The Indian stock market peaked on 10 Nov, two days after the announcement of the demonetisation program. Since then, the benchmark Nifty 50 Index has declined 6.6% between 10 Nov and 24 Nov, and the Nifty Bank Index has declined substantially more, 9.6%, during the same period. Since many have claimed demonetisation would be a bonanza for banks, and that they would profit handsomely from the surge in deposits, this market move seems a bit odd.
In order to understand this, we start with the question, why should we expect increases in deposits to be good for a bank? After all, deposits are not bank assets, they are bank liabilities, and they cause a money outflow in the form of interest payments. Nevertheless, under normal conditions, an increase in deposits is, in fact, good news for a bank, since it allows the bank to grow its loan portfolio, usually by an amount that is considerably larger than their new deposits. Since the bank lending rate is higher than the deposit rate, this leads to higher net income for the bank.