Demonetisation: Why banks could be the biggest loser

On November 26, the Reserve Bank of India (RBI) made an unprecedented announcement. It came at a time when Indian commercial banks were flush with funds from public deposits in high value currencies that were demonetised a few weeks ago.

The RBI asked commercial banks to maintain a cash reserve ratio (CRR) of 100 per cent with the central bank on all incremental deposits between September 16 and November 11.

CRR is a certain percentage of the total deposits banks have to keep with the RBI, a tool used by the apex bank to control liquidity or the availability of cash in the economy. It is a tool much disliked by bankers, as the central bank pays commercial banks no interest on such a reserve.

So, it’s all of pain, with little gain for banks. By telling banks to deposit their entire incremental deposits from the public, to the tune of Rs 3.24 lakh crore between September 16 and November 11 with it, the RBI was primarily targeting high volatility in the bond market.

To be sure, for the period of demonetisation from November 10 to 27, deposits are a whopping Rs 8.44 lakh crore, and RBI may ask that to be deposited too with similar directives. RBI has anyway said it will review this decision on December 8.

High on liquidity from deposits of demonetised notes, banks had been putting some of the money it earned from the public into government bonds, igniting a rally that saw the benchmark ten-year bond yield fall more than 50 basis points to its lowest in more than seven and half years.

Lower yields on bonds (instruments issued by borrowers to raise money from the public) meant lower returns for the investor. When there is a surge of liquidity, it can lead to disruptions in the bond market, forcing the hand of the regulator.

Falling yields would have also made it difficult for the RBI to further cut the repo rate (rate at which the RBI lends to commercial banks) in its upcoming monetary policy review on December 7. With liquidity in control, there is a near-consensus among experts that the RBI will cut rates that day, giving a reprieve to small-scale units and home and car buyers, since their cost of loans would fall.

Banks have been facing a dilemma since demonetisation was announced, since there aren’t enough avenues to park the surplus funds they collected as deposits from the public.

The offtake of credit from banks (for industrial projects, in particular) has been sluggish. Credit growth, languishing in single digits for several quarters, may slip even further to six per cent in this financial year due to demonetisation, say research firm Jefferies.

Most of the banks are parking these surplus funds in the short term instruments like the reverse repo window of RBI (where banks lend to the central bank, earning interest in the process) at 5.75 per cent interest rate or in the 91-days treasury bills, which offers around 6.50 per cent interest, or in government securities.

The latest RBI move is not good news for banks, as it will hurt commercial banks who have been betting on earning income on their incremental deposits post demonetisation. With the CRR move, the RBI will suck out about Rs 10.2 lakh crore (Rs 3.2 lakh crore via incremental CRR and Rs 7 lakh crore by using government bonds) from the banking system, says HSBC Securities and Capital Markets.

Crisil, meanwhile, expects banks to delay cutting their lending rates as a result of the RBI move.

It has been a common complaint that banks have not been passing on the earlier rate cuts by the RBI to their borrowers, though Arundhati Bhattacharya, CMD of the State Bank of India, the country’s largest lender, has assured that the rate cuts would be transmitted by it to consumers on a monthly basis. The impact of that is, nevertheless, yet to be felt.

Not in recent history have banks gone through so much pain, in dealing with currency shortages at their branches and ATMs on the one hand, and driving their staff to work overtime to deal with deposits and exchanges.

It goes without saying that banks have, over the past one month, spent their energies totally on demonetisation, doing little work that would have helped them improve their business of loans.

While the impact of that is bound to strain their profits for the current financial year, bankers may also be hoping for an early redressal to the current woes of the public. That, if not addressed soon, can erode public trust in banks for a long time.

(Courtesy of Mail Today.)

Also read: Bank deposit surge may end up derailing demonetisation