By The Editorial Board of TJEF
(Anil Shankar, Gandhali Inamdar and Isha Varma)
Introduction
Demonetization has been the buzz word since November 8th 2016 when our Prime Minister made the historic announcement about the decision to discontinue the 500 and 1000 rupee notes. This historic decision has affected almost all the sectors. Some have benefited while others have suffered. This paper intends to analyze the effects of demonetization on the major financial institutions and the Indian economy in general.
Effects of Demonetization on Banking sector
Since the advent of asset quality review (AQR), there has been a rise in the number of NPAs. To get an idea, the GNPA of banks is 6 lakh crore as of June, 2016 which is 8.2% of the total loans1. These are only the NPAs as there are an equal number of restructured loans which might transform to NPAs in future.
Figure 1: Total NPAs as of March 2016, Source: Finance Ministry
A recent data provided by the Finance ministry, which has been depicted in Figure 1, shows that 5.3 lakh crore of the 6 lakh crore NPAs are under the public sector banks. It’s clearly visible that there has been a rise in the NPAs from October 2015. This can be attributed to the ever greening of loans which led to the creation of a distorted picture of the banks. Though the asset quality review led to the identification of such NPAs which were previously classified as standard, the problem of NPAs existed since the 2008 financial crisis but remained hidden due to the above mentioned reason.
The data provided by the Finance ministry also had the top 10 sectors with highest NPAs which has been shown in Figure 2.
Figure 2: Top 10 sectors having highest NPAs, Source: Finance Ministry.
It’s clearly visible that the Basic Metal and Metal products sector has more than 50 % of the NPAs. Demonetization has affected the industrial production significantly. The recent industrial production data for October 2016 shows us that the industrial production went down by 1.8 % for October 2016 YoY. This was before demonetization. The November 2016 IIP data shows that industrial production increased to 5.7% YoY while in December, the value reduced to -0.4%. But again, this is a YoY data. To compare the effects of demonetization, one has to compare the actual IIP of the current month with the previous month. The actual data shows that the IIP has fallen from 178.1 in October 2016 to 175.8 in November, 2016 but increased to 183.5 in December, 2016 which can be seen in Figure 4. This is an interesting phenomenon because the IIP was expected to deteriorate further. But in contrast, the IIP MoM data increased. It can also be observed that the YoY data has decreased by -0.4% which means that even though the IIP has increased compared to the previous month, compared to last year’s December data, IIP has fared badly. So the increase in IIP MoM data can be attributed to a seasonal trend and that the overall outlook still looks edgy.
Figure 3: Industrial production data (YoY), Source: CSO
Figure 4: Industrial production data (MoM), Source: CSO
The decrease in the IIP can be attributed to the decrease in demand in many sectors which consumes metals. One such sector is the Automobiles. Post demonetization period has been a challenging one for the Auto industry as the demand for all types of vehicles has taken a dive. A recent data released by SIAM (Society of Indian Automobile Manufacturers) indicates that the total sales of cars, two wheelers, and commercial vehicles shrank by 18% in December 2016. Such a dive was last witnessed during December 2000. But the segment that was hit the most was the two-wheeler segment where there was a drop in sales by 22.5%. This can be attributed due to the fact that more than half of the motorcycle sales happen in the rural market where cash transactions are typically high. Post demonetization, the dearth in availability of cash led to reduced/conservative spending in the rural areas and this led to the fall in sales in the motorcycle segment. This trend might continue until the situation normalizes with RBI printing enough notes to satiate the demand of the economy.
The industrial sector includes manufacturing, mining, and utilities of which manufacturing accounts for 75.5 % of the total output. As mentioned earlier, it’s the manufacturing sector which relies on the metal industry for raw materials. And since there is a clear decline in the manufacturing sector due to the reduced demand post demonetization, the metal industry too will take a hit and their production would fall affecting their revenues. And since more than 50% of the NPAs are from the metal industry, the banks might face a challenging situation wherein the NPAs might worsen unless the RBI is able to stimulate the demand in the economy by printing more notes.
