On 8th November 2016, at 8:15 pm, the country was shaken. Prime Minister Narendra Modi’s government made an announcement which shook the entire country and led many in the country stand in long lines the very next day. This was demonetization. The concept of demonetisation means that the country’s currency which was in use was no longer valid and the entire cash currency was to be changed. It is basically the act of taking way the status of a legal tender of the Rupee, the currency of India. It usually takes place through pulling the already distributed cash in the economy and changing it or replacing it with the new money, i.e. in form of notes or coins. Many a time, the country changes the entire currency structure. In India, however, demonetization had impacted the Rs 500 and Rs 1000 notes. Overnight, the existing notes were no longer valid. The printing of Rs 1000 note was discontinued and a new note of Rs 2000 was introduced. In the weeks that followed the announcement, there was havoc in the country. People were standing in long lines in front of banks, ATMs for the exchange of their cash and to withdraw cash. India, primarily being a cash economy, where majority of transactions take place in cash, it was an utter shocker and a chaotic situation. Further, the demonetization was on Rs 500 and 1000 notes which account for 86% of the cash currency running in the market. This led to a liquidity crunch in the short run as many of the banks were unable to exchange cash due to the shortage of money. According to a study conducted by the Reserve Bank of India, the regulator of the economy, there have been 15.30 lakh crore bank notes which have been demonetized.
According to policy makers, the primary reason for this decisions was that it was to tackle black money in the economy. Further, from the very beginning of the 2014 term of PM Modi, he has been envisaging a digital economy with very little cash truncations. Thus, he wanted to fulfil this by eliminating the big value notes in the economy. Further, this was done to ensure effective tackling of the black money. Black Money is often stored in cash in people’s houses and thus, demonetization would help in reduction of corruption in our country. Another reasoning given by the policy makers is that fake currency is increasing becoming a source of funding for illegal and illicit activities. This step would help in tackling these illegal activities and terrorism. Though these, pretty big problems in the country, however, demonization didn’t have much impact on these according to several experts. They are of the opinion that demonetization caused much harm than good. One such was the banking sector which is elucidated in the present article.
Banking may be defined as the commercial activity of accepting and safeguarding money owned by other individuals and entities, so lending out this money so as to earn a profit. However, with the passage of your time, the activities covered by banking business have widened and now various other services also are offered by banks. The banking services nowadays include issuance of debit and credit cards, providing safe custody of valuable items, lockers, ATM services and online transfer of funds across the country. Banking plays a very important role in our everyday lives. They act as financial intermediators who help in providing funds to the creditors and absorbing any risk entailing in the loans and keep the country’s engine going. Banks form the core a part of any economy. They channelize the money for the functioning of various sectors. They are at sources of exchanges of currencies. In such circumstances when they act as post of exchange of currencies, a move like demonetization can have a disastrous impact on ill prepared bans. In fact this is what had happened in the after math of the announcement of demonetization.
An overall analysis of the move of demonetization, after four years shows that the banking sector faced the following.
Increase of deposits:
The banned notes of Rs 500 and Rs 1000 accounted for 86% of the currency circulated in the market. This meant the individuals had to submit their money and in exchange get the money bank. As the individuals who had the money where so many, there was an increase in the deposits in the banks. There was a sudden increase in the bank cash liquidity ratio and the size of public deposits had significantly increased.
Shortage of liquid cash:
Liquid cash implies the currency notes or coins in the hands of the consumers. After the demonization, the people of the country were squabbling over the lack of cash in their hands. Or even if they had the cash they were unable to use it as it had become illegal. People stood out in lines over hours in front of banks and ATMs to get their money exchanged. In fact this led to widespread protests in the country. A few deaths were also reported in the country due to exhaustion and heat. This had a huge impact on the economy with the stock markets plummeting and big business corporations losing thousands. In addition, several economic problems were created by this movie. It disrupted the entire supply and demand chain which is largely a cash based chain. The prices of essential commodities increased and petrol and diesel prices were also impacted. In fact, according to many studies, the worst hit were the small time traders who though didn’t have a bank account and now their entire livelihood was threatened.
Demand for government bonds
People increasingly started investing in government securities and government bonds as the stock markets were in pretty bad conditions and the government bonds acted as safe havens for the investors. Many public sector banks used this opportunity to use the excess cash in their banks to use as government bonds. This would eventually result in huge turnover for the banks. It will result in a likely 20-25% increase in the earnings and revenue of the banks.
