September spike, a damp squib for speculators

Surge in deposit accretion, before Nov 8, is only basic banking phenomena

The Centre’s demonetisation move has brought to fore some common misconceptions. For example, one critical concept is what creates deposit? The recent surge in bank deposits during September 2016 has sparked off debates, especially after November 8, 2016.

As per RBI data, the aggregate deposits grew at a whopping 11.3 per cent in September 2016 as compared to the average growth rate of around 9 per cent during the preceding months of the year. In fact, a cursory look at the data suggests that the entire surge in deposit growth took place in the last fortnight of September 2016. In absolute terms, the surge in deposit is ₹3.5 trillion, which catches more eyeballs. Thus the obvious conundrum is, who deposited ₹3.5 trillion and why?

Interestingly, the argument that the illicit cash was converted to deposits in the banking system pre-demonetisation doesn’t hold good, as the reduction in cash in circulation between September 16 and 30, 2016, was only ₹340 billion.

Money creation dynamics

There have been a lot of explanations for this, mostly attributed to the surge in government spending related to Pay Commission hikes, among other reasons.

Unarguably, these components might have contributed a portion to such a gigantic deposit accretion, but what is missing in all these arguments is the basic argument of deposit creation.

Actually, bank lending creates deposit and not vice versa. Joseph Schumpeter summed up Keynes’s contribution to the theory of credit creation: “ Nevertheless, it proved extraordinarily difficult for economists to recognize that bank loans and bank investments do create deposits”.

When a bank lends to XYZ, the lending bank transfers such amount to the borrower’s bank account or the borrower deposits the cheque to his account in his bank.

Concurrently borrower’s bank uses the same deposit to lend to someone else, after meeting the regulatory stipulations (namely SLR and CRR), and it goes on. This is effectively endogenous money creation.

On the other hand, when foreign money comes to the banking system through trade or capital channel, that creates exogenous money. Exogenous money creation also happens though the direct transfer of subsidy or benefits by government.

What caused the rise?

So, what happened in September 2016? Was there any sudden rise in credit in an environment of sluggish demand for credit? Credit data suggests no surprises to this hypothesis, as banking credit too grew by 10.4 per cent year on year, as compared to the average 9 per cent in the preceding fortnights. And in the similar vein to deposit growth, credit off-take took place in the last fortnight of September.

Now the next question is, why did credit off-take gain traction during such a period only? This is the usual practice for commercial banks to show a temporary increase in credit at the end of a quarter, and this happens on the last day of the quarter. The credit-deposit ratio also supports this argument, as it remained 1.35x without any change.

Last but not the least, the question, why did it show up in September 2016? Well, the answer is, the RBI releases banking data as on Friday, so the deposit or most of the data we are talking about are as on various dates but all are on Friday. It was actually a coincidence that the last quarter ending was also on a Friday. Hence, both the credit and deposit growth is actually visible as it has been reported. This has not happened for the first time; there are a number of such incidents and the data suggests similar observations. We have highlighted a few instances out of 30 in the last two decades, in the accompanying table.

Hence, the cause for bump-up in deposit was nothing but mostly a credit phenomenon, not much to do with the ongoing demonetisation controversy.

The writer is Associate Director – Credit & Market Research, India Ratings & Research

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