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All Bank Deposits Post Notebandi Have Been Invested in Govt Securities

Feb 16, 2017

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One of the many theories offered in favour of demonetisation or notebandi, has been that it has led to lower interest rates. The demonetised notes of Rs 500 and Rs 1,000 had to be deposited into the banks, where the money would be credited against the depositors' name.

This has essentially led to the total amount of deposits with banks increasing at a rapid rate. Between October 28, 2016, before the demonetisation happened, and January 20, 2017, the total deposits of banks went up by 5.7 per cent. This increase in a period of under three months is huge.

With an increase in deposits, banks have cut interest rates. The logic offered by many experts was that this cut in interest rates will lead to an increase in lending by banks and that would be good for the economy. But the data suggests that anything like that hasn't happened.

Take a look at Figure 1. It essentially shows the portion of bank deposits that have been invested in government securities, in the recent past.

Figure 1:

What does Figure 1 tell us? As on October 28, 2016, before demonetisation was carried out, around 29 per cent of bank deposits had been invested in government securities. As on January 20, 2017, the latest data that is available, the proportion had jumped to 34.1 per cent. Banks need to compulsorily invest just 20.5 per cent of their deposits in government securities.

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Further, between October 28, 2016, and January 20, 2017, the total amount of money banks got as deposits stands at Rs 5.63 lakh crore. During the same period, the total amount of money banks invested in government securities was Rs 6.99 lakh crore. This basically means that during the period under consideration 124 per cent of the money that came in as bank deposits was invested into government securities. Hence, not only all the deposits that came in between October 28, 2016, and January 20, 2017, have been invested by banks into government securities, some of the earlier deposits have also been invested into government securities.

Given that cash is fungible, this basically means that on the whole banks haven't loaned out any of the deposits that have come after demonetisation. All that money has been invested into government securities.

Now let's take a look at Figure 2. This essentially plots the portion of bank deposits which have been given out as loans (i.e. non-food credit). Banks give working-capital loans to the Food Corporation of India to carry out its operations, those have been adjusted for.

Figure 2:

What does Figure 2 tell us? It tells us that before demonetisation banks had loaned out 73.3 per cent of the deposits. This has since fallen to 69.7 per cent. This isn't surprising given that banks cannot immediately lend out all the money that has come in.

There is another question that needs to be answered here. Given that interest rates have fallen because of demonetisation, how much has bank lending gone up by, before and after demonetisation? Between October 28, 2016, and January 20, 2017, lending by banks went up by a minuscule 0.45 per cent. This basically means that the lending has more or less been flat.

Also, given that all the deposits that have come in since October 28, 2016, have been invested in government securities, this essentially means that some of the deposits that had come in earlier, have been lent out.

This, also tells us, all over again, that lower interest rates are not the only factor that leads to increased borrowing. Hence, the theory of lower interest rates leading to increased borrowing leading to better economic well-being, due to monetisation, does not really work. The data does not show that at all.

There is another point that needs to be made here. A significant amount of investments made by banks in government securities has been made under the market stabilisation scheme(MSS). The government securities issued under the market stabilisation scheme has all the characteristics of regular government securities. But, unlike the regular government securities, these securities are not issued to finance the fiscal deficit of the government. Fiscal deficit is the difference between what a government earns and what it spends and is financed by issuing financial securities referred to as government securities.

What this basically means is that money borrowed under the market stabilisation scheme lies idle. It isn't used to finance the expenditure of the government. On December 2, 2016, the RBI increased the ceiling of the government securities that could be issued under the market stabilisation scheme to Rs 6 lakh crore. Earlier the limit was Rs 30,000 crore.

As the RBI pointed out in a press release: "After the withdrawal of the legal tender character of the Rs 500 and Rs 1000 denomination notes with effect from November 9, 2016, there has been a surge in the deposits with the banks. Consequently, there has been a significant increase of liquidity in the banking system which is expected to continue for some time."

The government securities issued under the market stabilisation scheme sucked out this liquidity. But this money has been lying idle with the RBI. Earlier it was a part of the financial system and was helping people carry out transactions. This has reduced the velocity of money. And a lower velocity of money leads to lower economic activity.