Due to demonetization, the banks received a total of Rs. 12.4 trillion rupees. Due to this, it was expected that the banks would lend more at lower interest rates. But again, as mentioned above, when the demand in the system is low, the probability of these industries borrowing from the banks is quite low. A recent report by the famous credit rating agency, Moody’s Investors service, suggested that there would be an increase in deposits by 1 to 2 percent post demonetization which would happen after the initial inflows and sharp outflows of deposits until the situation stabilizes within a span of 3 months which would lead to lower lending rates. But these effects may be negated if sufficient liquidity does not return to the system.
Another positive effect of demonetization on banks is the increase in the number of card transactions. Though there has been a surge in the number of e-wallets, the banking sector still dominates the retail payment segment. Post demonetization period has witnessed a rise in the number of card transactions. ICICI has reported a 100% increase in debit card transactions and 40% increase in credit card transactions. SBI reported a 35% increase in card transactions. Overall, all banks observed a similar trend of increase in the number of card transactions with the data heavily skewed in the favor of debit cards. Another interesting observation was that the rise in the number of requests for PoS (Point of Sale) terminals. Large banks like HDFC, Axis bank, and ICICI have reported huge growth in the number of such requests post demonetization. According to the above three banks, most new requests were from new categories of merchants like beauty salons, the self-employed segment such as doctors, CAs, vegetable vendors etc. This is a positive impact for both the government as well as banks for two reasons. Firstly, merchants, who previously preferred cash, now opting for PoS terminal helps in realizing government’s objective of a cashless economy, which would, in turn, increase the tax base and help in faster fiscal consolidation. Secondly, banks will be able to realize a bigger bottom-line due to this entire exercise as the RBI is not inclined to cut the MDR (Merchant Discount Rate or in general known as the card transaction fees) as is the wish of the central government in order to promote the idea of cashless economy.
Overall, the demonetization move can help the banking sector make huge gains if the government and the RBI treads carefully by implementing policies to stimulate growth in other sectors of the economy and increase the liquidity in the system.
Effects of Demonetization on Microfinance
Microfinance in India
The various MFIs coming together have also constituted a self-regulatory organization called MFIN (Microfinance Institutions Network) to address grievances of microfinance clients and ensure that MFIs stick to their code of conduct.
Figure 5: Top MFIs as per Loan portfolio-2015 (IND)
Microcredit (small loans) is the most common product offering. In India, most microfinance loans have amounts not exceeding Rs.1,00,000. These loans are usually availed from two MFIs at most by rural households whose annual aggregate income does not exceed Rs.1,00,000 with a provision of daily loan repayment.
Growth in MFI sector
A CRISIL Report on May 18, 2016, states that MFIs are projected to grow at 125%11. The gross loan portfolio stood at Rs. 57,941 Cr in Q2FY17 as compared to Rs. 31,551 Cr in Q2FY16 growing by almost 84% YoY in Q2, MFIN said. The growth in MFI sector has been depicted in the figure 6.
Figure 6: Growth in Microfinance Industry
Impact of Currency Ban
The currency shock is hitting the cash-driven sector at a time of high growth. The demonetization of high-value currency notes has descended down as a setback for MFIs, which have temporarily stopped providing credit to their customers at the same time taking a major hit on loan repayments, e.g. Bandhan Bank. Many MFIs had deferred the repayment schedule of their borrowers for the subsequent few days.
Usually, MFIs record a repayment rate of 99%, but it took a blow after demonetization11. The sector is worried about taking the business forward in view of the increasing risk of loan defaults as the repayment rate has dropped to approximately 70% around November 10th following the announcement.
