Please note: I am not an economist or banker or accountant or even particularly good with money or calculations. As a result, almost all the conclusions in this article are actually quoted from news reports and analysis. I have merely strung them together. I could still be wrong, feel free to argue in the comments.
As soon as the demonetisation of Rs.500 and Rs.1000 notes was announced, I had said that it was a forced and public funded "bailout" of banks. This is a phenomenon polite people call recapitalization unless the government literally dumps money into banks.
This view has not changed. But many are skeptical, saying that excessive money with banks is not good for them as they will have to lend it out in order to earn from it. That is true, and they will have to lower interests and give out more loans and such. However, to those following the news, I'm simply presenting various things that happened in the year before the demonetisation. Particularly with regard to the Non Performing Assets - NPAs. Too many NPAs and the banks won't be able to function. On the other hand... pay attention here: The bank with the largest number of NPAs - State Bank of India - doesn't seem to be in as much crisis as several others - say... Indian Overseas Bank - guess why? Because with that size come plenty of other performing assets as well as deposits keeping the show going.
For the record, it isn't the first time that the government has forced the country into actions that end up putting money in banks. The Jan Dhan Yojana was the first. It doesn't seem to have yielded much. Then came the DBTL, where in spite of the Supreme Court saying that citizens must not be deprived of their rights because of not having an Aadhaar, a convoluted scheme was imposed on them where the gas subsidies provided for the state would be provided as deposits into their bank accounts as opposed to people paying less for gas while buying it. Small amounts at a time, but it would end up totaling to a good amount of money belonging to citizens getting deposited into the banks by the government. People were free to withdraw it, but at least some of it would hopefully remain as deposited, just like some Jan Dhan accounts would indeed see use even if most remained empty. But these are old stories.
The NPAs of banks had increased to an alarming level by the end of the December quarter, last year. Then governor of RBI, Raghuram Rajan had been on the case of banks for NPAs for a while, and took a firm view of the matter, giving the banks until March 2017 to deal with their NPAs. Banks were to start flagging and resolving NPAs and restructured loans and by March, skeletons were tumbling out of banking closets and it was clear that the banks had been underplaying NPAs in order to show better results to investors (presumably). With the pressure on from the RBI, the banks started turning the heat on defaulters. It is no secret that it is banks with large corporate loans struggling the worst with NPAs, and I can only speculate that people who knew people who knew people had a lot of money at stake. To quote from the linked article:
RBI had conducted an asset quality review of Indian banks and found many accounts that were showing stress were required to be classified as non-performing. But since banks were not classifying those accounts as NPA, the banking regulator directed lenders to classify them as sub-standard and provide accordingly. Sub-standard assets attract 15-20 per cent provisioning as compared to five per cent provisioning requirement in standard assets.
RBI had asked the banks to complete the exercise of classifying assets as NPA in the third and fourth quarter.
As a result, many banks including the likes of Bank of Baroda, IDBI Bank, Bank of India suffered record losses in the Oct-Dec quarter. Since the remaining accounts (those which were not classified as NPA in Q3), need to be classified as NPA in Q4, losses could her mount. Bankers said this has prompted the banks to call the management of the defaulting companies and ask them to make payments, which will help the lenders avoid further losses.
Incidentally, this is around the time when Narendra Modi claims that planning for demonetisation started (although there doesn't seem to be much evidence of planning going by the manner in which it has been carried out).
Soon after this began noises of Raghuram Rajan not continuing as the governor of RBI after his tenure was complete. What happened behind scenes is anyone's guess and rumors and claims out in public range from Raghuram Rajan not wanting to continue to the government not wanting him to continue. Regardless, he was succeeded by Urjit Patel, who headed GSPC in Modi's Gujarat when GSPC took loans to the tune of 20,000 crore and basically had nothing to show for them, with no gas ever being produced. His closeness to Ambani (who profited majorly from the GSPC mess) as well as Jignesh Patel is well known. So, given Modi's preference for complete incompetence in area where competence is expected being a requisite for appointments, who better than Urjit Patel to head RBI while it was overseeing banks reducing NPAs?
Unlike Raghuram Rajan's approach, where the RBI would support banks in dealing with bad loans, Urjit Patel was of the view that "bad banks" take over the debt. It is unclear what happened of that approach or whether and what efforts continued toward NPAs, but they continued to rise. Attempts by Modi (and one wonders why Modi) to get Indian state owned firms to take over floundering defaulting companies (and their debt) failed a month before demonetisation was declared by Modi. To quote from the link:
India's government is pushing state-owned steel, power and shipping firms to take over assets of private companies that have defaulted on loans, but faces resistance from them, leaving it scrambling to clear a $135 billion pile of stressed loans from banks' books.
