What does the currency ban mean for banks?
They may not be in a position to significantly increase lending and their capital base may get worse
The withdrawal of Rs500 and Rs1,000 notes on 8 November has changed the composition of money supply in the economy. A large part of what was currency in circulation is now coming to banks as deposits. The sudden inflow of deposits has given rise to speculation about how these will be utilized by the banks. There are reports that banks will increase lending. Some have suggested that banks’ non-performing asset (NPA) problems will get alleviated. This is not correct. Our analysis suggests that: (1) banks are not in a position to significantly increase lending, (2) their net interest income (NII) may fall over the next few quarters, worsening their capital position, and (3) their NPA situation may get worse, further adding to their capital woes.