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Categorized | Banks

India’s largest bank demands compensation for cash deluge

Posted on November 29, 2016

India’s largest lender has demanded compensation for the burden of managing a flood of deposits since the government’s shock demonetisation of high-value banknotes.

Almost $100bn has been deposited in Indian banks since November 8, when the government announced that the existing Rs1,000 and Rs500 notes were no longer legal tender, in an attempt to flush out undeclared “black money”.

As Indians flocked to deposit their obsolete notes some analysts thought that banks would respond by lowering lending rates. But the central bank, alarmed by the surge in banking sector liquidity, on Saturday ordered banks to transfer nearly half this amount to its cash reserve facility, which yields no interest.

“We do think that the banks need to be compensated for this loss,” Arundhati Bhattacharya, chairman of State Bank of India, told the Indian television station CNBC-TV18. “We are hoping that this is a temporary measure and that subsequently we will be given something.”

The Reserve Bank of India’s intervention forces banks to transfer to it a sum equivalent to the increase in their deposit base between September 16 and November 11, which amounts to Rs3.2tn ($47bn), according to HSBC.

The move has damped expectations that the demonetisation would prove a boon for the banking sector, with a rush of deposits helping to fund cheaper borrowing costs for businesses and households.

“The implications for the banking system are likely to be significantly negative,” wrote analysts at India Ratings & Research, arguing that the RBI could have soaked up liquidity through other avenues such as open market and reverse repo operations. 

Instead, they wrote, the central bank had saddled lenders with the costs of its intervention, “which will be a drag on the banking system”.

The concern over the impact on the banks comes amid broader concern over the economic impact of demonetisation. A shortage of new banknotes has driven a slowdown in consumer spending that prompted economists to slash their annual growth forecasts.

The benchmark Sensex index fell 7 per cent in the two weeks following Mr Modi’s announcement, though it has since regained some of the lost ground.

Pranjul Bhandari, an economist at HSBC, said that expectations of a sharp fall in lending rates had always been overblown. “There was always doubt about how long this extra liquidity would stay for,” she said, arguing that the banks would have held back due to anticipation of RBI intervention, as well as large-scale customer withdrawals once the new banknotes became readily available.

But any hit to margins is unwelcome for a banking sector where earnings have been badly dented during the past year by a profusion of distressed loans. 

Udit Kariwala, an analyst at India Ratings and Research, estimated that the cost to banks of the RBI’s new measure would be Rs10.5bn per month, adding that the full impact would depend on how long it was kept in place.

The central bank has said it will review the measure by December 9, but it was likely to release the funds only gradually, said Mr Kariwala, arguing that doing so “in one go will create excess liquidity again”.

Despite the discomfort caused by the RBI intervention, he added, the banks would benefit from a lasting boost to their deposit bases triggered by demonetisation. “It is still a structural positive,” he said.