GROUP 9 ICAI ITT

EFFECTS OF
DEMONETIZATION ON
BANKS
GROUP NUMBER: 9
 EFFECTS OF DEMONETIZATION ON BANKS

INDEX
Contents
❖ Concept of Demonetisation ....................................................................................................... 2
❖ History of Demonetisation in India ........................................................................................ 2
❖ OBJECTIVES OF DEMONETIZATION: ...................................................................................... 4
❖ DEMONETIZATION IN INDIA: ....................................................................................................... 4
❖ PROCEDURE FOR EXCHANGE OLD NOTES: ...................................................................... 5
❖ Demonetisation: The good, the bad, and the ugly ......................................................... 5
▪ The Good ............................................................................................................................................... 5
▪ The Bad .................................................................................................................................................. 6
▪ The Ugly ................................................................................................................................................ 6
❖ Pros & cons of Demonetization ............................................................................................... 8
There is no other decision that affected 1 billion people from rich to poor alike since independence like the
present demonetisation. Surely there will be pros and cons with this decision. ............................................... 8
❖ DEMONETISATION AND BANK OPERATIONS .................................................................. 10
1. Demonetization and Currency Demand ............................................................................................... 11
2. Demonetization and Bank Deposit Growth ......................................................................................... 12
3. Demonetization and Monetary Transmission ..................................................................................... 12
4. Demonetization and Financialization of Savings ................................................................................. 13
(a) Mutual Funds ................................................................................................................................ 13
(b) Life Insurance Companies .......................................................................................................... 14
(c) Non-Banking Financial Companies (NBFCs) ........................................................................... 14
5. Demonetization and Digitization of Payments .................................................................................. 15
6. Demonetisation and Detection of Fake Indian Currency Notes (FICNs) ....................................... 15
7. Impact of Demonetization on Balance Sheet of Banks ..................................................................... 16
8. Impact of Demonetization on Profitability of Banks ........................................................................ 16
❖ Results of Post Demonetization on Bank Operations ............................................ 18
❖ Conclusion......................................................................................................................................... 20
Bibliography ....................................................................................................................................................... 21

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❖ Concept of Demonetisation

D
emonetisation can be termed as the act of putting end to the current currency notes in the
market of the nation and exchanging it with the newly designed currency.
Demonetisation is mainly done by the government to put a full stop on corruption. It is
not only concerned with currency but also include precious metals in it. The word Demonetisation is
derived from a French language “demonetiser” back to 1850-55. The main aim behind
Demonetisation is to put an end to corruption, to end counterfeit Currency and to give a rest to the
cash system. Growing economies like India, has to look for the solutions of the prevailing issues like
this, in order to foster development. In the year 1982, Ghana, an African country, decided to
demonetize their 50-cedi currency, the decision resulted into chaos as the decision was not perfectly
implemented. Nations like Myanmar. North Korea and Zimbabwe has also taken up the decisions of
Demonetisation.
Demonetisation is referred to as the process of stripping a currency unit of its status to be used as a
legal tender. In simple words, demonetisation is the process by which the demonetised notes cease to
be accepted as legal currency for any kind of transaction.
After demonetisation is done, the old currency is replaced by a new currency, which may be of the
same denomination or may be of a higher denomination.
The impact of changing the legal tender status of a currency unit has a huge impact on the economic
transactions that take place in an economy.
Demonetisation can cause unrest in an economy or it can help in stabilizing the economy from
existing problems. Demonetisation is usually taken by a country for various reasons.

❖ History of Demonetisation in India

Demonetisation in India
Demonetisation in India has taken place three times till now, namely in the years of 1946, 1978 and
2016. Let us have a look at all the three events.
Demonetisation 1946

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The first demonetisation event happened in 1946, at that time the denominations of Rs.1000 and
Rs.10000 were removed from circulation.
There was a visibly low impact of the demonetisation as the higher denomination currencies were
not available to the common people.
In 1954, these notes were again introduced with an additional denomination of 5000.
Demonetisation in 1978
The second demonetisation in India took place in 1978, at that time the Prime Minister was Morarji
Desai. During the second demonetisation the denominations of 1000, 5000 and 10000 were taken out
of circulation.
The whole purpose of demonetisation was to reduce the circulation of black money in the country.
The announcement was made by Morarji Desai over the radio.
Demonetisation in 2016
The latest demonetisation was announced on 8th of November, 2016 by the Prime Minister Narendra
Modi.
During this demonetisation the notes that were taken out of circulation were the denominations of
500 and 1000.
PM Modi also introduced new currency of denominations 500 and 2000 after demonetisation.

