Nine months after India’s radical demonetisation exercise, the financial sector is still grappling with its complex implications.
The sudden withdrawal of high-value notes sent Indians rushing to banks to deposit the condemned currency. The central bank estimates that the intervention had boosted bank deposits by Rs2.8tn-Rs4.3tn ($43.7bn-$67.1bn) as of the end of March.
India’s dominant state-owned banks, ailing under a stubborn burden of bad loans, have struggled to translate this cheap funding into strong lending growth.
The slack is being taken up by their healthier private sector rivals, which are promising consumer credit without the lofty interest charged by informal moneylenders.
At IndusInd, a big private lender, consumer loans rose 22 per cent in the year to June. “The first loan is used to repay the loan shark,” Romesh Sobti, IndusInd chief executive, said. “That enables the second loan, and the third loan, which lift people out of poverty.”
The banks have competition for these low-income customers in the shape of non-bank lenders such as Bajaj Finserv, whose market capitalisation has quintupled in the past three years.
Sanjiv Bajaj, the company’s chief executive, says a key enabling factor is a dramatic improvement in India’s data infrastructure, which has slashed the costs of lending to poorer Indians.
Particularly useful has been the Aadhaar biometric identification system, which has now signed up more than 1bn Indians and enables lenders to confirm their customers’ details far more swiftly.
Three years ago, Bajaj Finserv identified $400 as the minimum profitable loan size. That figure has now fallen to $100, Mr Bajaj says.
For funding, non-bank lenders have been able to turn to a welcoming bond market, which has been helped by strong inflows to fixed income-focused mutual funds. Their assets under management were 52 per cent higher last month than two years before.
Analysts at Ambit Capital warn that many of these non-bank lenders could be vulnerable to any rise in defaults among small businesses. If their troubles then led to a bond market downturn, they write, appetite for financial savings products could be hit.
Still, by sucking more money into the financial system, demonetisation could help accelerate a trend in household savings that has been visible for the past six years.
Improvements in financial literacy, coupled with moderate inflation, are eroding a tendency to store wealth in land and other tangible goods.
In the financial year ending March 2016, gross financial savings overtook savings in physical assets, excluding precious metals, according to the latest government figures.
This shift has been sustained in part by a fast-expanding life assurance industry, where new business premium collections grew 26 per cent in the latest financial year.
Some of the biggest names in the global sector have set up local joint ventures that tailor their offerings to less affluent customers. AIG’s venture with Tata Sons offers policies with annual premiums as low as Rs586.
And in nearly every part of the Indian financial system, tech start-ups are angling for a piece of the pie.
Digital “wallet” providers such as Paytm, backed by Alibaba and SoftBank, were a big beneficiary of demonetisation: the shortage of cash prompted a jump in monthly mobile wallet transactions from 99.6m in October to 213m in December.
There are potential threats to these encouraging trends. An uptick in inflation, perhaps driven by a jump in the cost of India’s vast oil imports, would send many investors scrambling for the safety of physical assets.
The still nascent growth of the mutual fund industry could be undercut by a stock market slump — benchmark indices have nearly quadrupled since the global financial crisis.
Some doubters, moreover, question the merits of demonetisation itself. The cash shortage squeezed the incomes of millions of low-income Indians, and there is still no evidence that the intervention had its promised effect of wiping out billions in illicit “black money”.
Over the long term, however, it would be rash to bet against the steady spread of India’s formal financial sector.
As for how much credit for this is due to the government — that debate will continue to run.