Banks’ dilemma: High on funds, but low on notes

Over the past year, bank lending rates came down almost 100 basis points, term deposit rates declined by up to 75 basis points, the usually sticky savings bank deposit rate came off 50 basis points and digital transactions soared.

Normally, these developments would have unfolded over a couple of years. But all this happened double-quick after the Modi government announced that specified bank notes (SBNs) — ₹500 and ₹1,000 — would no longer be legal tender.

The demonetisation move led to the public scampering to bank branches to exchange/deposit the SBNs by December 30, 2016.

While the surfeit of liquidity due to deposit of SBNs prompted banks to cut interest rates, the cash crunch due to the sucking out of SBNs valued at ₹15.4 lakh crore pushed banks to ramp up their digital transaction infrastructure and get customers to adopt them.

In the backdrop of the currency shortage, the government asked banks to roll out point-of-sale (POS) machines to facilitate transactions at merchant outlets.

The RBI announced special measures whereby customer charges were not levied on all transactions involving cash withdrawal at POS (up to December 30). It also doubled the monthly transaction limit on pre-paid instruments (PPI) for individuals to ₹20,000. The cut in lending rates came at a time when credit growth hit the slow lane, touching multi-year lows, due to slowdown in the economy and banks turned cautious in lending in the face of mounting bad loans. Lower bank deposit rate nudged conservative depositors to look elsewhere, including mutual funds and stock markets, for better returns.

Bankers admit that demonetisation caused some stress to their MSME customers, many of whom used to transact in cash.

According to an RBI Mint Street Memo on ‘demonetisation and bank deposit growth’, in nominal terms, excess deposits accrued to the banking system due to demonetisation are estimated at ₹2.8-4.3 lakh crore. “Overall, there appears to have been a significant increase in bank deposits due to demonetisation, which if sustained, could have a favourable impact on financial savings and their channelisation to capital markets,” concluded the memo.

“From a banker’s perspective, I am very happy because it (demonetisation) substantially improved our resources, including low-cost deposits, which really helped us bring down the interest rate on advances,” said Rajkiran Rai G, Managing Director & CEO, Union Bank of India. “When you look at the MSME sector, it is said that more than 80 per cent of them are in the informal sector, taking credit at 18 per cent or 20 per cent or more. They were dealing in cash. So, demonetisation and GST are bringing them to the formal (credit) system.”

He added that by joining the formal system, MSMEs can now tap bank funds at much cheaper rates. “So, whatever cost is there by way of compliance (for MSMEs) should be more than offset by the savings in finance costs. So, I think, it is a positive.

“Anticipating this, we have launched a credit product linked to GST. So, we estimate the annual turnover of entrepreneurs who have filed one quarterly or three months return. Based on that we are giving 30 per cent of the turnover as overdraft limit,” he said. As per RBI data, as on October 13, 2017, deposit growth of all scheduled banks slowed to 9.75 per cent year-on-year (yoy) against 10.42 per cent as on October 14, 2016. This is due to the cut in deposit rates and savers chasing other asset classes. Despite the deposit rate cuts, banks continue to have surplus liquidity due to tepid demand for credit.

As on October 13, 2017, bank credit growth declined to 7.76 per cent yoy against 8.86 per cent as on October 14, 2016.

Madan Sabnavis, Chief Economist, CARE Ratings, said the fallout of people putting money in deposits (during the demonetisation period) was that banks’ deposits increased very sharply. So, banks had to deal with the huge liquidity that came into the system. Sabnavis observed that this happened at a time when credit wasn’t increasing because banks’ had diverted their attention from banking business to tackling notes and there was a slowdown in the economy.

“Surplus money was coming in at 7-8 per cent interest and banks were not able to deploy them anywhere. This meant it was a financial loss. Then the RBI said it will impound 100 per cent incremental cash reserve ratio (CRR). Then the banks complained saying they will lose money on this (because CRR doesn’t fetch anything).

“So, then the RBI went back on it and resorted to MSS (market stabilisation scheme for sterilising liquidity). And after the MSS bonds were floated they moved over to term reverse repo mode to mobilise extra liquidity. So, this meant that on the whole the banking sector was affected in terms of having surplus liquidity and carrying this particular cost of liquidity,” explained Sabnavis

That there has been a surge in digital transactions in the last one year. As per RBI data, transactions based on prepaid payment instruments (including mobile wallets and PPI cards) jumped in volume terms from 126.90 million (value: ₹6,022 crore) in October 2016 to 261.14 million (value: ₹10,288 crore) in August 2017.

The number of mobile banking transactions too increased from 78.10 million in October 2016 (value: ₹11,3564 crore) to 99.64 in August 2017 (value: ₹79,913 crore). Funds transfer via immediate payment service jumped from 42.09 million transactions in October 2016 (value: ₹34,357 crore) to 75.66 million transactions in August 2017 (value: ₹65,149 crore).

Amidst all this, banks had moved the Finance Ministry to compensate them for the losses incurred in implementing demonetisation. Their contention was that the staff had worked overtime to exchange/deposit bank notes, ATMs were recalibrated to accommodate new notes, expenses were incurred towards ferrying new and old notes across the country and there was an opportunity loss due to bank staff being engaged solely in exchanging currency instead of engaging in normal banking business. However, they have not yet heard from the Ministry.

The RBI received SBNs valued at ₹15.28 lakh crore out of the total ₹15.40 lakh crore worth of SBNs that were scrapped. This set off criticism in various quarters. However, the jury is still out on the effectiveness of the demonetisation exercise as authorities are investigating unusual growth in cash deposits (aggregating ₹1.6-1.7 lakh crore) in specific accounts that are usually less active.