Banks set for a profit boost as RBI calls for withdrawal of Rs 2,000 notes

By Preeti Singh and Saikat Das

A key metric of profitability for Indian banks, lending margins, is set to get a boost as the nation’s decision to withdraw its highest-value currency note bolsters bank deposits.

The Reserve Bank of India’s move to withdraw the 2,000 rupees ($24) notes will lead to growth in deposits at banks and lower their cost of funds, according to a note from Axis Mutual Fund. The step could boost deposits by as much as 2 trillion rupees through the end-September deadline to exchange the notes, the asset manager said.
Net interest margin, the difference between the banks’ lending rate and the amount it pays for deposits, will narrow in the year to March 31, as demand for loans outstrips the deposit growth, Fitch Ratings had warned earlier this year. Banks held 18.4 trillion rupees in deposits as of May, according to RBI.

But as the rush to deposit the high-value currency notes before the deadline gathers pace, banks’ margins could expand, said Madan Sabnavis, chief economist at state-run Bank of Baroda.
That is because the inflow of notes would lead to an increase in low cost deposits, known as current accounts and saving accounts, bringing down the overall cost of funds for the lenders and improve their margins, according to Virat Diwanji, group president and head - consumer banking, at Kotak Mahindra Bank Ltd. 
However, gains maybe short-lived as the people will start withdrawing the money. Still, the short-term deposit rates may ease for now, muting the impact of rising deposit rates on margins, according to a note from CareEdge Ratings Ltd.