the Indian economy. A new design was given

to these notes and was reintroduced in the year
1954. It had note created much public
inconvenience. The second ban was
announced on January 6th in the year of 1978
by Mr. R Janaki A senior officer of the RBI.
As per his orders notes of 10000, 5000 and
1000 were taken out of the market. A three-
day period was given to people, for getting
The first-time currency ban was declared on their currency exchanged and around 73.1
January 12, 1946 by the reserve bank, crores were demonetized. The third and the
removing the notes of 1000 and 10000 from most recent ban was announced by BJP

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government led by Mr. Narendra Modi on pumps, accepted the notes till November
November 8, 2016 the notes of 500 and 1000 11,2016 as per the government orders.
were taken out of the market for the purpose
of Demonetisation. Hospitals, airports, petrol

❖ OBJECTIVES OF DEMONETIZATION:

A
ccording to RBI, the most important reasons for the demonetization of 500 and 1000
rupee was the rise of fake currencies of same notes, and also the higher occurrence of
black money. The main objectives are:
1) To tackle black money in the economy.
2) To lower the cash circulation in the country which is directly related to corruption in our country.
3) To eliminate fake currency and dodgy (unreliable or dishonest) funds which have been used by
terror groups to find terrorism in India.
4) To analyse the impact of demonetization on the financial statements (balance sheet) of Scheduled
commercial banks in India.
5) To study the deposits trend under Pradhan Mantri Jan Dhan Yojna accounts.
6) To study the positive and negative outcomes of demonetization on banking operations.
7) To assess the impact of demonetization on the liquidity position of Scheduled commercial banks.
8) To evaluate the impact of demonetization on currency in circulation and GDP ratio.

❖ DEMONETIZATION IN INDIA:

1) BEFORE NOVEMBER 2016

This act is not happening first time in India, but it has happened twice, first in the year of 1946 and
then in the year of 1978. In January, 1946 Rs.1000 and Rs. 10000 bank notes were withdrawn and in
the year 1978 Rs.1000, Rs. 500 and Rs. 10000 notes were withdrawn on 16th January by the janata
party government.
2) IN NOVEMBER 2016
On Tuesday, 8th November Prime Minister of India Narender Modi announced the demonetization
of Rs. 500 and Rs. 1000 notes with effect from midnight, making these notes invalid.

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But, it has been taken care by government that the public that a person who changed his higher value
cash will get exactly the lower denominations
❖ PROCEDURE FOR EXCHANGE OLD NOTES:

The RBI laid down a detailed procedure for the exchange of the denominated bank notes with new
Rs. 500 and Rs. 2000 bank notes of the Mahatma Gandhi new series and Rs. 100 bank notes of the
preceding Mahatma Gandhi series. Citizens will have until 30 DECEMBER 2016 to tender their old
banknotes at any office of the RBI or any bank branch and credit the value into their respective bank
accounts. Cash withdrawals from bank accounts will be restricted to Rs. 10000 per day and Rs.
20000 per week from 9th November 2016 to 24th November 2016.
For immediate cash needs the old bank notes of value upto Rs. 4000 per person can be exchanged for
the new Rs. 500 and Rs. 2000 bank notes as well as Rs. 100 bank notes over the counter of bank
branches from 10th November 2016 by filling up a restriction from along with a valid ID proof. Cash
withdrawals from ATMs will be restricted to Rs. 2000 per day per card up to 18th November 2016
and the limits will be raised to Rs. 4000 per day per card from 19th November 2016.

