Demonetisation impact: Did the banks gain or lose?

One of the problems of forecasting the impact of a complex and massive first-time event of removing 86 per cent of the currency in circulation is that you are likely to be way off the mark in understanding all its ramifications. This is what could have happened to the forecasts that predicted huge gains for banks. A quick Google search shows that authors of such forecasts ranged from an eminent tax consultant, to a storied foreign broking company, one of India’s largest private-sector banks and an eminent economist. In short, a wide spectrum of experts believed banks would gain. 

Foreign broking firm CLSA said, “Indian banks, especially the state-owned ones, could see better third-quarter results as a consequence of demonetisation.” How would that be possible when the banks would be doing nothing other than exchanging notes and policing the depositors? “Demonetisation will have two or three big benefits for the banking system as a whole,” argued Aashish Agarwal, the country head of research at CLSA to a business paper. “Banks will get a lot of CASA (current and savings account) deposits coming at a huge spread to them. They will be paying an interest of 2-3 per cent on deposits and will be deploying them at 6-7 per cent. This gives them a spread of 3-4 per cent on a huge sum of deposits over a long period of time,” Agarwal said. “It will also improve liquidity, which will bring down interest rates. When interest rates come down, banks will make treasury gains on the total investment book.” In other words, the most popular logic that was repeated ad nauseam by experts was this: Inflation and interest rates would fall, and banks will be flooded with liquidity, loans and credit will freely flow to entrepreneurs. Except that the experts did not factor in something crucial: Costs on the banking system. This is the flip side to the benefits being touted. 

The first blow to the cheery consensus came in early December from saner heads in the Monetary Policy Committee. In the run-up to the Reserve Bank of India’s (RBI’s) monetary policy review meeting on December 7, there was a consensus that the central bank will cut interest rates. Some financial market experts even asserted that there could be a cut even before the meeting. However, far from an inter-meet cut of 50 basis points, or even 25 basis points, RBI announced no change in the repo rate at all. All six members of the panel were in favour of retaining the repo rate at 6.25 per cent. Governor Urjit Patel further added that achieving the inflation rate target was important for the monetary policy. 

Benefits without costs?

The upside of demonetisation for banks was touted with hardly any effort to estimate of the cost. A good cost estimate comes from Mahesh Vyas of the Centre for Monitoring Indian Economy. According to him, the cost of demonetisation to the banking sector is over Rs 35,000 crore, in terms of wages, additional security cost and the cost of recalibration of cash machines assuming that banks have spent 95 per cent of their time on this work. This still does not take into account “the opportunity cost of loss of business during these 50 days, the cost of maintaining the records of all the persons who submitted their identity proofs against the transactions made by them. This cost will continue for some time beyond the 50 days under consideration,” he argues.

And, belying the ecstatic estimates of a jump in lending just because banks have some extra cash, loan sanctions have collapsed. According to RBI data, credit or loan growth for in the first fortnight after demonetisation fell by Rs 65,000 crore between November 11 and November 25. Over the corresponding period last year, credit growth had gone up by Rs 38,000 crore. This means that credit has declined by Rs 1,00,000 crore in the first fortnight after the withdrawal of notes. There have been two more such fortnights since. Also, don’t forget that banks have done no business during this period, so their fee income will also fall. They will have to bear four per cent cost of money deposited into savings account, even as lending has shrunk. 

What has amazed me most over the last two months is how most experts have assumed that money being deposited under the pressure of currency swap would stay with the banks. First, to the extent that 90 per cent of the extra cash deposited was not idle but used in transactions, the deposits would start going out of banks from January. It has to, for the economy to get going. Bankers know this. They will wait and watch and step up their lending if at all they have extra liquidity then. I am not even sure we have an answer to a more important question — lend to whom? Have the banks suffered more costs today than the benefits they will enjoy in future? I think so. 
 

The writer is the editor of www.moneylife.in

Twitter: @Moneylifers