Rules of an exchange economy

How do we work out the obligations of banks in the post-demonetisation scenario?

For any two parties (individuals or corporates) entering into financial transaction, the arrangement is bound by contracts as are obligatory in an exchange economy where money is the medium of transactions. While contracts, especially when breached, are subject to the laws of the land, the basic norms of an exchange economy make it obligatory in any such exchange that the debtor has to honour the claims of the creditor.

As with all exchanges, the above also holds true for financial transactions between banks and the non-bank public. Those cover the deposits advanced by the non-bank public to the other (mostly banks) on a short- or long-term basis. While not explicit, there always exists a contract underlying those exchanges. The contract, as specified in standard documentations on related issues, “… is a voluntary arrangement between two or more parties that is enforceable at law as a binding legal agreement”.

Currency crisis

Let us now consider the implications of the recent demonetisation exercise in India. According to official statistics, the stock of M2 or narrow money, which is defined as the sum of currency held by the public plus their demand deposits in banks, comprises 18.64 per cent of GDP at current prices on an average between 2013-14 and 2015-16. Of the M2, currency in circulation (as held by the public, excluding cash with banks) has been at 90.67 per cent, demand deposits held by the public at 5.51 per cent and cash with banks at 3.73 per cent of M2, held as an average during the period. The large share of currency in circulation held by the public indicates its importance as the vehicle of transactions in the economy. Along with the demand deposits in banks, the sum is of crucial importance as an enabling factor for growth in the economy.

The recent ban on old currency notes affected the higher-value notes which comprised 86 per cent of the total value of notes in circulation. The most pressing concern is the current inadequacy of currency at banks and the consequent inability on their part to fulfil the cash demand of public. Thus even the promise to provide Rs.24,000 as the upper limit of cash withdrawal per week is being violated in most cases. This amounts to a failure on part of banks to manage their liability vis-à-vis the public. The situation is one of a breach of contract with banks failing to provide services to their customers. In other words, it amounts to a failure on the part of banks to meet the dues on their liabilities which include the interest as well as the principal in the demand deposits as are held as assets by the non-banking public with the banking system.

What constitutes breach

Let’s look at some similar violations amounting to a breach of contract between banks and their customers in the past, from what the Reserve Bank of India lists in its database as ‘Consumer Cases on Banking’. In P.N. Prasad v. Union Bank of India, 1991(1) CPR 198 (SCDRC-AP), the verdict was this: “The bank is liable for deficiency in service for inordinate delays in providing banking services and the customer of the bank is entitled to claim compensation for the loss and the injury suffered by him due to the inordinate delay in the payment of the amount of deposit certificate on its premature encashment.”

In a second such dispute, Dilip Madhukar Kambli v. Nilesh Vasant Borkar and Ors, 1991(1) CPR 571 (SCDRC-New Bombay, Maharashtra), it was recommended that “the banker is supposed to safeguard the interest of the depositors when his amount is entrusted to the custody of the Bank and the Bank is liable to return the amount with interest… This amounts to deficiency in service by the bank”.

In a third instance, N. Sahadevan v. Manager, Syndicate Bank, 1991(2) CPR 617 (SCDRC-Kerala), the verdict stated: “They (Banks) must be ever vigilant and solicitous about the interests of their customers departure from such standard can cause inconvenience not only to stray individuals but widespread economic disaster. The Banks should therefore be enjoined to maintain their services efficient and above reproach. In view of the above it was held that where the bank caused unexplained delay in the mail transfer of money it amounts to deficiency in service for which bank is bound to compensate.”

The above examples can be identified as a breach of contract relating to the access of customers to their demand deposits with banks. By extension, we must ask if the current post-demonetisation experience ought not to be viewed as a breach of contract. Relating the failure to a state of insolvency as under the Insolvency and Bankruptcy Code may be a bit far-fetched, however, because a delay in payment does not amount to default.

While the government is assuring the public that the current phase of ‘inconvenience’ is but temporary, uncertainties abound about the time span it will take for the ordeal to end. In the meantime, the alternative sources of access to cash via informal channels of, say, the village moneylender, would naturally be on tougher terms.

The hardships are both at the individual level of depositors who are denied access to their financial assets advanced to banks as well as for the economy with the unleashing of growth-retarding forces of austerity via shortage of liquidity. These call for further introspection, possibly along the legal implications of this very unjust policy.