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15 Chain Banking Advantages and Disadvantages

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.

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 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.

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.

List of the Disadvantages of Chain Banking

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 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.

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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