❖ Demonetisation: The good, the bad, and the ugly

▪ The Good

T
he year 2016 has overall been “a good year” for India, listing the highlights:
The GDP growth rate has held up at more than 7%. Foreign direct investment went up
significantly during the year. (It rose 30% on a year-on-year basis to $21.6 billion between
April and September 2016, according to public data published by the India Brand Equity Foundation,
a government sponsored trust.)
Initiatives such as the “Make in India” program “have borne early fruits.” Many MNCs including
Panasonic and Pepsi set up manufacturing facilities in India during the year.
“The start-up world has seen a drop-in investment activity, but It is that, as a return to sanity rather
than a worrisome contraction.”

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▪ The Bad

T
he claimed objective of the exercise has apparently changed from rooting out black money
to promoting cashless transactions. Several measures have been introduced, among them a
0.75% discount on digital payments made for buying petrol and diesel and a 0.5% cut in
the price of railway season tickets bought using digital technology.
In another twist, the government appears to be no longer pushing Demonetisation as a “cashless”
plan. It has now become a “less-cash” strategy.
In India, Bloomberg data shows the share of cash in the volume of consumer transactions is 98%
(against 55% in the U.S. and 48% in the U.K.). It is 90% in China and 86% in Japan. Much of the
cash transactions are in rural India. So, expectedly, life came to a near standstill and much misery
ensued when people found themselves unable to use their own money. Even when the money was in
a bank account, limits on ATM withdrawals compounded the problem further.
But India is also a country where finding novel, workable solution to problems – commonly known
as jugaad — is par for the course.
By December 31, the visible impact was a Parliament at near paralysis as politicians took pot shots at
each other, a plethora of banking riches coming back into “he system (some 90% of the Rs500 and
Rs1,000 notes were returned), and a host of new scams to convert black money into white with the
connivance of bankers and politicians.

▪ The Ugly

T
he term demonetisation has become a household name since the government pulled the old
Rs 500 and Rs. 1,000 notes out of circulation. While as per dictionary demonetisation
means "ending something (e.g. gold or silver) that is no longer the legal tender of a
country. Since our economy is heavily dependent on cash, as only less than half the population uses
banking system for monetary transactions, demonetisation has hit trade and consumption hard. With
people scrambling for cash to pay for goods and services, the move is likely to take a big toll on the

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country's growth and output during the current fiscal. Consumption makes up for around 56% of
India's GDP, hence, a drop in spending will pull down growth. The current step could also lead to
behavioural changes in households' savings and their consumption pattern, say economists. Nobody
is denying a short-term setback. The Reserve Bank of India (RBI) has reduced the GDP growth rate
forecast for 2016-17 from 7.6% to 7.1%, the Asian Development Bank from 7.4% to 7%, Fitch from
7.4% to 6.9% and Bank of America-Merrill Lynch from 7.7% to 7.4% (for calendar 2016). All
believe, however, that growth will recover the next year. It’s work-in-progress. Three events
dominated India’s economic landscape last year, but whether they can be described as “progress” is
debatable. “The timing is not right for implementation,” says West Bengal finance minister Amit
Mitra, who is also chairman of the empowered committee of state finance ministers. He lays the
blame squarely on the centre’s move to demonetize Rs500 and Rs1,000 notes. “According to
Wharton emeritus professor of management Jitendra Singh, while it is too early to assess the impact
of Demonetisation, the move raises long-term questions. “What will have been gained from this step,
and at what cost and mostly borne by whom?” Demonetisation represents much more than
destabilization; critics argue that it has struck a body blow on economic activity in India. The
decision – which was entirely unsuspected – was announced on 8 November 2016. While the pros
and cons of the measure still continue to be debated, the consensus of opinion appears to be that
while the proponents of Demonetisation may have had good intentions, the suffering it has caused to
millions of Indians is unwarranted. Since Rs500 and Rs1000 notes make up some 86% of the total
currency in circulation in India, especially in the vast rural areas, one economist compared the pain
to what individuals might experience if 86% of their blood was removed from their bodies. To be
sure, Demonetisation has its supporters. While industrialists and corporate chiefs (Ratan Tata,
Mukesh Ambani, K.V. Kamath and Deepak Parekh, to mention a few) favour the move, economists
(including Nobel laureates Amaryta Sen and Paul Krugman, among others) are critical. “The clan of
economists has spoiled the party [with] their estimates of how output will be affected as spending has
stopped, manufacturing hit and several workers laid off. The net result can be a fall of between 0.5%
and 2% in GDP,” “The debate still goes on.” According to Singh, Modi took “a bold, even visionary,
step” with Demonetisation in attempting to combat the black economy and counterfeiting, and
cutting financial support to terrorism. “What was always key, however, was how well the
implementation process would unfold,” he notes. “Even supporters of the decision would say that
the implementation was far from perfect.”

