The Moneychangers- The Politics around Demonetization
- In Economics
- 10:53 PM, Nov 13, 2016
- Shailendra Marathe
Arthur Hailey is one of my most favorite English fiction writers. He is a master of fiction who has the rare ability to write fast-paced thrillers on events that unfold in diverse industries. The names of Hailey's novels themselves indicate the background of the story; for example, 'Strong Medicine', 'Airport', 'Hotel', ‘Wheel’, and others. The recent currency demonetization initiated by the Indian government and the subsequent media reportage reminded me of “Moneychangers", one of exciting thrillers from Hailey's stable.
"Moneychangers" was published in 1975, and the plot revolves around the politics inside a major bank. In the trademark Hailey style, he explores events in the life of high-ranking executives in one of America’s largest banks. The political rivalry between the two contenders for the post of the CEO of the Bank, accompanied by fraud, embezzlement, insider trading, imprudent lending decisions, and approaching recession, ultimately leads to the run on the bank. The panicked depositors start withdrawing their money from the bank thus aggravating the crisis. The events outlined in the novel show why the business of banking is inherently risky. The banking business, runs on the trust of the people, be it investors, depositors, borrowers or other banks and counterparties with which the bank deals.
The banks make their profits mainly from the difference between the rate at which they lend and the rate at which they borrow (called net interest margin). To reduce their cost of borrowing, banks seek to raise a large portion of their liabilities from low cost products, such as current accounts and savings accounts (CASA), which carry no interest or a lower rate of interest as compared to other liabilities, such as Fixed Deposits, which is the other significant source of funding for the banks.
The private sector banks like ICICI and HDFC can generate higher net interest margins since they have significant CASA funds (around 45% of their liabilities). However, these low-cost CASA products carry a higher risk. The CASA funds are also called ‘demand deposits’, since the depositors can withdraw these from the bank at any time, thus creating a nightmare for the banks in matching their assets and liabilities. It is important to note here that most of banks' assets portfolio is of long term maturity, except a few like credit card outstanding. Thus, the banks must constantly monitor their liquidity as well as asset- liability to meet its obligations, retain public confidence, and stay in business.
On the asset side, the banks try to maintain minimum cash on hand, since the cash does not generate any returns for the bank. Handling cash takes more efforts towards counting, sorting, storage, retrieval, transport, record-keeping and auditing, as compared to other assets. Additionally, holding cash requires bank to take measures for its safekeeping and security. Moving cash to and from currency chests into branches and ATMs involves a lot of logistical, security and risk management effort. Hence the banks maintain minimum amount of cash at the branches and in the ATM machines.
With the withdrawal of existing stock of Rs 500 and Rs 1000 notes on 8th November, the mainstream media is fueling panic in the masses, in its rush for TRPs. The media has long abandoned its role of educating people when a situation of change or crisis emerges, as we have repeatedly observed during terror attacks, earthquakes and other crisis situations. Instead, journalists are selectively highlighting stories of long queues at the banks and ATMs, and of people suffering due to non-availability of cash. This continuous publicity has created fear in the minds of people, and they are queueing up in front of the ATMs and bank branches for withdrawing cash, even if they can manage without more cash for days and weeks. The RBI had to issue an appeal to the public to avoid panic and chaos, remain calm, and not withdraw cash many times.
The availability of money is determined by two factors, (1) the stock of money, and (2) the velocity of money. The velocity of money is the rate at which the money changes hands. If people start hoarding the money, the velocity of money goes down. With the stock of money remaining the same, the availability of money goes down, since the velocity has gone down. This phenomenon is also reflected in ‘Gresham’s Law’, which states that, bad money drives out good money out of circulation. We all have experienced that soiled currency notes get circulated fast because everybody wants to get rid of those notes first, while hoarding the crisp new notes.
The panic situation created by the mainstream media and the rhetoric of the opposition parties has the potential to create a self-fulfilling prophecy. A self-fulfilling prophecy is a prediction that directly or indirectly causes itself to become true, by the very terms of the prophecy itself, due to positive feedback between belief and behavior. For example, a rumor about non-availability of salt itself can lead to the shortage of salt if panic buying and hoarding persists. If people panic and rush to ATMs and bank branches, the ones who genuinely need the cash will be deprived of it. This will lead to more panic and rush for cash withdrawals. Additionally, those who have cash in their possession will hoard it, fearing they may not get it later.
There appears to be a systematic effort at creating panic in the minds of people regarding scarcity of currency notes. The words such as "currency ban" are scrolling across the TV screens and getting splashed across the front pages of the newspapers, when there is no "ban", but only exchange of current stock of currency notes with the new one. In the normal course rumors, can be ignored, however, since these rumors have the potential of turning itself into a reality (aka, a self-fulfilling prophecy), it must be countered with massive publicity. People must be educated about how long it will take for the situation to normalize. If the normalcy is expected within say, six weeks, it should be communicated. If expectations are not set realistically there will be a mismatch thus leading to chaos and distress.
Prime Minister Narendra Modi understands how big and critical this exercise is and that is why he personally announced this demonetization drive to the citizens, rather than leaving it to the Finance Ministry and the RBI. I hope and trust the situation is being monitored closely and continuous communication will flow. BJP must also ensure that the party leaders, MPs and MLAs are on the streets talking to citizens and allaying their fears. We all know that there is nothing like "over communication" when it comes to strategic initiatives, because rumors fill up the vacuum in the absence of credible official communication. And the PM himself must address the people again, if the rumor mongering persists.
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