of private finance, right issues, public offer for sale or issue of loan capital;
• Providing advice or consultancy to the corporate sector in the areas of finance, investment, capital and management structure etc;
• Offering advisory services and managing the investment portfolios of individuals, socities, trusts etc. for promotion of investment and 
• Maintaining relations with the government, semi-government, public and private agencies. 

Merchant bank is a very old banking institution. As the very name suggests, they in the past dealt both in goods and in bill of exchange. In addition, they also provided remittance facilities and acceptance credit for financing foreign trade. That is why they are simultaneously referred to as banks, merchants and financial houses. It implied that he was both a merchant and a banker. But the fact remains that a bank is a bank and never a merchant. Similarly, a merchant is a merchant, not a banker. On the other hand, financial houses are neither banks nor merchants.

In view of the separation of role as above between banker and merchants in the recent past, the merchant banker no more deals in merchandise. They are now found to be engaged in financing domestic trade and advising on amalgamations, mergers and takeovers etc. Other activities now-a-days they cover include: investment management, hire-purchase and leasing finance etc.

An examination of their services suggests that they offer a complete package of financial and advisory services in the areas like: (a) Promotion of new companies and (b) Finance syndication for industrial projects. They also offer services for balancing, modernization, replacement and expansion (BMRE) and for diversification of the existing companies. The merchant banking institutions, in addition to these functions, are also engaged in management of investment portfolio of the companies and corporations. 

What is Investment Banking?

Investment banks are the specialized institutions engaged in providing assistance to the commercial organizations and companies in raising their long-term capital through the sale of shares, stocks and bonds in the open market. Unlike commercial banks these institutions work primarily as middlemen between the corporate bodies and the investing public. Generally, they take the whole issue of new shares of the business corporations or of other bodies. Subsequently they reissue them to the public at a higher price. Sometimes they also act as agents on commission basis. But usually they underwrite the issue of securities.

Classification of Investment Banks

Investment banks may be classified as: (a) Originators, (b) Underwriters and (c) Retailers. As Originators, their task is to bring out the new issue of the securities. As underwriters, however, they undertake to buy up the entire issue if not subscribed or responded to by the investors. On the other hand, as retailers, they arrange the sale if the securities to the individuals and institutional investors. They may also arrange private placement of the shares through negotiation. All these functions may be performed separately or single institutions may also do all the jobs depending on the market situation.

Mechanism of Operation of Investment Banking

The investment bankers as Originators conduct the preliminary negotiations with the issuing company or corporation. They obtain from them the detailed reports on the background of the issuing corporation, its corporate powers, the description of its products, the valuation of plant and machinery and other assets, its ownership and capital structure, and the purpose of the new issue etc. Generally they get these reports verified by the experts, technicians, professionals and accountants. They also obtain legal opinion on the legality of the issue.

If the details favorable, the Originator comes into an agreement with the issuing company y or corporation agreeing to bring out the new issue. If the issue involves large amount the Originator requests other investment banks to join an ‘underwriting syndicate’. This syndicate acts as a selling group. Finally, the securities are offered for public subscription. Simultaneously, the Originator takes various steps to avoid any possible glut in the market prices of the securities. He generally leaves an “Open Order” to repurchase the securities. In this case the price is kept slightly below the price at which they are offered to the public.

Usefulness of Investment Banking

Investment bank renders highly useful services to the business and industry by providing the necessary capital for meeting the long-term needs. Considering this importance, it is frequently called the “entrepreneur of entrepreneurs”. On the other hand, the investing public is also immensely benefited by the activities of the investment banker. The independent and in depth analysis of the stock made by the investment banker gives an idea to the investors about the desirability of the shares. This helps the investors to make their decisions as to whether the shares can be brought or not. 

Deposit banking is actually deposit taking from the members of the public. That is why banks are now-a-days called deposit taking banks. Technically, deposit taking is a borrowing from the market. But unlike other kinds of borrowings, they are not payable otherwise than on demand by cheques. Banks are at liberty to use those deposits any way they like. In fact banks use those funds for lending. That is why second important function of a bank is lending. It is, therefore, clear that a modern joint stock banks starts actually from deposit banking.

It is interesting to note that banking did not start by deposit taking. Historically it started initially with money exchanging followed subsequently by money lending. It is well known that Italian goldsmiths, money lenders and indigenous bankers did the business of money exchanging and lending. They did this job on their own financial strength. Considering strength, financial soundness and goodwill, people at one stage started, however, depositing their money and valuables with them. This not only strengthened their capability to lend but also helped them to pay some interest on deposit.

But till the emergence of Joint Stock Company in the seventeenth century in Europe Deposit banking was not popular. With the popularity of Joint Stock Company having limited liability concept, the deposit banking as such also became popular. In fact, a modern bank now starts with deposits followed by lending and other functions like investment, remittance, foreign exchange business and safe custody etc.

The function of taking deposit or borrowing money has become so much a routine job that many banks even do asses marketing (lending) first to be subsequently matched by liability marketing (deposit mobilization). With the growing importance of wholesale banking (service to corporate and other big clients), some of the banks even borrow from call money market to meet the demands of such clients with the hope of paying them back later by mobilized deposits. It is, therefore, amply clear that Deposit banking is practically the most important function of a modern joint stock bank unlike in the past. 

