The Great Indian Demonetization

A lot is being said & written about the Great Indian Demonetisation exercise. While one side is hailing it as a brilliant move to weed out black money, the other is pointing out the various implementation problems that might push the country towards utter disaster. While the sentiments on both sides are understandable, this issue has multiple consequences and angles to it. It cannot be a binary good vs bad debate and while this big cash-cleanup continues, we need to ask one very uncomfortable question.

Who will demonetisation benefit the most?

I know, you’re tempted to say “ME! I, the common man, will benefit!”

Sure. You will benefit once the money situation stabilises, your wallets are loaded with newly-minted cash and there is a sudden spike in the gross domestic product. But more than you, there is one more player that will benefit on crazy-holy-moly-mother-of-jesus levels: The Banks.

While people line up to put their money into the system, the bankers are doing this. On loop.

(Sidenote: That video is mesmerizing. I know. AND it goes on for 10 hours!)

Let us take a deep dive into the magical world of banking to see how demonetisation benefits banks, since that is where all of our money is sitting at the moment.

In and (not) Out

It would be useful to point out at the very beginning that 98 percent of all transactions in India are done in cash. Well, they were until 23:59:59, November 8, 2016. Now, there is this sudden push to flush out that cash and stuff it into the banks. The Finance Minister, when asked about the Rs 4000 withdrawal limit at a press conference, said something quite interesting:

He’s right. The queues are shorter when you just want to go deposit old cash. But there are serpentine crazy queues for withdrawals and cash exchanges.

The amount you withdraw has also been capped for the next 50 days since there is a currency shortage. At the time of writing this article, the weekly cap for withdrawal is set at Rs 24,000 a week.

This, I think, is a genius move to stash all that crazy amounts of cash into banks. If you deposit upto Rs 2.5 lakh, there is no penalty. Over and above that, the income tax will pwn you and slap you 200% penalty (only it turns out that the IT officials are saying it’s not legally possible). So, bottom line: a bunch of people are depositing a lot of money, but there are limits set for withdrawals.

The deposits in the banks are swelling, improving their overall financial state. Let me very quickly explain banking in very, very simple terms. #NoobsUnite

Banking, in short

Banking is extremely complicated in the modern world. Banks act as middlemen for making payments, offer locker services, dabble with insurance, deal with foreign exchange, and much more. But its primary function is to accept deposits and give out loans.

So you deposit Rs 1000 in your account in Bobby Bank. Bobby Bank gives out Rs 750 of your Rs 1000 out as a loan to Babu Biryani Centre (BBC). The bank can’t just give out all the Rs 1000 as a loan since it has to keep a certain amount with itself as security. The deposits-to-borrowings ratio (both CRR & SLR) is set by the Reserve Bank of India and decides the bank’s capacity to give out loans. Right now, it’s around 25 percent.

So, to put it simply, 75 percent of the total deposits with the bank can be given out as loans which, in Bobby Bank’s case, comes to Rs 750. The banks charge higher interests on loans than it pays as interests on your savings. This little difference in rates is where it earns profits.

Banks perform the vital function of aggregation in our society. They collect deposits and give it out as loans for expanding businesses, buying cars, making movies, buying properties or funding start-ups. If there were no banks, there would be no money to go after big projects. But then, since humans are the ones giving out these loans through banks, they tend to make mistakes.

Deliberate or otherwise.

When Bobby Bank gives out Rs 750 to BBC to, say, open up a new branch, it’s taking a huge risk. What if BBC doesn’t pay that loan back? So they keep some security in the form of valuables, land, property etc, so that if BBC can’t pay back, they can sell the security and recover the money.

Let’s suppose crooked BBC does not pay the loan instalments. Their loan becomes a Non-Performing Asset (NPA) and the bank will start its recovery process. But at that point of time, the bank will register a loss because the interest it was supposed to get from BBC is not coming in. At the same time, it has to pay you an interest on your Rs 1000 deposit.

So… Bobby bank is screwed only.

Now if you have assimilated all that, let me tell you what has been happening in the Indian banking system.

As of March 2016, 9.32 percent of ALL the loans given out by Public Sector Banks have gone bad. That’s a total amount of Rs 4,76,816 crore.

So… Indian banks are screwed only.

What’s more, the Government, in a Parliamentary question, admitted this and further stated that the total NPAs might go up to 10.10 percent by March 2017.

These diggaj defaulters are mostly people like Vijay Mallya who took a loan, defaulted and then ran away to good ole London. His Kingfisher Airlines borrowed an amount of Rs 7,000 crore from 17 banks. These loans were declared as NPA and the recoverable amount has come to a mere Rs 6 crore. Go figure how much will be recovered from Rs 4.7 lakh crore.

The ‘Demon’ in Demonetisation

At this point of time, the demonetisation efforts seems to be disastrous. People from the informal sector, those who don’t have bank accounts, are suffering and going through a sudden cash crunch. It is all well documented and reported. There is no need to argue over the fact that the implementation is bad and it is being done at the cost of the common man who has cash on hand. On top of that, the Finance Minister has advised everyone to put money into the bank,  but very limited amounts are coming out.

There is a cash withdrawal limit set which, incredibly enough, might be constitutionally invalid and illegal. The RBI Act does not give power to the government to set such limits! However, you are presently allowed to make electronic transactions or through the services of useful organizations such as PayTM. (Cheap Shot: It’s partly Chinese!)

State Bank of India has reportedly parked Rs 38,670 crore of the public money till November 11. In the next 50 days, this amount is going to swell to gigantic proportions. The population has been given an option: either withdraw a limited amount of cash OR use plastic money for all your transactions. It is necessary to point out again that before demonetisation, 98 percent of all transactions were carried out in cash.  

This large amount of deposits will now help the banks cope with the massive losses they had been reporting for the past year. As expected, after demonetisation was announced, bank stocks soared to new 52-week highs.

Will demonetization benefit the economy?
Yes. It will.

If these large deposits increase the capability of banks to give out more loans, it means that a lot of new money will enter the economy. It will give a big boost to businesses to expand and also to the consumer to buy more expensive products against small loans. There is also talk of reducing bank interest rates in the near future. Thanks to the brand new shiny Monetary Policy Committee, there will be minimal resistance too! Consumerism will hit a new high and it would be like giving a shock treatment to the GDP. In the long term, things are about to get crazy good people!

But the big questions still remain unanswered. What of the previous loan defaulters who put our banks in this catatonic state in the first place? Maybe this whole move was done with the very intention of jump starting the loan-giving machinery again. Will we see fresh loans being issued to the SAME people who earlier defaulted and lost massive amounts of public money?

Another random question: The Supreme Court asked the RBI to reveal the names of defaulters over Rs 500 crore. The RBI gave it to the court in a sealed envelope and asked that it be kept confidential. Whatever happened to that?

This might turn out to be the greatest income redistribution exercise in our history. It only remains to be seen whether the money flows upwards to the rich or downwards to the poor. (Oh and don’t even start with the trickle-down effect argument with me. It just doesn’t work.)

So much to ponder upon. There is an urgent need to put into place a system which tells the public how fresh credit will be issued by the banks after this Great Indian Demonetization ends. And also to whom it will be given out. Hey, it’s our money after all! We should know how it is being spent!

I leave you with this excellent video that explains Banking – in a nutshell.