Advantages and limitations of universal banking

Universal Banking includes not only services related to savings and loans but also investments. However in practice the term ‘universal banks’ refers to those banks that offer a wide range of financial services, beyond commercial banking and investment banking, insurance etc. Universal banking is a combination of commercial banking, investment banking and various other activities including insurance.

It is a multipurpose and multi-functional financial supermarket providing both ‘Banking and Financial Services’ through a single window. As per the World Bank,” In Universal Banking, large banks operate extensive network of branches, provide many different services, hold several claims on firms (including equity and debt) and participate directly in the Corporate Governance of firms that rely on the banks for funding or as insurance underwriters.”

In a nutshell, a Universal Banking is a superstore for financial products, under one roof. Corporates can get loans and avail of other handy services, while individuals can bank and borrow. It includes not only services related to savings and loans but also investment. However in practice the term ‘Universal Banking’ refers to those banks that offer wide range of financial services beyond the commercial banking functions like Mutual Funds, Merchant Banking, Factoring, Insurance, Credit Cards, Retail loans, Housing Finance, Auto Loans, etc.

Advantages of universal banking:

  • Economies of scale from lower operational costs, i.e., larger scale can avoid the wasteful duplication of marketing, research and development and information gathering efforts.
  • By offering a broader set of financial products than what a specialized bank provides, a universal bank is able to establish long-term relationship with the customers and provide them with a package of financial services through a single-window.
  • Flexibility in adapting to the fast changing environment.
  • Better and innovative products.
  • Reduction of risk by diversification.
  • Access to international financial markets.
  • Higher output due to specialization.

Limitations of universal banking:

  • The failure of a larger institution could have serious ramifications for the entire system in that if one universal bank were to collapse, it could lead to a systemic financial crisis. Thus, Universal Banking could subject the economy to the increased systemic risk.
  • Universal bankers may be tempted to take excessive risks. In such cases, the government would be forced to step in to save the bank.
  • Vulnerable to high risks due to investment banking activities coupled with focus on commercial banking activities.
  • By virtue of their sheer size, universal banks may gain monopoly power in the market, which can have significant undesirable consequences for economic efficiency.
  • Universal banks may tend to work primarily with large established customers and ignore or discourage smaller and newly established businesses.
  • Universal banks could use such practices as limit pricing or predatory pricing to prevent smaller specialized banks from serving the market. This argument mainly stems from the economies of scale and scope.
  • Combining commercial and investment banking gives rise to conflict of interests, as universal banks may not objectively advise their clients on optimal means of financing or they may have an interest in securities because of underwriting activities.
  • There may be conflict between the investment banker’s promotional role and the commercial banker’s obligation to provide disinterested advice .
  • Banks may deploy their own assets in securities with consequent risk to commercial and savings deposits.
  • Unsound loans may be made in order to shore up the price of securities or the financial position of companies in which a bank had invested its own assets.
  • A commercial bank’s financial interest in the ownership, price, or distribution of securities inevitably may tempt bank officials to press their banking customers into investing in securities which the bank itself was under pressure to sell because of its own pecuniary stake in the transaction.