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❖ Pros & cons of Demonetization

There is no other decision that affected 1 billion people from rich to poor alike since independence
like the present demonetisation. Surely there will be pros and cons with this decision.

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Pros
• The decision taken by PM Modi is to know how much black money is there with people. RBI
will have data about how much currency it printed and released into market. Now with
demonetisation move the money with people will come to the banks in the form of deposits. So
the
• The Government will now have an approximate figure about black money. Now it will fill up
that black money with new currency to ensure that all that money which is in circulation is
white. Now the Government can track the movement of money. Any suspicious transaction can
easily be track down. So, zero black money.
• No more black money means all legal transactions. From now Government can easily find out
who is holding black money. Banks will galore with deposits so liquidity is easily available at
lowest interest. Lowest interest means more investments and more employment. More business
means more income thru taxes so no cash crunch for welfare schemes. Use of digital economy
Increase in tax payment These are the PROS the Government is talking about.

Cons
• But there is danger lie also in this. No easy money for people. When 100% white money is
there people won't go spending spree. So, markets will be dull.
• When markets are dull business is also dull So low turnover means low taxable income.
• So far, many companies started new businesses or expanded their business by diverting their
black money into new ventures. From now they can't do that some employment opportunities
are lost.
• Deposit rates may be reduced. This will affect people getting deposited income. Huge cash
deposits in banks will become burden unless they don't divert them into market in form of
loans. An estimated 5–10 lakhs crores deposits will be available with Banks for companies and
Business entrepreneurs to utilise for their business purposes. The companies which are already
availed loans from banks and the companies which have no any new plans to expand their
business will not take loans.
• There is no such large-scale business environment for start-ups in India. So, employment
generation will be difficult and it may lead to collapse of the economy.
• Hackers focusing India.
• Banks being dysfunctional.

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❖ DEMONETISATION AND BANK OPERATIONS

Demonetisation has brought a plethora of challenges in addition to the challenges which are already
facing by Banks. The influences were short-term and long-term views. In the short-term, it disrupted
the banks and stressed strongly to carry out bank operations and in the long run it helped the banks to
pool the deposits without incurring any cost.
Demonetisation led to several changes for the financial sector which can be summarised below-

(a) Shift in currency demand: There has been a significant shift in the income
elasticity of currency demand in the post-demonetisation period to 0.9 from more than 1 in
the pre-demonetisation period, reflecting a reduction in cash intensity in retail transactions.

(b) Significant growth in bank deposits: The ‘excess’ low-cost bank deposit growth, a
mirror image of the decline in currency in circulation (CIC), following demonetisation
has been estimated in the range of 3.0-4.7 percentage points.

(c) Greater financial inclusion: Since demonetisation, 50 million new accounts were
opened under Pradhan Mantri Jan Dhan Yojana (PMJDY) by October 2017.

(d) Detection of suspicious transactions: The amount of unusual cash deposits in

special types of accounts (such as the Basic Saving Bank Deposit, PMJDY, Kisan
Credit Card (KCC), loan accounts and the like) is estimated in the range of `1.6-1.7
trillion.

(e) Improved monetary transmission: In an environment of a surge in low-cost current

account and saving account (CASA) deposits, banks announced a large cut in their
marginal cost of funds-based lending rates (MCLR) with a 100 basis points (bps)
reduction in the 1-year MCLR.

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(f) Increase in mutual fund investments by households: A sizeable expansion in the

collections of debt/income-oriented mutual funds occurred after demonetisation i.e.,
during November 2016 to March 2017. The assets under management (AUM) by
mutual funds increased from about `16 trillion to `21 trillion between end-October
2016 and end-October 2017.

(g) Higher collections under life insurance schemes: The cumulative insurance
premium collections during November 2016 to January 2017 increased by 46 per cent
over the same period of the previous year.

