The Definition and Concept of Demonetization

Introduction

Demonetization is the act of stripping a currency unit of its status as legal tender. It is necessary whenever there is a change of national currency. The old unit of currency must be retired and replaced with a new currency unit. In 2016, the Indian government decided to demonetize the 500 and 1000 rupee notes, the two biggest denomination notes. These notes accounted for 86% of the country’s cash supply.

The government’s goal was to eradicate counterfeit currency, fight tax evasion, eliminate black money gotten from money laundering and terrorist financing activities, and promote a cashless economy. By making the larger denomination notes worthless, individuals and entities with huge sums of black money gotten from parallel cash systems were forced to convert the money at a bank which is by law required to acquire tax information from the entity.

The demonetization initiative caused a sudden breakdown in India’s commercial ecosystem. Trade across all facets of the economy was disrupted, and cash centric sectors like agriculture, fishing, and the voluminous informal market were virtually shut down, with many businesses and livelihoods going under completely - not to mention the economic impact of millions of people standing in line for hours to exchange or deposit canceled banknotes rather than working or doing business.

"The unbanked and informal economy is hard hit," explained Monishankar Prasad, the New Delhi-based author and editor for Alochonaa, an Australian current events publication. "The poor do not have the access to structural and cultural resources to adapt to shock doctrine economics. The poor were taken totally off guard and the banking infrastructure in the surroundings is rather limited. The tech class has poor exposure to critical social theory in order to understand the impact on the ground.

There is an empathy deficit." If there is any immediate casualty to Prime Minister Narendra Modi’s demonetization exercise, announced on 8 November, that could possibly be for the country’s cooperative banks, which are struggling to stay afloat. Though inefficient, cooperative banks are still critical for the last mile in rural India. This will continue for at least the next 5 - 10 years till larger banks/payment banks/small finance banks take firm hold in rural India.

Post demonetization, the cooperative banking sector is gasping for breath on account of a severe liquidity crisis. Soon after the demonetization announcement, cooperative banks were asked not to accept the old Rs. 500, Rs 1,000 currency note deposits or exchange those notes with the new currency notes. This meant that these lenders could only deal with permissible denominations of Rs 100 and below or takes deposits in new currencies that are hardly available in the system.

This has effectively left many smaller cooperative banks with a few thousand rupees of funds. “There is practically no business in the bank for last two months or so. It is going to be tough” said an official with one of the primary cooperative banks, a state where cooperative banks play a crucial role in taking the banking services to the last mile. Cooperative banks are particularly important for farmers and lower income groups who want small ticket loans in less time in relation to larger banks.

Impact of Demonetization on Cooperative Banking System

The volume of rural credit in India is mainly for short term credit (one year) for production of Kharif and Rabi crops and vegetables and medium term credit (three to five years) for allied sectors such as wells, pump sets, dairy, poultry, horticulture, plantation, etc. A small portion goes to non-agricultural sector such as artisans and tiny business/services.

There are three types of cooperative banks in India, state cooperative bank, urban cooperative banks and district cooperative banks. Only DCBs were banned by RBI after allegations of money laundering. But around 100 urban cooperatives banks are also being probed by the ED. In the first three weeks after demonetization, nearly Rs. 12,000 crore worth high-value cash deposits worth Rs. 80 lakh each were made by 325 urban cooperative banks from remote districts, This is nearly a 25-fold increase in cash balance of these urban cooperative banks compared to their last balance on November 7.

The government and Reserve Bank of India (RBI) are set to bring out tougher norms for cooperative banks, which have come under scanner for alleged discrepancies and irregularities in the wake of the demonetization drive. According to a recent report by the income tax department, most banks have indulged in money laundering after the central government announced ban on high-value bank notes of Rs. 500 and Rs. 1,000 from November 8 midnight. Many banks accepted and exchanged the old currency notes at a premium and parked large deposits in multiple accounts, the report added. Moreover, several accounts have been opened without following Know Your-Customer norm, the report pointed out.

A senior government official said these banks could become conduits for black money in the future. At present, the scrutiny and vigilance on these banks is not as stringent as that on scheduled commercial banks. “These banks need to be monitored as carefully as any other scheduled commercial banks have been used for a large number of inappropriate activities in the past and these can be used for the same purpose in the future” the official, who did not wish to be identified.

