The cash cushion that Indian banks built up over the summer is thinning out fast. Surplus liquidity in the banking system has dropped to about ₹46,200 crore as of 26 October, down from a peak of nearly ₹11 lakh crore in early September, according to a Bloomberg Economics index. That is a fall of roughly 96 per cent in under two months.
The squeeze is largely by design. The Reserve Bank of India (RBI) has been keeping rupee liquidity tight to make it costlier for traders to borrow rupees and buy dollars, as the currency came under pressure and neared record lows earlier this month.
How the RBI got here
Over the past several weeks, the central bank has used a mix of tools to drain excess funds from the system. These include open market sales of government bonds and a tighter daily cash reserve ratio (CRR) requirement, under which banks must maintain 99 per cent of their CRR on a daily basis from 16 October, against 90 per cent earlier. The RBI also raised its policy rate earlier in October, its first hike in close to four years.
At the same time, relief has been rationed. The RBI has so far capped its liquidity support through variable rate repo operations at ₹1.5 lakh crore, and has not added more funds on days when banks bid for more than what was on offer.
Madhavi Arora, chief economist at Emkay Global Financial Services, said the tightness appears intentional, aimed at raising the cost of hedging against, or betting on, further rupee weakness. Analysts at Emkay and IDFC First Bank expect the crunch to continue, with the RBI seemingly reluctant to fully restore system liquidity.
RBI Governor Sanjay Malhotra said last week that monetary policy can at times be used to address financial-stability risks. Asked whether interest rates could be part of the currency-defence toolkit, he said it is something the Monetary Policy Committee does deliberate on.
Funding costs are moving up
The impact is already visible in short-term funding markets. Rates on fresh three-month and six-month certificates of deposit (CDs) rose by about 40–50 basis points last week to a seven-month high, while overnight borrowing rates and deposit yields have also firmed.
Costlier bank funding tends to flow through to non-banking financial companies (NBFCs), which rely heavily on bank loans and market borrowing. Ajay Manglunia, executive director at Capri Global Capital, noted that with uncertainty over the rate path and crude oil prices, investors are likely to demand a premium, and the borrowing cost curve could steepen.
What it means for banks
For lenders, the shift from abundant to scarce liquidity matters on several fronts. Tighter funds and higher CD rates can squeeze net interest margins, particularly for banks that are leaning on bulk deposits to fund loan growth. Treasury desks are likely to stay cautious, and deposit competition could intensify through the busy festive and year-end credit season.
Much will depend on how long the RBI keeps its hand on the brake. If pressure on the rupee eases, the central bank could open the liquidity taps more freely. Until then, banks and NBFCs should plan for a period of tighter money and higher short-term borrowing costs.