(h) Accelerated digitisation of retail payments: The latest data reveal that prepaid
payment instrument (PPI) volumes increased by 54 per cent between November 2016
and August 2017, as also mirrored in the significant drop in the income elasticity of
currency demand referred to earlier.

(i) Higher rate of detection of fake Indian currency notes (FICNs): In the post
demonetisation period, the rate of detection of FICNs rose to 6 pieces and 12 pieces
for `500 and `1000 notes, respectively, for every million pieces of notes processed -
more than twice during the pre-demonetisation period

1. Demonetization and Currency Demand

F ollowing Demonetisation, there has been a decline in CIC. The demonetized notes were
accepted at bank counters till December 30, 2016. Between November 4, 2016 to January 6,
2017 (i.e., between weeks immediately prior to and the lowest level of CIC witnessed after
Demonetisation), total CIC declined by about `9 trillion. CIC, which recorded significant
downward movement immediately after Demonetisation, still remains below its trend:

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i. As on October 27, 2017, CIC was lower by 8.0 per cent on y-o-y basis as against
an increase of 17.2 per cent in the previous year, notwithstanding the rapid pace of
remonetisation.
ii. As on October 27, 2017, CIC stood at 91 per cent of its pre-Demonetisation level,
and even lower at 81 per cent, if it is assumed that the increase in CIC would have
followed the baseline growth rate (Chart 1b).2 (iii) As a proportion of broad
money (M3), CIC fell to 12.3 per cent on October 13, 2017 as compared with 14.4
per cent on November 11, 2016 Thus, there seems to be a noticeable downward
trend shift in CIC even without constraints on cash withdrawals. This suggests
that Demonetisation, given the data available so far, has had a significant effect on
the currency holding habits of the public which, in conjunction with greater
digitization of retail transactions and the sharp increase in electronic modes of
payments, may have led to a durable downward shift in the currency demand of
households.

2. Demonetization and Bank Deposit Growth

B etween October 28, 2016 to January 6, 2017 notes in circulation declined by about `9
trillion which, in turn, was largely reflected in an increase of about 4 percentage points in
the share of CASA deposits (low-cost deposits) in aggregate deposits of the banking system
Demonetisation also led to a significant increase in financial intermediation, with an increase of
38 per cent in deposits in PMJDY accounts, with addition of 27 million accounts post-
Demonetisation (November 9, 2016 to March 31, 2017). The latest data indicate that 50 million
new accounts were opened since Demonetisation until October, 2017.

3. Demonetization and Monetary Transmission

s banks credited the depositors’ accounts with the value of surrendered demonetized bank
A notes, CASA deposits of banks rose sharply in the post Demonetisation period. The share
of the low-cost CASA deposits in total bank deposits increased from 35.2 per cent in October
2016 to 40.6 per cent in March 2017, before declining to 38.6 per cent in June 2017. With credit
demand remaining sluggish, banks reduced their term deposit rates significantly towards end-

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December 2016/early January 2017; interest rates on saving deposit accounts, however, were left
unchanged. In an environment of surplus liquidity, weak credit demand, lower cost of term
deposits and a surge in low cost CASA deposits, banks announced a large cut in their MCLRs in
January 2017. The median term deposit rates of SCBs declined by 62 bps during November
2016-August 2017, while the weighted average term deposit rate of banks declined by 69 bps.
The weighted average lending rate (WALR) of banks in respect of fresh rupee loans declined by
nearly 100 bps during November 2016-August 2017. The 1-year median MCLR has declined by
a cumulative 80 bps since November 2016. This is significant, considering that the 1-year median
MCLR declined by only 15 bps during the preceding seven months (April-October 2016) when
the policy repo rate was reduced by 50 bps. The WALR on outstanding rupee loans declined by
50 bps during November 2016-August 2017. Thus, a large part of the transmission was facilitated
by the surplus liquidity on account of demonetisation.

