What was the impact of demonetization on banks?

Staff of Monetary Policy Department of RBI prepared a paper describing how demonetization affected the banks.

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Impact on Balance Sheet and Profitability of Banks

Demonetization has had a significant impact on the balance sheet of scheduled commercial banks (SCBs), both in terms of size and composition.

Impact of Demonetization on Balance Sheet of banks

• Decline in currency in circulation on account of demonetisation led to a surge in bank deposits.
• Total currency in circulation declined by about ₹ 8,800 billion (₹8.8 lac crores). This, in turn, was largely reflected in sharp increase of about ₹ 6,720 billion (₹ 6.72 lac crores) in aggregate deposits of the banking system even after outflows in NRI deposits during the period.

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• Between end-December 2016 and early March 2017, there was a net increase in currency in circulation by about ₹ 2,600 billion. During this period, deposits with banks also declined moderately.
• As per data for October 28, 2016 (prior to demonetisation) and February 17, 2017 (latest available), aggregate deposits of SCBs increased by ₹ 5,549 billion during the period.

• Bulk of the deposits so mobilised by SCBs have been deployed in: (i) reverse repos of various tenors with the RBI; and (ii) cash management bills (CMBs) issued under the Market Stabilisation Scheme (which is a part of investment in government securities in the balance sheet of banks).
• Loans and advances extended by banks increased by ₹ 1,008 billion. The incremental credit deposit ratio for the period was only 18.2 per cent.
• Additional deposits mobilised by commercial banks have been largely deployed in liquid assets. This may be due to the expected transitory nature of the bulk of such deposits and weak demand as reflected in the subdued growth of credit.

Impact of Demonetization on Profitability of Banks

• Banks’ net profits essentially reflect the difference between interest earned on loans and advances and investments, and interest paid on deposits and borrowings, adjusted for operating costs and provisions.
• Loans and advances and investments, which are the main sources of interest income, together constitute more than 85 per cent (61 per cent accounted for by loans and advances and 25 per cent by investments).
• The sharp increase of 4.1 percentage points in the share of CASA deposits in aggregate deposits to 39.3 per cent (up to February 17, 2017) resulted in a reduction in the cost of aggregate deposits.
• Banks have also lowered their term deposit rates; the median term deposit rate declined by 38 bps during November 2016-February 2017.
• The decline in the cost of funding resulted in decline in the 1-year median marginal cost of funds based lending rate (MCLR) by as much as 70 bps post-demonetisation (November 2016-February 2017).
• Banks earned return of around 6.23-6.33 per cent under reverse repos and market stabilisation scheme (MSS)as against the cost of CASA deposits of around 3.2 per cent.
• Accordingly, for an average deployment of about ₹ 6 trillion in a quarter under reverse repos and MSS securities, banks’ net interest income from increased deposits is estimated at about ₹ 45 billion in a quarter after demonetisation.
• Banks continue to enjoy the increased share of low cost CASA deposits, although it is gradually declining with the increase in currency in circulation.
• The increase in net interest income would need to be adjusted for the cost of managing withdrawal of SBNs and injection of new bank notes (such as calibration of ATM machines, staff overtime, security arrangements, lower fees/waiver of fees on digital modes of payments), the exact details of which are not available at this stage.

Monetary Policy Transmission to Lending Rates

• Surplus liquidity conditions have helped facilitate the transmission of monetary policy to market interest rates. Post demonetisation, several banks lowered their domestic term deposit rates and lending rates.
• The 1-year median MCLR has declined by a cumulative 70 bps since November 2016 even when the policy repo rate was not changed. This is significant, considering that the 1-year median MCLR declined by only 15 bps during the preceding seven months

 

Monetary Transmission: Reduction in Deposit and Lending Rates – Post-demonetisation (up to March 7, 2017)
(bps)
Bank Group	MCLR (Median)	Term Deposit Rates (Median)
	1 year	Up to 1 year	1 to 3 years	All Tenors
Public Sector Banks	85	26	35	28
Private Sector Banks	65	50	48	50
Foreign Banks	40	8	34	6
Scheduled Commercial Banks	70	31	40	38
MCLR: Marginal Cost of Funds based Lending Rate. Source: RBI

 

Impact of demonetization on Jan Dhan Accounts

• Post-demonetisation, 2.33 crores new accounts were opened under the Pradhan Mantri Jan Dhan Yojana (PMJDY), bulk of which (80 per cent) were with public sector banks.
• The total balance in PMJDY deposit accounts peaked at ₹ 746 billion as on December 7, 2016 from ₹ 456 billion as on November 9, 2016 – an increase of 63.6 per cent.