Understanding the Dynamics of Payments System in Banking

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How do firms make payments to one another? Do they actually pay cash? Do they transfer deposits from one account to another at a bank?

An important characteristic of the economy is the time lapse between the production and consumption of goods. Production always precedes consumption, hence producers produce in anticipation of some levels of consumption. Similarly, retailers who stock these consumer goods expect to sell those products in the market in the future. So, at every level of the chain from production to final consumption, there is a element of time-lapse in their cash commitments and cash inflows. How is this managed?

Suppose firm A is a retailer and firm B is a wholesaler, trading in goods and both have an account at a ‘Bank’. When firm A buys goods from B, it does not have the requisite money in the form of cash to pay B. So, it might issue ‘Bills of Exchange’ which is a promise to pay B the cost of goods bought, say in 90 days. The balance sheets of A and B may look something like this:

Bills appear as liability for A and an asset for B, allowing A to buy without making payments right away

If the Firm B is satisfied with this, then there is no need for a bank. However, B might need ‘liquid’ cash in the form of currency notes to pay somebody else which Bills do not provide as they are ‘illiquid’ for its term (here, 90 days). Or B might not be sure if A will repay the amount. So, B might look for a entity to discount the Bills and provide it with cash.

Enter the Bank:

Bank discounts the bills, providing B with liquidity

What incentive does bank have to do this transaction? Notes are zero-interest assets for the bank. When the bank discounts bills, it acquires an interest paying asset. However, the Bills are not means of payment for the deposits it has as liabilities – only notes can serve that purpose. So, the transaction of Bills for notes has an element of liquidity risk for the bank i.e. it may not have sufficient notes to satisfy the withdrawal demands of depositors.

How might the Bank reduce this risk? Instead of paying notes to B, what if the Bank opens a deposit account for B? What does B’s and Bank’s balance sheets look like then?

Bank does not have to immediately supply B with the notes that it had to, earlier.

In this iteration, the Bank promises to pay notes, instead of paying notes immediately. This is a way for the bank of economize its note issue. This adjusts the liquidity risk of the bank, but only slightly. Is there another way?

What if the Bank guarantees the Bills of Exchange by ‘accepting’ the Bill, saying something like – “If the firm A does not pay the Bill on maturity, I’ll pay”. How do the balance sheets look like then?

Bank just guarantees the Bill

In this case, if A isn’t able to pay the amount mentioned in the Bill, the Bank has to pay it on the maturity of the Bill. So, the bank does not have to worry about liquidity for the term of the Bill (here, 90 days). This is similar to time deposits, which can be liquidated only after a certain time period, although it is contingent on A’s business in this case. This is very similar to the more complicated Credit Default Swaps (CDSs).

But why would Bank engage in this transaction? B pays Bank a ‘premium’ (fee) upfront for guaranteeing a future payment. So, if Bank can judge well that A will pay on time, this business seems without much risk. Worry for the bank is if A is unable to pay on time.

We see that in these iterations that Banks provide firms with liquid assets (notes/deposits) in exchange for illiquid assets (Bill of Exchange) allowing for balance sheets to expand temporarily for trade to happen and then the balance sheets contract when A makes the payment.

On completion of first iteration, the balance sheets look like this:

Bank receives the notes from A when the latter earns notes from sale of goods and fulfills its cash commitments. Note that B is not directly affected by this repayment, in fact B is not involved at all.

In case of deposits, the balance sheet look like this:

In this case, B may or not be directly affected by A’s repayment. If B has already withdrawn from Bank, A’s repayment won’t affect it. However, if B hasn’t withdrawn from its deposit account at the bank and bank is at a shortage of notes, then B might be affected.

In case of ‘acceptance’, if A repays the notes to B, the guarantee of the Bank is not invoked and the balance sheets look like this:

Bank does not have to pay any money to B and the acceptance expires without being invoked.

In this case, A’s ability to pay in notes becomes vital for B because it determines whether B will have to invoke the ‘guarantee’ with Bank or not. So, unlike previous iterations, B is dependent on A for future cash inflows. If A does not pay, then the balance sheets look like this:

Bank ‘guarantee’ is invoked by B when A is unable to pay on maturity of the Bills

In this case, B has an alternate source of liquid funds from the Bank – which can either supply it with notes or open a deposit account (much like it did in the second iteration!). Also, note that while the acceptance is invoked, the Bills of Exchange remain unsettled and shift to the balance sheet of Bank which is better able to bear it. We can also see that the problem here is not necessarily of A defaulting, but of A having to delay its payments and disturbing the timeline of cash inflow of B.