4. Demonetization and Financialization of Savings

D emonetisation also resulted in gains for the non-banking financial intermediaries such as
debt/ income oriented mutual funds and insurance companies. In fact, the aggregate
balance sheet of the non-banking financial companies (NBFCs) expanded by 14.5 per cent during
2016-17. The financialization of saving can be broken up under three non-banking financial
intermediaries: mutual funds, insurance companies and NBFCs.
(a) Mutual Funds
Moderation in interest rates on bank deposits after demonetisation and decline in the price
of gold enhanced the relative attractiveness of both debt and equity oriented mutual funds.
Reflective of this, AUM by mutual funds increased to `17.5 trillion by end-March 2017
and further to `21.4 trillion at end October 2017. The buoyant equity market also improved
the attractiveness of equity oriented mutual funds. Resource mobilisation under equity
schemes more than doubled during this period. There were also net inflows in the
income/debt schemes during November 2016-June 2017 in contrast to net outflows during
November 2015-June 2016. This was reflected in a sharp increase in the overall resources
mobilised by mutual funds during November 2016-June 2017 as compared with the same

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period last year. Higher resource mobilisation by mutual funds after demonetisation has
mainly been driven by retail and high net worth individual investors.

(b) Life Insurance Companies

Collections of premia by life insurance companies more than doubled in November 2016.
Premia collected by Life Insurance Corporation (LIC) of India increased by 142 per cent
(y-o-y) in November 2016, whereas collection by private sector life insurance companies
increased by nearly 50 per cent. About 85 per cent of the total collections by LIC of India
in November 2016 were under the ‘single premium’ policies, which are paid lump sum,
unlike the non-single premium policies that can be paid monthly, quarterly or annually.
The LIC of India revised downward the annuity rates of its immediate annuity plan
Jeevan Akshay VI purchased from December 1, 2016, which might have created a spurt
in collections in the month of November 2016. The cumulative collections during
November 2016 to January 2017 increased by 46 per cent over the same period of the
previous year. Despite subsequent slowdown in the growth rate, the premium collections
still witnessed an average growth of 22 per cent during November 2016 to September
2017.
(c) Non-Banking Financial Companies (NBFCs)
Loans disbursed by all categories of NBFCs declined significantly in November 2016 as
compared with the monthly average disbursals during April October 2016, especially by
micro finance companies (NBFC-MFIs) whose business is cash intensive (Table 4).
Disbursements by Asset Finance Companies (AFCs) and Loan Companies (LCs)
generally contracted up to February 2017. Disbursals turned positive from March 2017
and grew generally at a higher rate than the monthly average disbursals recorded during
April October 2016. In the case of MFIs, however, disbursals continued to contract in
comparison with the monthly average of disbursals during April-October 2016 in view of
the uncertainty surrounding loan waivers by state governments. In contrast to disbursals,
growth in collections (i.e., repayments of loans due) of AFCs and LCs during November
2016-June 2017 increased significantly over the monthly average collections during
April-October 2016 (Table 5). Collections by NBFC-MFIs declined during November
2016-February 2017 vis-à-vis April October 2016, but witnessed an improvement during

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the months of March, May and June 2017. Bank credit to NBFCs decelerated from 5.1
per cent (y-o-y) in October 2016 to 1.3 per cent in November 2016; however, it
subsequently improved to 10.9 per cent in March 2017. In terms of the returns submitted
by the reporting NBFCs, loans and advances by NBFCs increased broadly at the same
rate in the year ending March 2017 (16.4 per cent) as in the year ending March 2016
(16.6 per cent) (Table 6). In summary, demonetisation appears to have led to the
acceleration of the financialization of savings in India

5. Demonetization and Digitization of Payments

A nother important outcome of demonetisation has been the considerable increase in use of
digital transactions. The pattern of digital transactions in March 2017 over November
2016 showed that growth rates surged in both value and volume terms compared to the
corresponding period last year. The behaviour of electronic payments suggests that the surge in
digital activity has been sustained. The latest data reveal that Prepaid Payment Instrument (PPI)
volumes increased by 54 per cent between November 2016 and August 2017 and the transactions
under the Immediate Payment Service (IMPS) more than doubled during the same period (Table
7). Debit and credit card payments at point of sale (PoS), the familiar and time-tested mode of
digital payments, also recorded a sharp pick-up. In addition, there appears to be a structural break
in the volume and value of retail electronic payments, coinciding with the onset of
demonetisation and the special measures put in place to promote digital payments. The trend in
the volume of retail electronic payments points to a structural shift having taken place after
November 2016

