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With credit demand down, banks may struggle to pass on any rate cut

business Updated: Dec 07, 2016 10:56 IST
credit demand down

Banks may be flush with cash after demonetisation pushed people to deposit old Rs 500 and Rs 1,000 notes into bank accounts, but it has also compounded problems. Banks, already operating on wafer-thin margins, are expected to take a hit on their earnings due to low demand, delaying their ability to pass on the rate cuts widely expected in RBI’s monetary policy on Wednesday.(Reuters)

Banks may be flush with cash after demonetisation pushed people to deposit old Rs 500 and Rs 1,000 notes into bank accounts, but it has also compounded problems. Banks, already operating on wafer-thin margins, are expected to take a hit on their earnings due to low demand, delaying their ability to pass on the rate cuts widely expected in RBI’s monetary policy on Wednesday.

Also, the objective of demonetisation, to flush out black money and see a part of it disappear, thereby reducing RBI’s liabilities and adding to the government’s coffers, now seems a distant dream.

But perhaps the most crucial fallout would be the moderation in growth expectations that have so far been scaled down from 7.8% to 7.2% and to further to 7%. Coupled with low credit off-take, this could have a multiplier impact in the near term.

For the government, which has been projecting demonetisation as one of its political milestones, it could actually be an expensive exercise.

The numbers so far don’t point in that direction though. According to RBI’s latest statistics, public deposits with banks grew 8.4% in the year so far till November 11, with around Rs 1.31 lakh crore flowing into banks’ books in the last 14 days, indicating that a larger part of the overall deposits were from old currencies after they were rendered invalid.

Total deposits with banks during April-November – this is the first time in five years that figures were computed till November 11 – totalled R7.87 lakh crore, according to RBI data. The figure was Rs 6.56 lakh crore during the April-October 28 period last year .

According to State Bank of India, Rs 8.44 lakh crore was deposited and exchanged in banks till November 27, 60% of the Rs 14 lakh crore that was demonetised.

With so much money sloshing in bank vaults, the natural step would be to lend and let this money earn. But there is no such fortune as demand hasn’t picked up and capacity utilisation in factories is still at 70% to 75%, a trend that hasn’t improved in three years.

“Most companies in the manufacturing sector have large unused cash. But they are not deploying this cash and also not taking on loans. Banks cannot lend to infrastructure as sectoral limits have been reached. So two of the largest arms of industry are not tapping for loans,” said Sunil Sinha, principal economist, India Ratings & Research.

RBI’s non-food credit -- the amount lent to industry -- numbers support the claim. The figures rose Rs 1.21 lakh crore in the year so far, lower than the Rs 2.70 lakh crore lent last year.

Last Saturday, the central bank hiked the cash reserve ratio (CRR) – a mandatory amount that banks have to park with the central bank – to 100% of incremental deposits. It was just 4% earlier. Banks don’t earn any interest on CRR. They, however, get 6.22% on funds deposited under the reverse repo window of RBI, and pay 6.26% on repo loans from RBI. So they are already losing 4 basis points. As banks pay 4% on savings bank deposits, it adds up to 4.04% to their costs.

Repo is the rate at which RBI lends to banks. Reverse repo is the rate at which banks lent to the central bank.

Hence, though banks have received ample deposits during this period, incremental CRR will put an enormous strain on the banking system. For the accretion of Rs 3.76 lakh crore in deposits, banks have to maintain Rs 4.69 lakh crore in regulatory ratios. According to SBI, banks are likely to receive around R12.94 lakh crore as deposits in high denomination notes between November 10 and December 30.

“Even if we safely assume 85% withdrawal rate, the deposits that will be kept with banks will be R1.94 lakh crore, of which banks have to keep Rs 48,100 crore in the form of CRR and SLR investments. Hence, the net liquidity that will remain in the system will be Rs 1.46 lakh crore,” said Soumya Kanti Ghosh, SBI’s chief economic adviser.

As banks are not earning enough, their ability to cut rates, if RBI reduces interest rates on Wednesday is limited.

But the slowdown is more worrisome. Although demonetisation could be positive in the long term, Madan Sabnavis, chief economist with CARE, said: “There prevails uncertainty regarding near-term effects and its duration, given the unprecedented nature of the move and the evolving policy measures by RBI and government to address the currency crunch. It thus calls for a relook at earlier projections to the prospects of Indian economy for 2016-17.”

With the deadline of December 31 for deposits of old currency, and with Rs 8.44 lakh crore already being deposited till Nov 27, the trend for the remaining days may well exceed expectations. Then it may defeat the government’s purpose of cancelling undeclared amount and absorbing it as dividend and non-tax revenues (the government had pegged it at around Rs 3 lakh crore). The assumption was that the fear of criminal prosecution or fines would deter a large part of the population from depositing unaccounted cash.

However SBI’s Ghosh said the government objective may be partly realised. “If we closely look at data, the daily working day average deposited/exchanged at banks has declined significantly from Rs 60,500 crore (November 10-18) to Rs 50,100 crore (November 19-27), a decline of 17%.”