Economic and Political Weekly

Bank Deposits in the Indian Economy: A Comment Author(s): G.
Narayanan Reviewed work(s): Source: Economic and Political Weekly, Vol. 3, No. 3 (Jan. 20, 1968), p. 199 Published by: Economic and Political Weekly Stable URL: http://www.jstor.org/stable/4358156 . Accessed: 25/01/2013 17:33
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Bank
Deposits
in
the
Indian
Economy
A Comment
G Narayanan
In his article 'Bank Deposits in the Indian Economy: Creation and Leakages' (Special Number, August 1967), V G Pendharkar does not considetr the impact of expansion of deposits with the non-banking sector on the growth of bank deposits. He does not see any possibility of growth of bank deposits being adversely affected since he holds that deposits initially diverted from banks to non-banks would find thei way back to the banking system and remain there. Actually, given the general scarcity of loanable funds and Reserve Bank restrictions on lending by commercial banks, there is a natural tendency for interest rates to tise in the uncontrolled sector and thlis does cut into the expansion of bank deposits. The recognition of the non-banking sector as an active conmpetitor for deposits is, therefore, essential for adoption of policy measures to prevent progressive erosion of the importance of the banking system.
PENDHARKAR'S concern over the continuing large leakage of cash out of the banking system with its consequent impact on the rate of growth of bank deposits merits wide attention. The Reserve Bank has essayed, over the years, a policy for expansion of the banking habit by inducing branch expansion, ensuring a modicum of security of deposits through deposit insurance, and so on. Surprisingly, Pendharkar is quite complacent about the likely impact of the growth of deposits with the non-bankiig sector on deposit growth in the banking system. He does not see any possibility of an erosion in bankdeposit growth on account of this factor since he holds the view that deposits initially diverted from banks to nonbanks would fhnd their way back to the banking system and remain there. At any point of time the structure of financial assets held by the public would reflect relative preferences as between different types of assets, depending upon factors such as liquidity and yield. Other things remaining the same, if yields on relatively illiquid assets increase, the public would tend to shift its asset holdings from money to non-money assets. Similarly, if a large yield differential appears between two types of assets with the same liquidity characteristics, there will be a tendency to shift from the holding of low-yield assets to high-yield assets. The point at issue is whether such shifts in the asset preferences of the public from bank deposits to non-bank deposits could have an impact on the level and rate of growth of bank deposits. Pendharkar seems to conclude that, whatever may be the changes in the public preference pattern, they will be helpless in reducing their holdings of bank deposits since, in the first instance, the non-bank houses and, subsequently, the borrowers from these houses and recepients of payment from such borrowers will keep the funds so received in the form of deposits with banks. Given (i) a stock of currency with the public and (ii) the cash reserve requirenmentsof, banks, the rate of growth of bank deposits will depend upon the public's preterence as between cash and bank deposits. The latter relationship would tend to be stable as long as there are no competing assets available with liquidity characteristics similar to bank deposits. If such competing assets are available, would it not be reasonable to presume that though the public preference as between cash and bank deposits in any form may be unchanged, there would be a change in cash to bank deposits ratio, since non-bank deposits would fill part of the demand for earning but relatively liquid assets? Let us assume that the ratio of banks deposits to currency with the public is 1:1 to begin with. Now let 25 per cent of deposits in banks be shifted to nonbanks. At this stage, since non-banks will keep the funds as deposits in banks, bank deposits will remain unchanged but the non-financial sector would have succeeded in (a) reducing its bank deposit/currency ratio to 0.75 :1 and (b) maintaining its total deposit/currency ratio at 1:1. In the third stage, let non-banks issue cheques to members of the public who borrow from them. The public holdings of total deposits will then rise to 1.25 and of bank deposits to 1. If the public desires to maintain its total deposit/ currency ratio at 1: 1, this will be reflected in a withdrawal of cash both from banks and non-banks. Assuming, however, that the stock of cash is constant, equilibrium will be reached only through contraction of total deposits to 1; if the preference as between bank deposits and non-bank deposits is assumed to remain unchanged. banks will end up with deposits of 0.75, non-banks with deposits of 0.25 and cash with the public will be 1. This is admittedly a crude presentation but should serve as a broad description of the entire process. A more accuratc working out of the new equilibrium will have to take into account changes in banks' own cash holdings, and the reserve practices of non-banks including assumptions on the proportion Df their reserves held as cash and as depositwith other banks. The fiscal result will, however, not be significantly different from the crude description given above. The recognition of the non-baniksector as an active competitor for deposits is essential for the adoption of policy measures to prevent a progressive erosion of the importance of the bankinig system. The complacence which appears to have developed regarding the entire structure and level of bank deposit rates is based primarily on the assumption that, despite the increasing statistical evidence regarding the growth of nonbank deposits (with industrial and trading companies, hire purchase institutions, nidhis, chit ftnds, etc), there cannot be an absolute diversion of deposits from banks to non-banks. Given a general scarcity of loanable funds and Reserve Bank restriCtionson lending by commercial banks, there is a natural tendency for interest rates to rise in the uncontrolled sectors, which cuts into the expansion of bank deposits. If the Reserve Bank becomes aware of this potential of the non-bank sector, its monetary policy would ensure a more competitive yield structure for bank deposits vis-a-vis deposits with non-banks.
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