Sunday, 20 November 2016

Demonetisation and Impact on Banking Sector

The Prime Minister's recent announcement on demonetisation has wrecked havoc across the country, rendering 86% of the currency worthless outside of a bank branch. There have been several opinions on the pros and cons of this move, with some citing it as a major risk taken by Mr. Modi halfway through his term and others believing it to be transformational, if we can pull this off. Nonetheless, banks have ended up collecting about Rs 4 trillion and are currently flush with cash. Though a certain amount of these deposits have been withdrawn, a large chunk still remains stacked in the coffers of the banks.

With a drastic reduction of cash in circulation in the economy, it would indeed impact economic growth if this money is not put back again into the system by the banks. Since the Current Account/Savings Account deposits have increased with the banks in last few weeks, money is available with the banks at a cheaper cost, thus creating an opportunity for them to pounce upon. However, the ability of the banks to create credit has been hampered with rising NPAs in the banking sector, now touching about Rs 6 trillion. The industrial credit growth which continued to grow at an elevated rate of 20% over four years ago, has contracted by 0.2% in August 2016 although gross bank credit expanded by 7.6%. This deceleration is attributable to lack of investment activity and low capacity utilisations in the industry. In fact, the Indian economy is going through the biggest deleveraging of the past quarter century with highest asset sales since liberalisation. Indian companies have sold assets in 2016 more than in any year since liberalisation. Asset sale deals announced, pending or completed are worth $40.85 billion largely with respect to distressed indebted corporations.

With these facts, the point to ponder upon, is what are banks doing with the cash? 

The net injection (The difference between the amount of money lent by RBI to banks and the amount of overnight deposits into RBI by banks) declined sharply as banks kept their newly acquired deposits with RBI.

(Views are personal) 

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