So, in these temporary expansion of balance sheets on both sides,the Bank provides both firms A and B with elasticity to carry out their respective trades in the market while enforcing discipline on them when Bills mature. We should not forget that these are not the only balance sheets in the market.

Different Bills mature at different points in time, so the Bank knows when it can expect to receive cash. On the liabilities side, it can broadly predict the withdrawal preferences of its depositors. To match these cash commitments with cash inflows, not just in amounts but also line them up in time, is the very essence of banking.

Reference:

  1. Mehrling, P.; Course: ‘Money and Banking’ at Barnard College – See
    http://www.perrymehrling.com/

India: The Agrarian Crisis

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Qualitatively and quantitatively, there is a difference between the terms – rural, agriculture and agrarian – although there is a lot of overlap. Everything rural is not agriculture, for example, the industrial workers in villages. Similarly, everything agrarian is not limited to agriculture either. There are weavers, tailors, masons, carpenters who depend on agriculture, which is the act of cultivation.

Farmers, who?

According to the Census of India, the farmer or ‘main cultivator; is someone operating a plot of land for 180 days or more, such that their livelihood is most dependent on it. This definition does not place gender or land ownership qualification. However, the image that we have of a farmer is of a man with a plough or a tractor. Actually, more than 60% of work done in agriculture is by women, overwhelmingly dalit and adivasi women.

Dalit farmers who own land, either have land but no title deed (‘patta’) due to word of mouth sale, or they have a ‘patta’ but don’t occupy the land as some zameendar has taken over. Similarly, adivasis are counted as encroachers in their own lands. When a suicide happens, the police do not follow the census definition but ask for the ‘patta’ for counting purposes. Women, dalits and adivasis are often excluded as their family cannot show the ‘patta’ in the dead person’s name.

Counting Suicides – How?

The counting of suicides in India was done by the National Crime Records Bureau (NCRB). It used to be like a giant census of crime where each local police station filed its crime numbers to the District Crime Records Bureau. Each district then consolidated the data and filed it onward to the State Crime Records Bureau which then compiled the data to be sent to NCRB for analysis. It published Crime data and ‘ADSI’ (Accidental Deaths and Suicides in India) data separately.

This was by no means a perfect setup. The data was already skewed by the prejudices of society. For example, it showed zero women farmer suicides in Punjab and Haryana since women were not counted in the farmer’s category due to social prejudice. However, as the number of women farmers’ suicides fell, the number of non-farmer women suicides explodes. So, one could at least see that the data depicted the bias.

Hiding Suicides!

Starting 2013-14, there was a explicit imposition of prejudice, with data structures being altered to bring down the numbers. But it didn’t work. Later in 2017, the government shut down NCRB and merged with Bureau of Police Research and Development (BPRD) because the former was providing inconvenient data. BPRD mostly outsources its reports to consultants and does sample surveys occasionally while NCRB was a census. This was meant to suppress farmer suicide data, but it naturaally hid all other data as well. So, after 10 months, NCRB was de-merged but has not been allowed to publish farmer suicide data.

The numbers that are reported today come from Revenue departments of state governments – a system that started in Maharashtra in 2006-07. The revenue department collects number of suicides as it has to disburse compensation given to suicide families. To decide whether a farmer suicide is genuine or not, they form committees in all collectorates, whose main aim is to bring the numbers down.

In this endeavor, they have created new categories to not count all people on the farm. For example, a separate category of “No. of farmers’ relative suicide”, who are not included in farmer’s suicide even if they work on the farm. From 2014 onward, the numbers do not mean a thing as they cannot be trusted and cannot be compared with previous 20 years.

They have divided farmers into farmers who are landowners, tenants farmers and agricultural laborers – as farmer suicide numbers fall, the ‘other’ category explodes. Tenancy are word of mouth agreements without documents, which means that they cannot get a bank loan and have to depend on moneylenders for borrowing input materials. However, when a crop fails, the landowner whose name is on the ‘patta’ is given compensation by the government although all inputs were borne by tenant. Tenants are included in the agricultural labor category and there are no records of them either.