6. Demonetisation and Detection of Fake Indian Currency Notes (FICNs)

D uring 2016-17, 762,072 pieces of counterfeit notes were detected in the banking system,
20.4 per cent higher than in the previous year. Coincident with the announcement of the
withdrawal of legal tender status of SBNs on November 8, 2016, the Reserve Bank launched a
nation-wide exercise to estimate the density of FICNs detected during the counting and

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verification of notes. The result showed the rate of FICNs detected per million pieces of notes
processed at the currency chest level was 7 pieces for `500 denomination and 19 pieces for `1000
denomination. At the Reserve Bank’s currency verification and processing system, there were 2
pieces of FICNs of `500 denomination and 6 pieces of FICNs of `1000 denomination for every
million pieces of notes processed during 2015-16; these rose to 6 pieces and 12 pieces,
respectively, during the post-demonetisation period. As compared to 2015-16, 12 clusters for
`500 denomination and 14 clusters for `1000 denomination showed a statistically significant
higher rate of FICN detection during the post-demonetisation period.4 These findings imply a
significant pick-up in the rate of FICN detection at the Reserve Bank level in the post
demonetisation period as compared to a year ago.

7. Impact of Demonetization on Balance Sheet of Banks

D ecline in currency in circulation on account of demonetisation led to a surge in bank

deposits. Total currency in circulation declined by about ₹ 8,800 billion (₹8.8 lac crores). This, in
turn, was largely reflected in a sharp increase of about ₹ 6,720 billion (₹ 6.72 lac crores) in aggregate
deposits of the banking system even after outflows in NRI deposits during the period. Between end-
December 2016 and early March 2017, there was a net increase in currency in circulation by about ₹
2,600 billion. During this period, deposits with banks also declined moderately. As per data for October
28, 2016 (prior to demonetisation) and February 17, 2017 (latest available), aggregate deposits of SCBs
increased by ₹ 5,549 billion during the period. Bulk of the deposits so mobilized by SCBs have been
deployed in: (i) reverse repos of various tenors with the RBI; and (ii) cash management bills (CMBs)
issued under the Market Stabilization Scheme (which is a part of investment in government securities in
the balance sheet of banks). Loans and advances extended by banks increased by ₹ 1,008 billion. The
incremental credit deposit ratio for the period was only 18.2 per cent. Additional deposits mobilized by
commercial banks have been largely deployed in liquid assets. This may be due to the expected transitory
nature of the bulk of such deposits and weak demand as reflected in the subdued growth of credit.

8. Impact of Demonetization on Profitability of Banks

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anks’ net profits essentially reflect the difference between interest earned on loans and advances
B and investments, and interest paid on deposits and borrowings, adjusted for operating costs and
provisions. Loans and advances and investments, which are the main sources of interest income, together
constitute more than 85 per cent (61 per cent accounted for by loans and advances and 25 per cent by
investments). The sharp increase of 4.1 percentage points in the share of CASA deposits in aggregate
deposits to 39.3 per cent (up to February 17, 2017) resulted in a reduction in the cost of aggregate
deposits. Banks have also lowered their term deposit rates; the median term deposit rate declined by 38
bps during November 2016-February 2017. The decline in the cost of funding resulted in decline in the 1-
year median marginal cost of funds-based lending rate (MCLR) by as much as 70 bps post-demonetisation
(November 2016-February 2017). Banks earned a return of around 6.23-6.33 per cent under reverse repos
and market stabilization scheme (MSS)as against the cost of CASA deposits of around 3.2 per
cent. Accordingly, for an average deployment of about ₹ 6 trillion in a quarter under reverse repos and
MSS securities, banks’ net interest income from increased deposits is estimated at about ₹ 45 billion in a
quarter after demonetisation. Banks continue to enjoy the increased share of low-cost CASA deposits,
although it is gradually declining with the increase in currency in circulation. The increase in net interest
income would need to be adjusted for the cost of managing withdrawal of SBNs and injection of new
bank notes (such as calibration of ATM machines, staff overtime, security arrangements, lower
fees/waiver of fees on digital modes of payments), the exact details of which are not available at this
stage.