The resultant liquidity crunch is likely to hurt repayment capacity of borrowers and lead to short-term delinquencies in loan accounts, as observed by India Ratings & Research because of demonetization hurting SMEs. In particular, a section of borrowers associated with the construction sector and unorganized sector self-employed individuals have been negatively impacted.
Issues faced by MFI sector
Some industrial experts felt that the notification on demonetization drive was overly concentrated on retail customers and that it lacked clarity when it came to institutional customers. The answer to above ambiguity came in the form of a press release on 21st November by RBI giving borrowers of loans of upto Rs.1 Crore, an additional 60-day ‘forbearance’ window to make loan repayments, extending the cut-off norm for NPA recognition to 150 days for loan payments due between 1st November and 31st December intended to offer respite to MFIs on loan provisioning grounds12. The short term deferment of NPA recognition norm will not only prevent a spike in bad and/or restructured loans due to temporary delays in collection of dues but also assist in re-building the collections system for NBFCs and MFIs.
The cash crunch has also brought out some of the irregular practices of the fast growing MFI industry. These include lack of diversification among MFI borrower profiles, surging individual size of microfinance loans, concentration of majority of the loans in few states, increased instances of multiple lending to the same set of borrowers.
It’s not the case that there were no red flags before demonetization. The rapid growth in MFI industry attracted a fair share of unregistered and unregulated lenders, said Saibal Paul, Associate Director, Sa-Dhan, a self-regulatory organization (SRO) for the microfinance sector, while adding that such players are breaking rules and tempting the people to borrow more than they can possibly repay.
Also, in the August 2015 report by Religare Capital Markets titled ‘Indian Microfinance – Crisis Brewing’, the brokerage house pointed out “multiple weak spots” in the sector. According to the RBI rules, a borrower can’t take loans from more than two lenders at a given time, subject to a total limit of one lakh rupees. However, these restrictions do not consider formal banks and informal moneylending channel. The report claimed an optimistic overlap of 25-40%.
Short term Trouble
1. Lack of sufficient liquid cash in hand for loan disbursements and fall in collections.
2. Non-payment of loans within stipulated time leading to loan defaults possibly leading to their classification as NPAs.
3. Negative implications on Credit Ratings of various MFIs and NBFCs with possible downgrading in case of some.
Long term Issues
1. Rural Economy which is majorly cash based is hit adversely as higher denomination notes are not always practical to use even if available.
2. Fight for maintaining market share under present crisis may cause weakening of credit appraisal standards by MFIs.
3. Increasing focus of Government towards Digital payments and Direct-To-Account (DTA) payments could demand a change in the collections mechanism.
4. Even if all MFIs are allowed to function as a business correspondent for banks allowing them to accept old currency notes, it would mean additional paperwork thereby adding to labour and time costs.
The additional 60-day forbearance window provided for deferring NPA recognition could be exploited by end consumers for intentionally deferring payments adding to the cash woes for MFIs.
Contradictory Opinion
A section of the industry has a contradicting opinion about the victim status of Microfinance industry. It opines that to certain extent, the microfinance industry is paying for its own relaxed attitude towards re-routing loan disbursements and repayments through bank accounts and assisting the formal banking system especially the Jan-Dhan scheme.
Way Forward
Paytm launched its new variant of Point of Sales (POS) service through their app on 26th November 2016 for users targeting SMEs, wholesale vendors and small store owners hit by cash crunch. The service provides an alternative to the conventional swipe POS machines found at retail outlets. This service does not have a daily transaction limit of Rs.20,000 as in case of mobile wallets and can thus complement the wallet payment systems for higher end transactions.
Country’s largest bank SBI is also reaching to chaiwallahs (tea vendors), dabbawallas (tiffin service providers) and vegetable vendors to accept payments through SBI Buddy app and POS machines.