Over and above this, the surfeit of deposits coming in has led to banks slashing the interest rates on their fixed deposits. Take a look at Figure 3.

Figure 3: Repo, Base Lending Rate and Term Deposit Rate (Per cent)

Let's analyse Figure 3 in some detail. The base rate is essentially the interest rate below which a bank cannot lend i.e. the interest rate at which a bank lends to its best customer. The term deposit rate is essentially the interest rate that a bank pays on its fixed deposits.

Since January 2014, the term deposit rate of banks has fallen. At the same time, the base rate has also fallen. Nevertheless, the term deposit rates have fallen much more and at a far greater speed than the base rates.

This is something that becomes clear by looking at Figure 3 carefully. The gap between the average base rate and the average term deposit rates has increased considerably between January 2014 and December 2016. The base rate has barely moved from 10 per cent to around 9.5 per cent. On the other hand, the term deposit rate has moved from around 8.5 per cent and is now below 7 per cent.

As the Economic Survey points out: "By December 2016 the gap between the average term deposit rate and the average base rate had grown to 2.7 percentage points, from 1.6 percentage points in January 2015."

The question is why have the banks done this? Over the longer term, the banks have been trying to make up for their bad loans by doing this. As the Economic Survey points out: "They have tried to compensate for the lack of earnings from the non-performing part of their portfolio by widening their interest margins."

Over the short term, they are simply doing this because of the surfeit of deposits that have come in. They have invested this money in government securities (a large part), which do not pay a high rate of return like lending that money out would. To compensate for this, the banks have cut interest rates on their fixed deposits faster than the interest rates on their loans.

Hence, notebandi or demonetisation has led to lower interest rates on fixed deposits. A major part of the household financial savings in India are held in the form of bank fixed deposits. Anyone looking to meet an investment goal now must save a greater amount and this will leave a lower amount of money for consumption.

Further, lower interest rates haven't led to a higher lending by banks. All this has led to is money lying idle with the RBI. And that is something that India cannot afford.

Vivek Kaul is the Editor of the Diary and The Vivek Kaul Letter. Vivek is a writer who has worked at senior positions with the Daily News and Analysis (DNA) and The Economic Times, in the past. He is the author of the Easy Money trilogy. The latest book in the trilogy Easy Money: The Greatest Ponzi Scheme Ever and How It Is Set to Destroy the Global Financial System was published in March 2015. The books were bestsellers on Amazon. His writing has also appeared in The Times of India, The Hindu, The Hindu Business Line, Business World, Business Today, India Today, Business Standard, Forbes India, Deccan Chronicle, The Asian Age, Mutual Fund Insight, Wealth Insight, Swarajya, Bangalore Mirror among others.

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12 Responses to "All Bank Deposits Post Notebandi Have Been Invested in Govt Securities"

suneel khandekar

Feb 17, 2017

excellent data mining by vivek kaul ; I am so fortunate I subscribed to his dairy and could get so many insights in the overall systems , best form of news writing ever seen

Like 

Ambi Subramanian

Feb 16, 2017

An eye opener with facts and figures.

Like 

Nagabhushan Vishwanath

Feb 16, 2017

The Lending / Base rate to customer has not dropped as the deposit rate. Banks are charging good customers more for their lack of due diligence while sanctioning loans and consequently recovery of Bad Debts. Vijay Mallya is an example and this is now being recovered from customers who are prompt with repayment.
Is this fair ? Can RBI not influence State Banks to reduce the Rate and not burden good customers ?

I am sure most of the customers are suffering because of few cruel elements who took advantage of the bank's loop holes while sanctioning.