Decrease in interest rates:
There was a surplus of cash reserves at the banks. This meant that the rates set by the RBI, including the CLR and CRR were fulfliied and additional money was left. Thus many banks stated giving out loans at a lower interest rate. This, this move resulted in many private and public sector banks significantly increasing their loans capacities. In fact, according to one such study, it had almost increased by 20%.
Increase use of bank accounts:
Demonetization though had a number of pitfalls, however, it steadily increased in people having a bank account. This move was coupled with the initiatives by the government to engage in people having a bank account. This led many poor families and individuals below the poverty line to open zero bank account, which would help them being connected with government initiatives and providing an avenue for storage of money.
UPI and advent of online banking
With a crunch of cash in the economy many people turned to digital payments and plastic money. The online banking platform increased significantly. In fact, people used platforms such as Paytm and PhonePay more than they were first launched. In cities, there was a 42% in the use of credit and debit cards by the consumers in the markets. This thus helped people to engage in digital interface which traditionally do not. There was a steady increase in digital payment and tools.
Crippling of rural banking:
The worst affected banks were in fact the rural banking sector. Rural lending is mainly catered by public sector banks. There was a severe falling of credit growth in these banks especially in rural areas predominated by agriculture. There was a fall by 6.1% in the economic year of 2017.
Losses suffered by banks:
The provisions of demonetization was not all rosy. It created significant problem in the banks and banking sector in general.
i) There was loss of bank revenue in the form of no charge towards the ATMs. It made the banks almost to lose Rs 100 per day.
ii) There were many other discounts and offers provided by the banks to ease the pain of the consumers. One such as the merchant discount rate on credit and debit cards. It resulted in a huge loss to the bank revenue with 1% in every transaction.
iii) The banks didn’t have an interest on the surplus deposits. There was an increase in Rs 3 Lakh Crore in the form of cash reverse in the banks. However, there was no interests on such amount for almost one month.
iv) Increase in logistics expenses such as transportation vans. They were significant used during this period and to move such huge amounts of cash to the Reserve Bank of India, was a problem of its own.
v) There was a sudden drop in consumers willing to spend on high value items such as cars and houses. This resulted in losses to banks.
Reduction in MSME businesses:
The most impacted sector was the MSME. There was a decline in small and medium enterprises and thus loss was caused to them. This resulted in them missing on the instalments of the banks and thus it caused a crunch in the economy. According to a study there was decrease of about 60% in the business of such companies. Thus, it adversely increased the Non-performing assets of the country.
Strain on employees:
Bank employees were kept under stress and they were working overtime for almost two months after the announcement of demonetization. Due the immense pressure, it resulted in a number of problems in lives of bank employees. With witnessing a flurry of customers every day, it was a difficult task.
The concept of demonetisation means that the country’s currency which was in use was no longer valid and the entire cash currency was to be changed. In India, which is primarily a cash based economy, people have faced immense inconvenience because of demonetization.It caused a number of problems in the economy. However, they have been a pros such as increase in the use of plastic cards, online banking etc. however with the increases cons, it seems that it was a very bad policy decision on the part of the government.
“The views of the authors are personal“
Frequently Asked Questions
What is demonetisation?
The concept of demonetisation means that the country’s currency which was in use was no longer valid and the entire cash currency was to be changed. It is basically the act of taking way the status of a legal tender of the Rupee, the currency of India. It usually takes place through pulling the already distributed cash in the economy and changing it or replacing it with the new money, i.e. in form of notes or coins. Many a time, the country changes the entire currency structure.
Why did Indian Policy makers decide on demonetization?
According to policy makers, the primary reason for this decision was that it was to tackle black money in the economy. Black Money is often stored in cash in people’s houses and thus, demonetization would help in reduction of corruption in our country. Another reasoning given by the policy makers is that fake currency is increasing becoming a source of funding for illegal and illicit activities. This step would help in tackling these illegal activities and terrorism.
How did demonetization occur in India?
In India, demonetization had impacted the Rs 500 and Rs 1000 notes. Overnight, the existing notes of Rs 500 and Rs 1000 were no longer valid. The printing of Rs 1000 note was discontinued and a new note of Rs 2000 was introduced. Further, a new Rs 500 currency note was introduced.
What was the impact on banking sector?
Banks are chief institutions affected by demonetization. Though it affected bank operations, it helped the economy to find growth of the country through financial institutions. It has caused problems to bank employees as their job increased significantly. Demonetization, however has also introduced a slew of positive aspects such as increase in the use of plastic cards, online Banking etc.