Banks can’t rely only on RBI to bridge their liquidity deficit

Besides some key expected measures, the Monetary Policy 2025-26 on April 9, 2025, is expected to cut the repo rate by another 25 basis points to bring the repo rate down to 6 per cent while maintaining the neutral stance of the policy.

The monetary policy committee (MPC) can draw comfort from the fact that CPI inflation is down to 3.61 per cent in February from 4.26 per cent in January 2025 and from 5.09 per cent in February 2024, affirming a sequential decline. Moreover, food inflation is also down from 5.97 per cent in January to 3.75 per cent in February.

Q3 GDP in Q3 ended better at 6.2 per cent, up from 5.6 per cent in Q2, indicating its continued resilience despite downside risks. To achieve 6.5 per cent GDP growth in FY25, monetary policy support will be needed.

Growth will need monetary policy support to reach the average targeted GDP level of 6.5 per cent during FY25 and to sustain better trends. The domestic economy will need More Further rate cuts during 2025 by RBI will be required, even though both the US Federal Reserve and the Bank of England have paused the interest rates due to increasing uncertainty. Even the Bank of Japan held the uncollateralised overnight call rate at 0.5 per cent.

The average core inflation in the US is at 2.8 per cent, higher than expected. The average CPI index in the UK too stood at 2.8 per cent on a year-on-year basis in February 2025, a notch down from 3 per cent in the 12 months to January 2025. The ongoing global tariff tiff and geopolitical complexity continue to pose downside risks to growth and upside risks to inflation.

Liquidity stress

RBI has been actively providing liquidity support with the reduction of CRR from 4.5 per cent to 4 per cent in December 2024, releasing ₹1.12 trillion into the banking system. It is conducting daily variable rate repo (VRR) auctions of different tenures.

It is also conducting USD/INR Buy/Sell swap auctions for durable liquidity, and open market operations (OMO) by purchasing government securities. Despite continuous liquidity supply, the liquidity deficit in the banking system is estimated to be close to ₹1.58 lakh crore which could be narrowed down to ₹40,788 crore on Wednesday, March 26, due to the US Dollar-Rupee swap auction.

Even then, the Weighted Average Call Rate (WACR) was at 6.31 per cent, above the repo rate of 6.25 per cent, indicating the liquidity stress. The business model and building up the balanced composition of risk-adjusted mix of assets/liabilities is the commercial call of the banks. The LAF is a temporary relief provided by the central bank to maintain an efficient and orderly payment and settlement system. Banks cannot depend on RBI’s the LAF of the RBI for serving their business needs.

Reasons for liquidity deficit

The deposit growth has been trailing behind credit growth in the last three years. Deposit growth was 10.3 per cent, 10.97 per cent, and 14 per cent during FY22, FY23, and FY24. The bank credit growth was at 13 per cent, 17.3 per cent, and 20 per cent, surpassing deposit growth during the same period. Along with lower deposit growth, the CASA ratio is on the decline from 43.68 per cent in FY22 to 39.95 per cent by March 2024, as higher interest on term deposits is prompting customers to tap the opportunities.

Another important dimension is the spike in the incremental credit-deposit (CD) ratio, up from 90 per cent, 112 per cent, and 106 per cent during the last three years. The deposit growth during FY25 until March 7 is 10.2 per cent, while credit growth is 11.2 per cent. The incremental CD ratio is high at 125. Banks are also maintaining LCR much beyond the threshold of 100 per cent as a prudent measure.

The reasons for slow bank deposit growth in banks can be due to a combination of factors such as the shift in the savings priorities of bank customers, a fall in household savings, better opportunities for alternative investment, and a rising preference an increase in sensitivity towards insurance.

Given this scenario, when deployment is in excess of sources, banks have to depend on borrowings, CDs at higher interest rates that can impinge upon the profitability in coming quarters. Resting on the RBI for a perpetual liquidity solution is not possible. Banks have to re-engineer their balance sheet structure and fine tune business model.

With big data, banks can explore the use of AI tools to map districts that have a higher cash-to-GDP ratio, low Credit-Deposit ratio, and low per capita deposit base in PMJDY and Basic Savings Bank deposit (BSBD) Accounts and identify strategic geographies to accelerate deposit mobilisation by activating Rural/Semi-urban branches and intense deployment of business correspondents (BCs), engaging ASHA workers, NGOs.

The financial inclusion index of the RBI reaches 64.2 by March 2024, up from 53.9 in 2021, indicating the spread of banking. Better exploration of the network of Financial Literacy Centres (FLCs) and Centres for Financial Literacy to disseminate financial and digital literacy to educate masses to actively use the banking system for savings, borrowing, and remittances.

Way forward

Banks may have to work out a long-term Balance Sheet Re-engineering mission to streamline liquidity flows to gradually develop an independent risk-adjusted resources management strategy to fight the adversities of durable liquidity gaps. While the RBI creates an enabling environment, banks have to realign well-optimised sustainable business models to serve a growing economy.

Directing the balance sheet to grow on a well-etched risk-adjusted path is essential rather than letting it shape up by the evolving macroeconomic and business environment. Risk management is a proactive strategy and cannot be used after risk begins to hit the balance sheet. RBI therefore insists use of simulated models, stress testing, and back testing tools to strike the right balance sheet management strategy.

The writer is an Adjunct Professor, Institute of Insurance and Risk Management, Hyderabad. Views expressed are personal