Born out of the need of providing financial services through institutions to low income clients, Microfinance industry has surely blossomed through years with its exceptionally high audience coverage, repayment rate among other achievements. Demonetization has certainly hit the cash-driven sector inversely affecting both its disbursements and loan repayments. As cash liquidity is poised to increase in days ahead, short term cash troubles would get resolved. Banking licences to large MFIs can aid financial inclusion drive. Also, taking cues from changing trends and many government initiatives towards financial inclusion, “less-cash” & “cash-less” future and digital payments, MFIs should on updating and upgrading their business model, including multi-modal business through banks, smartphone payments, e-wallets among many others by undertaking end-user financial education initiatives taking advantage of the mobile phone & smartphone penetration in rural, semi-urban and urban areas to ensure speedy recovery and sustainable growth in the now Volatile, Uncertain, Complex & Ambiguous (VUCA) BFSI world.
Effects of Demonetization on Insurance Sector
India’s Insurance sector with around 52 insurance companies has a worth of 41 billion US dollars. This market share is divided between Life insurance and Non-life insurance companies. Since the opening up of this industry to private players in 2000, the Indian insurance sector has seen a rapid growth. In 2015, insurance market size was USD 75.88 billion and this market is expected to grow to USD 280 billion by 2020 considering the growth of Indian economy and the increasing disposable income. But the recent demonetization policy in India has brought insurance sector at crossroads.
Figure 7: Ten-year growth of Insurance sector in terms of premium
In India, the primary reason for keeping cash at home has been to safeguard oneself from unforeseen medical emergencies. This is because even today most people in India prefer payments by cash and hence, hospitals, doctors, and other medical facility providers are not well equipped with digital payment facilities and likewise since hospitals are not equipped people prefer cash payments. With the implementation of demonetization, the whole chain of customers, doctors and pharmacies are severely affected. The most affected being the people with unaccounted cash who used to pay for medical treatments using lakhs of rupees. After demonetization, cashless methods of providing healthcare facilities have been a savior. In fact, health care provided by way of health insurance has come as a boon for many insurance seekers. The reason is that it is the only way to get the required treatment done without worrying about cash payments. As a result, the health insurance companies will have more buyers and there will be more people looking out for health insurance schemes offered by private and public insurance companies. Consequently, the economies of scale will bring down the cost of buying health insurance.
Experts have predicted that with more frequent replenishment requirements, the demand for insurance would go up.
Penetration of insurance in India is very less as compared to that in developed countries and an initiative like demonetization is expected to expand the insurance market. A larger number of small businesses would consider buying insurance to cover the risks as the cash transactions become restricted. Also, the income at the bottom of the pyramid (individual and business) is expected to rise, which would be a positive sign for the overall insurance industry.
Insurance companies sell insurance in bulk to other companies who buy as an insurance cover for all their employees. Insurance company executives revealed that a few such companies are demanding insurance limits as high as 500 crores per location. However, insurance industry experts have said that this is a temporary situation, till the customers do not have adequate cash. But it does increase the revenue of insurance companies in the short run.
Companies that manage cash and ATM machine functioning are covered by insurance companies. Even banks take cover for ATM machines against any theft or damage. Post-demonetization, companies that took a cover of mere 1-2 crores for such purposes are now demanding as high as 20 crores. The reason is the greater amount of cash being exchanged.
The Indian insurance sector is majorly driven by the government agencies like Life Insurance Corporation of India, Oriental Insurance Co. Ltd, New India Assurance Co. Ltd, and others. Soon after the announcement of demonetization, these companies started taking steps to manage the change. LIC for example, extended its grace period for the customers to pay their premiums of several policies without any penalty, by a period of 20 days. This allowed people to have some time in order to withdraw any necessary amount from the bank ATMs.
On a downside, the private insurance sector which mainly deals in cash is adversely affected by demonetization as it is not ready to except the premiums in terms of online banking or credit in terms of bank transfers.
With a few detrimental effects, demonetization essentially seems to be beneficial for the insurance sector due to the increase in insurance policy buyers and most importantly due to a transformation towards becoming an internet banking equipped sector.
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