The Reserve Bank of India (RBI) has been actively addressing a persistent liquidity crunch in the banking system, which has strained credit availability and pushed short-term interest rates higher. Over the past two months, the central bank has injected Rs 15.5 lakh crore through various measures to ease liquidity stress and support economic growth. Despite these efforts, liquidity remains tight due to multiple factors, including forex market interventions, tax outflows, and slow deposit growth. This explainer breaks down the current liquidity situation, the reasons behind the deficit, RBI’s response, and the potential impact on the economy.
What is happening with liquidity in the banking system?
The Reserve Bank of India (RBI) has infused Rs 15.5 lakh crore into the banking system over the past two months through durable and transient liquidity measures to address the ongoing liquidity deficit and support credit growth. However, liquidity remains tight due to factors such as the central bank’s foreign exchange market interventions, government tax flow dynamics, currency leakages, and foreign portfolio investor (FPI) outflows.
How has RBI addressed the liquidity deficit?
RBI injected about Rs 5.5 lakh crore of durable liquidity in Q4FY25 through open market operation (OMO) purchases, longer-duration variable repo rate (VRR) auctions, and forex (USD/INR) buy/sell swaps. Additionally, between February 16 and March 17, 2025, the central bank conducted 22 fine-tuning VRR operations and two main VRR operations, injecting Rs 9.68 lakh crore into the system with maturities ranging from 1 to 8 days.
What are the key measures RBI has taken?
OMO purchases involve RBI buying government securities (G-Secs) from banks to provide durable liquidity. VRR auctions allow banks to place G-Secs as collateral and draw short-term liquidity. Forex buy/sell swaps involve banks selling dollars to the RBI initially and repurchasing them later by returning rupee funds along with the swap premium after the swap tenor. To manage transient liquidity tightness, RBI has been conducting daily VRR auctions since January 16, 2025, allowing standalone primary dealers (SPDs) to participate and address short-term liquidity mismatches.
Has the liquidity deficit improved?
RBI’s measures have moderated the liquidity deficit, with the average daily net injection under the liquidity adjustment facility (LAF) reducing to Rs 1.41 lakh crore between February 16 and March 13, 2025, from Rs 1.92 lakh crore during January 16 to February 15, 2025. The liquidity deficit, which peaked at Rs 3.15 lakh crore on January 23, eased to Rs 2.26 lakh crore by March 18, 2025. Despite prevailing liquidity tightness, banks’ placements of surplus funds under the standing deposit facility (SDF) averaged Rs 1.15 lakh crore between February 16 and March 13, higher than Rs 0.85 lakh crore in the previous month.
Why is liquidity so critical?
Liquidity is essential for the economy, ensuring that banks have enough money to lend and keeping interest rates under control. Adequate liquidity boosts credit growth and gives corporates the confidence to spend on capital expenditure, creating a virtuous cycle of economic growth.
What is the current situation with liquidity?
Indian banks are facing a liquidity crunch, which has constrained their ability to support growth. On January 23, 2025, the liquidity deficit peaked at Rs 3.15 lakh crore, marking a 15-year high. As of February 27, 2025, the deficit had eased to around Rs 1.81 lakh crore, but liquidity remains tight.
What is a liquidity deficit?
In banking terms, liquidity refers to the availability of cash and cash-equivalents that banks use to lend, invest, and meet obligations. A liquidity deficit occurs when banks don’t have enough free cash to meet short-term needs, resulting in a situation where they have more bills to pay than money on hand.
Do banks not have enough money?
Not exactly. To bridge this gap, banks borrow from the RBI using various liquidity tools. These measures help banks meet short-term funding needs, but prolonged liquidity stress can increase borrowing costs and impact credit availability in the economy.
What caused the recent liquidity crunch?
Multiple factors have contributed to the liquidity crunch. Advance tax outflows in December 2024 saw corporations pay over Rs 3 lakh crore, temporarily exiting the banking system and reducing available liquidity. Festive season withdrawals during Diwali, Christmas, and New Year increased cash demand. RBI’s forex market interventions between October 2024 and January 2025 absorbed rupees from the system to stabilise the rupee, reducing liquidity. Slow deposit growth and higher interest rates have further exacerbated liquidity stress.
What are the consequences of liquidity stress?
Liquidity stress tightens financial conditions, making borrowing costlier and slowing economic momentum. Rising borrowing costs lead to higher short-term interest rates, squeezing bank profits. This impacts banks’ ability to lend and reduces consumption, weakening overall economic momentum. Non-banking financial companies (NBFCs), which rely heavily on borrowing, face higher rates, limiting their ability to finance key sectors like housing and MSMEs.
How has RBI responded to the liquidity crunch?
The RBI has taken several measures to address the liquidity crunch. A 50 basis point cut in the Cash Reserve Ratio (CRR) in December 2024 injected approximately Rs 1.2 lakh crore into the system. OMO purchases in January and February 2025 added Rs 60,000 crore of liquidity. The introduction of a 56-day VRR worth Rs 50,000 crore in February 2025 provided longer-term liquidity support. A 25 basis point repo rate cut in February 2025 reduced borrowing costs, improving cash flow and boosting credit growth. Forex buy/sell swaps in January and February 2025 helped manage rupee stability and regulate liquidity.
How do these measures affect the market?
Liquidity stress has shaken market confidence, fuelling uncertainty and investor caution. Banking stocks have been under pressure due to tighter financial conditions and higher borrowing costs.
What lies ahead?
The RBI continues to monitor liquidity conditions and has more tools at its disposal, including repo rate adjustments, relaxed marginal standing facility (MSF) norms, and changes in the standing deposit facility (SDF) rate. Accelerating government spending can also inject fresh liquidity, helping banks manage liquidity pressures and keep the economy on track.