Demonetization: Retaining Credibility of Co-operative Banks

With move to demonetize Rs. 500 and Rs.1000 notes by the central government had a strange fall out when Cooperative Banks which are the backbone of the rural economy, have been paralyzed with the ban of accepting the old currency that are no long legal tender now. Operations at 370 district central cooperative banks (DCCBs) and over 93,000 primary agricultural credit societies (PACS) have been severely hit with the Reserve Bank of India (RBI) slapping restrictions following the demonetization of Rs. 500 and Rs. 1,000 notes.

In a direction to the banks, RBI says that they have advised the Urban Cooperative Banks through its Regional Offices and the State Cooperative Banks through National Bank for Agricultural and Rural Development (NABARD) of the need to ensure strict compliance with the instructions issued with regard to exchange of specified bank notes as also deposit of such notes into the accounts of their customers. But there were reports that some cooperative banks were not strictly adhering to the instructions issued in connection with the withdrawal of legal tender status of the existing Rs. 500 and Rs. 1000 bank notes (specified bank notes).

The Reserve Bank of India’s restrictions drive during the demonetization for the Cooperative Banks who have provided credit to farmers and three-tier banking system is one of the largest in the country. Like the Railways, the Cooperative Banks have also been described as the lifeline of the state’s economy and there had been protests following the RBI decision and the cooperative sector went on strike last week. The government must allow Cooperative Banks to function or farmers which have been their source of funds for decades and have suddenly become invalid. Dr. Anand Rai Vyapamm scam whistleblower has rightly pointed out that this step was taken because some cooperative banks are dominated by politicians and were reportedly being used to launder Rs. 500 and Rs. 1000 notes.

The discrimination towards the Cooperative Banks will put the credibility of the banks at stake. The RBI and the Central Government should have taken this into consideration before meting out discriminatory treatment. The whole chaos will takes away the trust of common man from cooperative banks. Customers will think twice again before depositing their hard-earned money or taking a loan against their property from a local cooperative bank.

Due to uncertainty, the people will now be scared to park their money in future in these banks due to uncertainty as their credibility has also taken a hit. The current crisis could take the shape of a permanent mutilation if cash crunch continues for a few months and it will take a long time for them to recover. Instead, the government should have tried to strengthen the infrastructure and capabilities of these banks instead of bringing them on the verge of collapse.

Cooperatives play a major role

DCC banks in Maharashtra alone hold nearly Rs 2,270 crore in such old notes. Many of the state cooperatives are controlled by the NCP and the Shiv Sena has a sizeable presence in their workers’ unions.

There are in all 31 DCCBs, of which Pune DCCB has the largest deposit of demonetised notes (Rs 811 crore), followed by Satara DCCB (Rs 399 crore) and Nashik DCCB with Rs 365 crore. With their money DCCBs were finding it difficult to raise money to extend crop loans for the upcoming agricultural season. They were also struggling to meet the government’s directive to provide an advance of Rs 10,000 to every farmer until the larger issue of loan waiver was formalized.

Chief executive officer of Kolhapur DCCB, MLA Hasan Mushrif, said, "It is a moral victory for the bank, which has been sitting on Rs 279.78 crore in the form of old denomination notes and incurring losses of Rs 15 lakh as interest on this deposit. The government has not mentioned anything regarding compensation for the interest we have lost. Besides, the note ban tainted our image among the rural masses and has affected our deposit collection."

Conclusion

Cash crunch is the new norm for most people after demonetization, and some of the worst impacted are customers of co-operative financial institutes - banks and societies. One problem with the structure of the cooperatives is that there are multiple regulators. The control of the Reserve Bank of India (RBI) on state, district and urban cooperative banks get diluted because of this. Also, cooperative banks and societies chose their management through an election process.

Given that cooperative banks are largely controlled by politicians, investors also need to be very careful about their banking practices. If the loans are granted very easily, the deposits will be at risk. Customers should not get lured to banking with a cooperative financial institution just because it does not insist on you giving PAN number, or does not deduct TDS on interest, etc. If you are not comfortable doing the due diligence, then it is best to avoid cooperative banks.

Even as things are on the mend, the problems - situational and institutional - are still there. There is surely cause for concern, but experts advise against any panic decisions. They insist that investors need to evaluate whether or not they are banking with strong institutions. Instead of avoiding cooperative banks altogether, customers need to do stress on due diligence.