Are Bank NPAs linked to Note Exchange Exercise | ‘Note Bandi’

It’s being seen that any criticism of the removal of Rs 500 and Rs 1000 notes is not getting favorable hearing.  Which is sad as this removal or ban or de-monetization exercise has many dimensions to it.  Some of those are intrinsically related to ordinary citizens.

Is the action of the de-monetization of Rs 500 and Rs 1000 notes linked to Non-performing Assets of Banks (NPAs)?

I’m asking this as some people are asking this question.

Assuming that our readers are interested in this question, here’s our take on the question.

Banks are quite weary of NPAs. Simply because NPAs, as the name suggests are non-performing assets. For instance, if a debtor (one who takes loan for the bank) stops paying interest to the bank, then it becomes a non-performing asset for the bank. Obviously banks want to keep NPAs at low levels. That’s they want the percentage of NPAs at a low-level. How do they do it?

Banks have two ways to accomplish this.

One, they can either stop assets from becoming non-performing, This they can do by minimizing bad loans or ensuring their conformance (interest is paid in a timely manner and; no new loans are given to habitual defaulters).

Two, the banks can keep giving loans to habitual defaulters (keep increasing NPAs), but ensure that their balance sheets remain clean. How do they do it? By ‘Write-off’ the NPAs. In simple words, they adjust the present NPA with real money or assets from their chest; and rather than declaring the non-conformance as default, make the defaulter sign an undertaking that although the loan has been written off, the defaulter is still liable to pay the debt. This solves two purposes: The bank manages to keep its balance sheet clean and; the defaulter can again be issued a new loan.

In a developing economy or a fast growing economy the percentage of NPAs keeps increasing. In an economy where Businesses are growing, the percentage of NPAs increase many-folds. In a country such as India, they range in Lakh of crores of Rupees. If NPAs are that big then writing offs also range in Lakh of crores of Rupees. As most of such debts are never paid. But an ever-increasing bank chests because of public money helps banks do some balance sheet jugglery.

At present when Lakhs are Rupees are being deposited in banks on the pretext of Note exchange, it has become easier for banks to reduce their NPAs. As more money in Bank chest means lower percentage of NPAs. For banks this means easier write-offs and; an ability to sanction more bad loans.