Crisis Beyond Farmers

Beyond the core agriculture community, there are potters, weavers, tailors, carpenters, masons etc. whose livelihood depends on the economy of agriculture. They are paid mostly in food by the farmers and not in cash. As farmers go into crisis, nobody orders a new cart or a plough or retools their equipment. So, these allied occupations that form the agrarian economy go into crisis as well – seen in the suicides by weavers, carpenters etc. But the numbers do not reflect this. The agrarian population is much larger, at about 51% compared to the 8% who are ‘main cultivators’. So, as we have seen, everyone in the agrarian society is not a farmer.

Many Crises

Moreover, there is no one crisis. It is a multiplicity of crises, much of it policy driven. Nature is surely erratic and a huge problem but it is also a convenient villain for conscious policies that have driven the agrarian economy to the brink. There is the employment crisis, water crisis, migration crisis, credit crisis and the bank crisis. It has gone way beyond the agrarian, it is now a societal or a civilizational crisis – a crisis of our humanity. The question that needs to be asked is, how are comfortable with lakhs of farmers committing suicide every year?

How did this crisis come to be?

In 1998-99, farmers were not making demands for loan waivers or Minimum Support Price (MSP). It must be noted that even today, only 6% farmers have access to MSP. The cost of cultivation has increased by more than 400% in 10-15 years due to price gouging by agri-business corporations in the name of free markets. The native seeds that were earlier sold very cheaply, were replaced by 50 times costly hybrids and then by even costlier (150-200 times) branded ones – overtaking completely the market of homegrown seeds.

At the same time, agricultural credit was looted and diverted to corporations. In the last 20 years, loans to poorest farmers have collapsed by more than 50%, while loans of 20-25 crores have more than doubled. National Bank for Agriculture and Rural Development (NABARD) which oversees the distribution of this credit, in 2017-18, allocated 53% of the credit for Maharashtra to Mumbai city. Who were these entities to whom credit was disbursed through urban and metro bank branches in Bandra? Agri-business entities in Mumbai – companies of seeds, fertilizers, pesticides – were brought under the relaxed definition of agriculture in priority sector lending. This meant that they received a large chunk of agriculture credit.

That is why farmers are today in such a sticky mess, due to diversion of credit away from them. Just as prices were increasing for inputs, agriculture credit was shifted from farmers to agri-businesses, bleeding the farmers for the last two decades. This has been so drastic that the bottom quintile of Indian population has seen its wealth turn negative, that is, they are net in debt. This reflects a phenomenal policy-driven immiserization. This has harmful effects on education of children of agrarian workers who are forced to take jobs leaving aside their education. As the agrarian economy collapses, people are also forced to migrate in search for jobs.

The Water Crisis

The water crisis manifests most clearly in regular droughts, which lead to failure of rabi crops, which causes failure of fodder and hence, livestock deaths. More subtly, there are huge transfers of water:

  • From agriculture to industry, with state police against protesters,
  • From food crops to cash crops (e.g. sugarcane which consumes 10 times more water than Jawar),
  • From rural to urban areas – Urban areas use about 400% more water (Water for Mumbai comes from Adivasi areas in Thane who have no pipe connections),
  • From poor to rich (e.g. alcohol and beer factory are provided water cheaply while poor have to buy at a higher cost),
  • From livelihood to lifestyle consumption – water used water parks, swimming pools while people do not have it for drinking

Conclusion

Agriculture Produce Market Committees which were sought to create a transparent market have failed. They have acted to transfer products to corporates power and are controlled by people who work as middlemen for entities like Reliance Fresh and Godrej Natural. This means that the local vegetable seller does not have access to fresh fruits and vegetables.

While we may get the products we want cheaply, it does not mean farmers get their due. 77% of Indian farmers buy food on the market because they have small size land holding and do not produce sufficiently. In such fragmented cultivation, crashes in prices hurts them badly. There is little in the way of relief. Loan waivers are being looked down upon as subsidies. We should not forget that EU and USA give the biggest agricultural subsidies in the world and that subsidies reduces our own costs of consumption. They serve to lighten the burden of the farmers even if they do not solve the problem.

We are complicit in being part of the problem. Does it matter to us any more that others suffer even if we do not? Does justice mean anything to us, even when we are not denied it?

The agrarian crisis is, in many ways, a crisis of our humanity. Are these just suicides or induced murders – driven by policy?

Note: This essay is a summary of notes taken from Mr. P. Sainath’s lecture on: “Agrarian Crisis in the Age of Inequality” at IIT Bombay in April, 2019.