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❖ Results of Post Demonetization on Bank Operations

There are positive and negative results of Post Demonetization on Bank operations. Both have
influenced Banks’ liquidity and profitability and employees too.

1. Free flow of deposits: Banks have gained deposits

The following substantially after demonetization which they can invest for
improving their liquidity and profitability.
are positive
results of
demonetization. 2. Improved digital Interface: Improvement in digital tools
and equipment to execute bank transactions has avoided cash
loss for various reasons like theft, dacoits and
misappropriations

3. People’s surplus at Bank: cash is an idle asset which does

not yield any income unless kept in a bank. So, demonetization
made the people keep their surplus money in a bank to earn
some sort of income.

4. Increased number of Customers: Demonetization has

influenced the public to come and execute transactions with
banks. It made even a non income group people visit banks and
have an account. It increased the number of account holders in
banks while increasing deposit corpus.

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 EFFECTS OF DEMONETIZATION ON BANKS

Similarly, Demonetization has brought some operational issues to Banks. Its disturbed Banks’ Employees,
Operational Costs and Profitability

1. Cash Reserve Requirement: 100% CRR on incremental

The following deposits meant that banks did not earn any interest on Rs. 3
Lakh crore of deposits for nearly a fortnight.
are negative
influences of
Demonetization 2. Waived off ATM Charges: ATM charges were waived off
during banned note exchange and banks incurred a loss of Rs.
20 in every transaction.

3. Waived off Merchant Discount Rate: Banks incurred loss

of 1% discount charges from merchants on using every card
transaction.

4. Reduced SMEs' Sale and influence on NPAs: During

demonetization, some SME businesses had seen their sales
drop by 50-80 per cent and could default in their instalments to
banks. This led the banks to consider it as NPA and affected its
level in banks.

5. Stress on Employees: Bank Employees were put under

pressure and overtime work environment. It depressed them
and kept an imbalanced lifestyle. Few cases were found where
the employees committed suicide due to work pressure.

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 EFFECTS OF DEMONETIZATION ON BANKS

❖ Conclusion

D
emonetisation would be positive for sectors like banking and infrastructure in the medium
to long term and could be negative for sectors like consumer durables, luxury items,
jewellery, real estate and allied sectors, in the near to medium term. It can also lead to
improved tax compliance, fiscal balance, lower inflation, lower corruption, complete elimination of
fake currency, a step for sustained economic growth in the longer term. Banks have gained deposits
substantially after demonetization which they can invest for improving their profitability. There non-
performing advances have also come down. Besides as banks will reduce their cash holdings due to
more digital interface it will add to their long-term profitability and cash loss for various reasons like
theft, dacoit and misappropriation will be avoided. Cash is an idle asset and it does not yield any
income unless kept in a bank. So, people will keep their surplus cash in banks instead of at home.
Thus, demonetization is not an unmixed blessing but merits are more than demerits and the economy
will move forward with less cash holdings by banks.
To conclude, an important effect of demonetisation has been the inducement to shift towards formal
channels of saving by households and a noticeable downward shift in the currency demand of public.
There has been a sharp increase in the number of accounts under the PMJDY and the deposits in
such accounts have also surged, which has given a boost to financial inclusion efforts. During
demonetisation and the subsequent period, there has been a distinct increase in saving flows into
equity/ debt oriented mutual funds and life insurance policies. Apart from this, non-banking financial
companies seem to have recorded improvement in collections and disbursals. Demonetisation-led
increase in CASA deposits also led to significant improvement in transmission to bank lending rates
during the post demonetisation period. The challenge, going forward, would be to channel these
funds into productive segments of the economy and expand the footprints of the digital economy,
which has undergone a sharp increase − another important consequence of demonetisation.

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Bibliography
IJCRT. (n.d.). Retrieved from https://ijcrt.org/papers/IJCRT1704373.pdf

1. https://en.wikipedia.org/wiki/2016_Indian_banknote_demonetisation
2. https://www.bankbazaar.com/savings-account/demonetisation.html

Group Members
NAME REGISTRATION NUMBER

Ethan Chawda CRO0712973

Krishna Gupta WRO0755991

Miti Sheth WRO0736858

Manan Bohra WRO0733661

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