India’s banking system is facing a sharp cash squeeze as the Reserve Bank of India (RBI) maintains tight liquidity conditions to curb bets against the rupee. The central bank’s liquidity strategy has reduced surplus funds available to lenders, pushing short-term borrowing rates higher and raising concerns about funding costs across financial markets.
Excess funds held by Indian banks fell from a peak of ₹11 trillion ($116 billion) in early September to ₹46,200 crore as of October 26, according to a Bloomberg Economics index. The decline has accelerated since the RBI introduced broad measures earlier this month to defend the rupee as it approached a record low.
Analysts at IDFC First Bank and Emkay Global Financial Services expect liquidity conditions to remain tight. They believe the central bank is reluctant to fully replenish the funds available to the banking system.
Key Highlights
- Bank surplus liquidity dropped from ₹11 trillion in early September to ₹46,200 crore on October 26.
- RBI’s currency-defense measures have pushed overnight borrowing rates toward the upper end of its policy range.
- Higher funding costs could increase borrowing expenses for non-bank lenders and other market participants.
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RBI’s Liquidity Strategy Targets Rupee Speculation
Emkay Global Financial Services Chief Economist Madhavi Arora said the tight liquidity conditions appeared intentional. According to her, the RBI’s actions are designed to increase the cost of hedging against further rupee weakness and taking positions against the currency.
When borrowing rupees becomes more expensive, traders face higher costs when borrowing the domestic currency to buy dollars. This can discourage speculative bets against the rupee.
However, the RBI has offered only limited relief to banks. It has capped liquidity support at ₹1.5 trillion so far, without providing additional funds on days when demand exceeded the available amount.
The resulting squeeze has pushed overnight borrowing rates close to the upper end of the central bank’s policy range.
RBI Governor Sanjay Malhotra said on Friday that monetary policy could sometimes be used to address financial stability risks. Asked whether interest rates could be part of the central bank’s currency-defense measures, he said the rate-setting committee “certainly deliberates on” the issue.
His comments indicate that interest rates remain among the tools considered when assessing risks to financial stability.
Bank Funding Costs Rise as Cash Tightness Spreads
The impact of the liquidity squeeze is spreading beyond overnight borrowing markets. Rates on fresh three-month and six-month certificates of deposit rose by around 40–50 basis points last week, reaching a seven-month high.
Certificates of deposit help banks raise short-term funds. Higher rates on these instruments increase banks’ borrowing costs, which could eventually affect the cost of funding for non-bank lenders as well.
Ajay Manglunia, Executive Director at Non-Bank Lender Capri Global Capital, said uncertainty over interest rates was making investors cautious. He added that rising crude oil prices could lead investors to demand higher returns on their investments.
“There is a lot of uncertainty on where rates will go from here, but if the macro situation stays as is and crude oil prices inch higher, investors will want a premium on their investments,” Manglunia said.
He warned that borrowing costs could rise further, adding that “the borrowing cost curve can get steeper.”
With banks’ surplus funds falling sharply, the RBI’s liquidity strategy is becoming a key factor for short-term interest rates and funding conditions. If tight conditions persist, banks and non-bank lenders could face continued pressure to secure funds at higher costs.
