With credit demand down, banks may struggle to pass on any rate cut
Banks may be flush with cash after demonetisation pushed people to deposit old ₹500 and ₹1,000 notes into bank accounts (they have around ₹8.44 lakh crore in their coffers), but it has also compounded their problems. Already under pressure, banks are expected to take a further hit on their earnings due to low demand, delaying their ability to pass on the rate cuts widely expected in RBI’s monetary policy review on Wednesday.
Also, the objective of demonetisation, to flush out black money from the system, thereby reducing RBI’s liabilities and adding to the government’s coffers, 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 now 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 ₹1.31 lakh crore flowing into banks’ books in the last 14 days.
Total deposits with banks during April-November – this is the first time in five years that figures were computed till November 11 – totalled ₹7.87 lakh crore, according to RBI data. The figure was ₹6.56 lakh crore during the AprilOctober 28 period last year.
According to State Bank of India, 60% of the ₹14 lakh crore (₹8.44 lakh crore ) has been deposited and exchanged in banks till November 27.
With so much money sloshing in bank vaults, the natural step would be to lend and let this money earn. But demand hasn’t picked up and capacity utilisation in factories is still at 70% to 75%, a trend that hasn’t improved in the last three years. “Most companies in the manufacturing sector have unused cash. Banks cannot lend to infrastructure as sectoral limits have been reached. So two of the largest arms of the 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 figure stood at ₹1.21 lakh crore so far this year, lower than the ₹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 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 RBI.
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 ₹3.76 lakh crore in deposits, banks have to maintain ₹4.69 lakh crore in regulatory ratios. According to SBI, banks are likely to receive around ₹12.94 lakh crore as deposits in high-denomination notes between November 10 and December 30.
“Even if we assume an 85% withdrawal rate, deposits with banks will be ₹1.94 lakh crore, of which they have to keep ₹48,100 crore in the form of CRR and SLR investments. Net liquidity in the system will be ₹1.46 lakh crore,” said Soumya Kanti Ghosh, chief economic adviser, SBI.
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. 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 growth projections for 2016-17.”
With the deadline of December 31 for deposits of old currency, and with ₹8.44 lakh crore already being deposited till November 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 ₹3 lakh crore). The assumption was that the fear of criminal prosecution or fines would deter people 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 ₹60,500 crore (November 10-18) to ₹50,100 crore (November 19-27), a decline of 17%.”