Ever since the Centre announced its demonetisation move a fortnight back, banks are getting flush with cash. Over Rs6 lakh crore of defunct Rs500 and Rs1,000 series currency notes has been deposited in banks and going by the current trend, the pace will sustain till December 30.
As the current surge in deposits continues, banks are expected to pare their lending rates without waiting for the RBI to cut rates in December. While the size of the deposits of invalid currency notes with banks has been so humongous, withdrawals have been far less significant — they work out to less than quarter of the total deposits.
Now that there is so much liquidity with banks, will they lower their lending rates? The answer is not a clear ‘yes’ yet. Banks will have to wait for a while before they wield the scissors. Banks may want to see the stickiness of these deposits.
Given the strict curbs put on deposits and withdrawals, many people may be depositing their money into banks, but the duration of these deposits remains uncertain. Banks fear people may pull out deposits once the dust settles, and that will result in a run on the banking system.
If most people withdraw their deposits, that would mean a sudden exit of a substantial chunk of money from the banking system. In that case the deposits base of banks will be back to square one.
This is, therefore, a valid reason for banks to hold on to their rates for the time being. On the contrary, if the inrush of deposits sustains over a period of time, banks are likely to cut their lending rates to goad people to opt for retail loans.
Having said that, experts believe the additional liquidity build-up in banks may not dry up soon. People may not want to pull out all their funds in a hurry. They are expected to wait for a medium to long-term tenure before they decide on what to do with their funds.
No matter what the Prime Minster may say, there is yet no clarity on the next course of action against black money in the country. Most people are still wary and they weigh their options. In the current scenario, banks are not left with too many options.
Going forward, deposits are likely to swell while consumption may take a backseat. The deposit bulge may push banks to cut lending rates which will be regardless of whether the RBI brings down the repo rate in its next monetary review in December.
The bump in the cash situation has spun off a major problem for banks that will be hard-pressed to find ways and means to park these funds. In case there is a sluggish offtake, banks are likely to park these funds in reverse repo (depositing it with RBI) or they will buy treasury bills.
These may not be the best options in terms of profitability, but they do not have much of a choice except for lowering interest rates to allure investors to take loans.
The inflow of deposits has already resulted in a cut in deposit rates and money market rates. As demonetisation is deflationary in nature, a rate cut is in the offing. If the additional liquidity is deposited with RBI, the latter might want to make the reverse repo (the interest that RBI pays banks on their deposits) cheaper.
As the situations stand now, RBI may want to cut both repo and reverse repo rates in the coming monetary review meeting. Until then, there will be no clarity on the issue. Banks are flush with liquidity but they cannot make lending cheaper.
The central bank may be favourable towards a rate cut, but the cash glut may force it to hold its hand for some more time. It is a dog in the manger situation.