Last month, steel ministry officials met with Modi to outline measures to revive a sector reeling under bad loans and cheap Chinese imports. Days later, in a renewed push, Finance Minister Arun Jaitley met with top lenders, including State Bank of India (SBI.NS) and ICICI Bank (ICBK.NS), steel and shipping ministry officials and some state-owned companies.
He gave the state-owned firms a list of 23 troubled steel, power and shipping companies with bad loans totaling $14.5 billion, according to government officials and minutes of the meeting seen by Reuters.
The state-owned firms were "encouraged" to buy at least one asset and take a minority stake in a company on the list.
The banks needed lots of money and fast, or many of them being Public Sector Banks with the government owning more than half of them, it would stress the government for funds. One wonders what was wrong with turning the screws on NPAs harder. The banks needed money and fast.
How could this be achieved? Well, how about if all the people in India put most of the money they had into banks and left most of it there?
What followed, with demonetisation seems to be a harebrained scheme to get most of the cash with the country into banks. This is how not only do the banks not have enough cash planned and are not even in a position to provide enough cash in the near future, we have increasing noises about "cashless" transactions being an intent behind the demonetisation. So the money gets transferred from account to account, but remains with the banks instead of returning to the people with limits withdrawn and notes available again.
Then with demonetisation with banks bloated with funds, some of the staggering NPAs were "written off" to reduce their burden and free the money the banks would have to provision for the bad loans. Any taxes the government got would be a bonus (but given the expenses and waivers of demonetisation, I doubt these were the real motive).
Added feedback from someone who knows more about money than me: While the increased deposits will allow the banks to lend more, earn more, lower interest rates, etc, the interest earned by the banks and taxes to the government will no doubt be useful toward recapitalizing the banks. As will various confiscations of deposits be.
So now the thoughtless demonetisation with it unending new rules being pulled out of hats has happened. Banks have a different problem. Too much cash. And the methods to deal with it won't necessarily result in big profits for them. What they will do to existing loans with the economy and thus borrowers stressed far worse is anyone's guess.
Finally, how do I know that this is really a bank bailout and not a coincidence? Well, now that things are going south with the demonetisation, the usual process of protecting Modi from the consequences of his own action has already begun. From being "Freedom at Midnight" - Modi's project planned meticulously and in complete and necessary secrecy for 10 months, the story now is that the RBI and Finance Ministry presented the demonetisation plan to Modi in a manner that "turning down the scheme was out of the question". And guess why (emphasis mine):
Prime Minister Narendra Modi is working “more than ten hours a day” just on ensuring that the 8 November money measures announced by him ensure a smooth landing for the economy rather than turbulence. This despite the fact that the plan actually owed its origin to the Reserve Bank of India and the Ministry of Finance, who persuaded the PM to go forward with an idea which will affect (and has affected) over a billion citizens of this country. Prime Minister Modi showed moral courage in coming forward and accepting ownership of the currency swap scheme announced on 8 November, and has since then publicly backed every twist and turn in that policy by the monetary and fiscal authorities. Senior officials say “Prime Minister Modi was presented with the issue in such a way that turning down the scheme was out of the question”. Through the plan, concerned officials wished to “shield those in high positions in banks across the country from the consequences of the crony-oriented lending that they had been doing, specially since 2006”, the year when Narasimha Rao’s liberalisation policy was fully substituted by the UPA into a faux Nehruvian economic policy that combined Fabian socialism with Wall Street ways. “Officials argued that a windfall of up to Rs 550,000 crore would flow to the banks through the enforced extinguishing of currency notes issued by the RBI, and that this would recapitalise several banks that were in effect bankrupt, thereby allowing them to lend again”. The Prime Minister was assured that “steps would be taken to ensure that the common man suffered minimal discomfort” and that “the informal economy would accelerate its absorption into the formal without jobs being affected”. It needs to be mentioned that it is the formal sector that is responsible for not repaying bank loans of a value crossing Rs 750,000 crore, which will be several times the value of tax evasion by the informal sector. NPAs are being written off by banks at an accelerating pace over the past six years, with still more businesses declaring themselves unviable by the month.
I rest my case.