Did Banks become poor after demonetization? Find out ...
History would remember 8-Nov-2016, demonetization drive to recall all Rs 500 & Rs 1000 notes. We only got to see these things in films. I never imagined, at such a scale it can be done, but things were different under the power of our Honorable Prime Minister Shri Narendra Modi ji and his team. A demonetization drive to recall all Rs 500 & Rs 1000 notes, very secretly planned and the way it was announced on 8th Nov 2016 at 8:00 PM was it self a considered a great success and surprise to many.
Due to the level of secrecy maintained before execution for the right result. Both common man and bankers were not prepared for unanticipated rush. From 8th night itself, there were long queue in front of the ATM to get Rs 100 notes. Small became big & big became worthless from 8th night. Source of the money had got the value of the money. 9th was declared as a holiday, so that banks & bankers get to work on plan of action till Dec-31. On 10th the queue in front of each Bank went up to a kilometer. Most of them to deposit new & old Rs 1000 & Rs 500 notes and many to get Rs 100 notes. A phenomena of a bank run with a difference, where most of the people came to deposit and many for exchanging, and very few to withdrawing. Banks were flooded with more money.
All banks cash chests were full, so banks have become more poor. I am sure you would be confused. If money is deposited into the banks, then banks should become rich right. No, you are wrong. For every rupee the bank is holding, bank would pay interest on it till you withdraw. Which means for every rupee bank is paying rupee+ some paisa (Which was at minimum of 3.5% per annually) to its depositor. Banks make money, only if they lend the money at higher interest rate then they borrow, the longer they hold with out circulating the maximum they loose. So banks become rich on by giving and collecting it back. So that should have answered , why all rich banks have become more poor now.
I use to say, Money is like the blood, bank is like the heart. Black money is like a cancer cells in the blood and demonetization was the operation to clean up the Black money cancer cells. But the side effects of demonetization was, heart was able to suck more money into it and pump less into the system. If heart failed to suck or pump it would be a Cardiac arrest. Demonetization was not a Cardiac arrest but different case. Heart was able to suck more than it can pump enough into the system, which would lead to organs in the body to get less oxygen rich blood and slowly each organ would get paralyzed and slowly with the excessive blood in the right heart and the lungs would convert to thick blood and into tumor then to cancer and in parallel would start to swell the heart & the lungs and slowly and painfully lead to entire system failure. RIP.
With 2 months of demonetization all the institutional financial borrowing was in stand still. Every one thought now banks would lend all that was received and interest rate would drastically come down. Every one was expecting that RBI would slash the REPO rates on Jan-8th-2017 soon after demonetization. Now good set of financial jokes to follow.
Joke 1: For every ones surprise no change in REPO rates by RBI. Without demonetization itself everyone was expected, to boost the business a 25 to 50 basis points cut for JFM(Jan Feb Mar) as the growth was in right tract and inflation was under control.
Joke 2: Because of the all the inflow of the cash into the bank at a dead cheap rate of 3.5-6% rate(saving bank interest rate), with the new formula of MCLR, the banks rate had come down. Now real good joke was, banks instead of passing this benefit to new borrowers, it went on to increase it's margins with assuming that over all rate drop because of MCLR coming down, it would look like decrease in the interest rate and it would be able to lend more. Fooling the customers. Banks should have passed it on and should have given it at a 0 margins. That would have reduced the interest rates future. Which means higher borrowing power, which means higher buying power.
Jokes apart, lets get into the real problems. Assert division of the banks which lends money was literally went into a lull time during demonetization, with the clear instruction not to lend. Some of the banks, had decreased the FOIR as they were not sure of the demonetization impact on the future of the high paid jobs and business. This meant the borrowing power of the individual had come down. Which would directly impact the purchasing power of the individual. Now the actual problem to the banks started.
Banks are ready to lend, but are borrowers are capable of paying it back. Lending by definition itself is not giving money but to collect the last penny from the borrower or else its considered charity. Banks were not prepared with so much inflow of money into its system. So they had not planned well to lend the money. Planning would mean, they should have increased the employee count in the assert division. But the bigger problem was not hiring the manpower with the right skill set to calculate the risk of a customer, the BIGGER PROBLEM was to find the right customers to lend. Banks top lending products are home loans, business loans , vehicle loans, personal loans & bill discounting.
The cream of lending in banks is home loans. During demonetization all the real estate transactions were in stand still. Demonetization had direct impact on the builders and real estate & with real estate RERA bill coming shortly added bigger confusion and great insecurity. Best was , all the buyers were in the assumption that prices would drop and they all were waiting for it. To add more confusion to confusion was input tax credit in the GST. Where most of the articles written by scholars mentioned the price of the property would come down with input tax credit passed to the customers with GST. With so much of confusion, only people who were in blissful state & who didn't understand this confusion went on to buy properties. Which meant, banks were not able to find enough customers to lend in its cream product 'Home Loans'.
Business loans by itself, is one of the most complex product in lending. With the demonetization, 3rd quarter was badly affected and its ripple were not silenced in the next quarter too. Now if some one had projected the growth in last 2 quarters either they know how to make up a balance sheet with out business or they were PayTM. Identifying the right business to lend itself during such events is very tough. With overall turnovers coming down business had again faced same challenge of FOIR and the borrowing power was less. Most of the business had to turn to non-traditional lenders for borrowing, which by itself defeated the purpose of demonetization and with the side effect of banks not able to lend the money to these businesses.
If I am not wrong, other than during the demonetization, Vehicle finance and personal loans were not highly affected. What followed was, most of the private companies which tend to give annual hike during March used demonetization as a Mantra and didn't give a great hike. At micro level this affected the borrowing power for a individual. This too would have had a affect but not much.
Banks were able to identify this issue and recently to increase its life span, they went on to decrease the interest rates for all savings account and increase transaction and other charges to pay for what they have. As they are failing to lend to maximum. I am sure if this continues, Indian banks would be like Japanese banks which would implement negative interest rates. Which means, for putting the your money into your savings account, bank would charge you interest rate. Which any way happening with all new transnational charges.
Its high time RBI & Government of India get together and act on the situation before it paralyzes the banking system.
My next article will be on "Demonetization, RERA & GST a killer times for a 2016-2017 startups ?"