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which was in use was no longer valid and the entire cash currency was to be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 Overnight, the existing notes were no longer valid.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.

Conclusion:

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.