Like (1)

C S JACOB

Feb 16, 2017

The points made by the author are valid. For easier understanding one would go by the bare data instead of expressing them in percentage change. Prior to demonitisation, the total money stock M3, for the fortnight ended 28-10-2016, was Rs 124 trillion (lakh crore). This comprised of Rs 107 tn in bank deposits and Rs 17 tn as currency with public. The corresponding figures as on 20-1-2016 were Rs 122 tn, Rs 113 tn and Rs 9 tn respectively. Thus, the increase in the bank deposits of Rs 6 tn, which the RBI claims, has come about due to the restrictions placed on withdrawals. This cannot be considered due to an increase in saving. If the banks indulges in increased lending, as more notes were inducted into circulation and people withdraw more and more of their own money, the banks will have to find funds to honour the demand from the depositors. So the excess liquidity in the bank is nothing but a propaganda to show that the demonitisation has resulted in increased lendable funds. The real position would be known hopefully, by June 2017 when all the invalidated notes worth Rs 15 tn were replaced by new notes. Till such time the banks cannot commit that fund for lending.

Like (1)

a k saraf

Feb 16, 2017

It seems the blame for fall in term deposit rates have been put on Demonetization.
You have yourself said the interest rates have been falling since 2014. If you look into detail, how much reduction before demonstration and how much after demonetization, the facts will be clear..

Like (1)

S ramji

Feb 16, 2017

RBI had increased CRR to 100% for deposits during a particular period, what is the position of this provision now. Are banks allowed to take out deposits from CRR as and when customers withdraw cash from their account. What has been the withdrawal from these deposits in Jan/Feb 2017, where can we get this data.

Who will bear the Interest cost of MARKET STABILISATION , RBI or will it finally land on the common man. What is the rate of interest offered on market stabilisation and what will be the outgo this financial year. Does the budget provide for this interest.

Like (1)

Seshadri kannan

Feb 16, 2017

I have been reading your message, and I do not understand what all is driving at, especially this today's one. What it means for a common man? What it tells about Demonetisation? To me all appears only as of academic interest. You started on the subject of Demonetisation. And after February middle, how much it has helped or damaged the economy of a common man? Prices, real estate, including rolling of black money, appear to continue, as a layman I see. The tension, problems of smaller denomination etc. is it continuing or people finally forgott these? Modi knows as all the politicians, public memory is short. He made big promises. Where are those today?if this ignorance continues, it will only encourad the government to play more havoc and the govt rides on the back of a safe horse.

Like (1)

Ruchir Shah

Feb 16, 2017

Vivek, doesn't it take time to do lending; as in there should be credit worthy customers to whom funds can be lent. Just because Banks have got deposits, does it mean they start lending from day 1, at the cost of credit quality. And as a corollary the funds are bound to get parked in G-Sec, there is no harm in that (as it will generate some return). On the Figure 2, where the proportion of bank deposits to loan have been analysed, whereby as per your analysis deposits have gone up but loans haven't, doesn't it also mean that recoveries have been better and people have paid loans in demonetized currency? Most of the Banks are reporting better credit quality numbers and lower slippage in this quarter. Your analysis on Figure 3 is also loop sided. Historically, in a falling rate scenario deposit rates will fall faster then lending rates and in a rising rate scenario loans will get repriced faster then deposits. That's precisely how Banks keep up with NIMs. Let me know your thoughts on this...

Like (1)

Ravi Katari

Feb 16, 2017

Dear Vivek,
as always your analyses are illuminating. And often alarming. Why do I get the feeling that our lives are now ruled by an increasingly authoritarian Govt ? It has been one thing after another since Nov 8th, and to now learn that the NPAs of banks are being set off by giving the average citizen a bad deal sounds almost criminal.
The astonishing thing is that everybody has bought into the PMs assurance that 'this is a good thing and will hit the filthy rich', and is a tribute to his control over the masses of our country.
What it also implies is that lending to businesses is not taking off, so what price our 7pct growth rate ?
Rgds
Ravi Katari

Like (1)

V Bhandari

Feb 16, 2017

Economists, bankers & governments have been bluffing the world that lowering interest rates leads to more investments or economic activity. People and businesses have to borrow money when they need it at the least possible cost. They can never wait for interest rates to fall. This whole rigmarole of reducing interest paid to savings of people to benefit industrialists and the economy is the biggest Ponzi scheme in the world. If you are truthful stop promoting it.

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