Chain Banking

Chain banking – a common phenomenon under Unit banking system-is in fact an offshoot of Unit banking and relates to the ownership pattern of the banks. Under this system, two or more Unit banks are controlled by an individual or group of individuals or members of his/their family. For this purpose, the common owners hold majority of the shares in each bank. By virtue of the shareholding, they become common directors of each bank. Banks, however, maintain their separate identity. 

Holding Company Banking

Holding company banking – also called Group banking – actually refers to two or more Unit banks which are held as subsidiaries by a holding company. Such type of banking is in fact similar to Chain banking having, however, one difference between them. In case of Chain banking, one individual or group of individuals or members of the family own two or more banks while in case of Holding company banking, a company in place of individuals owns two or more Unit banks. Holding company may or may not however, undertake business of banking.

Chain and Holding Company Banking: For And Against

Chain banking and Holding company banking or Group banking – offshoots of Unit banking developed in the United States of America – have many advantages. They are found to be better placed to pool greater resources and hence they enjoy economies of scale as well. They can also concentrate on serving a locality more effectively.

However, these systems of banking have certain disadvantages as well. They may suffer from lack of control and wring utilization of funds. Moreover, they may help concentration of economic power. That is why, even the United States of America presently discouraging by law this system of banking. 

Branch banking system has many advantages over the Unit banking system. The main advantages of the branch banking system over the Unit banking system are the following:

1. Scale of Operation: Since Branch banking involves larger number of branches; operational cost under this system tends to be lower. The per unit cost of product as well as administrative cost are lower because staff members can be utilized more effectively. Larger resources help the banks in arriving at the advantages of scale of operation.  

2. Risk Diversification: Under branch banking system the risks of business can be diversified. Since branches are located in different localities/regions doing different kinds of business, risk or loss of one branch can be compensated by the other.

3. More Coverage: Branch banking can offer more services to a greater number of clients. Qualified and component staff members can meet various needs of customers located at various places through branches at their door-steps.

4. Utilization of Fund: Funds can be better utilized under Branch banking system. One branch having excess liquidity can remit the fund to another branch having shortage eliminating thus the incidence of idle fund.

5. Area Development: Credit needs of the areas where branches are located can be effectively met through Branch banking system. As result, area development is facilitated.

Branch banking, however, has some disadvantages as well. The disadvantages as pointed out by the followers of Unit banking system may be summarized as follows:

1. Control Problems: Larger banks having many branches located at different places suffer many times from the problems of controls. With the growth in number of branches, complexities in the areas like manpower, business and systems and procedures also develop which at times may go beyond control.

2. Delayed Decision: A bank following the branch banking system many times suffer from the problem of delayed decisions because of limited powers of the branches. Delay takes place due to time taken for processing and many other factors.

3. Centralized Economic Power: Larger banks mobilize larger amount of deposits which are deployable. Hence the management of those banks enjoys huge economic power. Many times they use these resources to further their interest at the cost of others.

4. Diversion of Fund: Banks following branch banking system can divert mobilized funds from one place to another ignoring the interest and needs of the people located at the command area of a particular branch. Thus funds of rural areas may be diverted to the urban areas at the cost of the rural people.

5. Uneconomic Expansion: Branch banking system may also lead the banks to open branches at unprofitable locations because of political and other pressures.  Thus they may be burdened with unprofitable branches/offices causing erosion in their profitability.

In conclusion, it may be said that the advantages of Branch banking are in reality the disadvantages of Unit banking. On the other hand, disadvantages of Branch banking often turn out to be the advantages of Unit banking. Considering this aspect of the issue, no separate discussion on advantages and disadvantages of Unit banking has been made here. 

As the very name suggests, banking operations under Unit banking system are conducted by a single office/unit of the bank. The office is located in particular area having no other branches. It collects deposits from the small communities living in that particular area. In turn, it places those deposits with the banks in the cities. City banks, in turn, place those deposits with the bigger banks in the bigger cities. Thus all the banks get connected with each other directly or indirectly.

Since the Unit banks are small in size, the can not provide remittance facilities to their customers. For providing such facilities, however, they take the help of larger banks through a mechanism called correspondent relationship banking. 

Branch banking - a popular system of banking in the sub-continent as well as in many other countries of Asia and Africa - refers to a system of banking where a large bank having a Head office operates through a network of branches throughout the country and abroad. In case of smaller banks, however number of branches may be small located in particular area.

The business of banking under Branch banking system is conducted in the branches whereas Head Office works as controlling and monitoring unit. No banking is performed at the Head office. The branches are managed by the Managers posted for the purpose. They run the operations on the basis of guidelines and manuals provided to them by the Head office. Under Branch banking system, a bank may have as many branches as it can profitably manage. Each branch is however, treated as a separate unit for assessing its performance.

The main characteristics of Branch banking may, therefore, be summarized as follows:

1. The bank having a Head office or registered office is guided, managed and controlled by a single Board of Directors, of which Managing Director (Chief Executive Officer) is the ex-official member. 
2. Actual banking operations are conducted at the branches and those are controlled, monitored and guided by the Head office through guidelines, instruction manuals, statements and returns.
3. Day-to-day management of the bank is vested with the Managing Director or Chief Executive Officer (CEO) who operates through other officials at Head office. 
4. Branches are managed by the Managers having appropriate business, financial and administrative powers delegated to them by the Head office.
5. Each branch is treated as a separate unit for business and performance purposes. But while assessing the performance of the bank, the performance of all the branches are aggregated.