Banks' Liquidity Shortfall Shrinks to ₹20,000 Crore

The banking system's liquidity deficit significantly declined to ₹20,416.70 crore as of March 4, down from ₹1.1 lakh crore on March 3, as per data from the Reserve Bank of India (RBI). Experts attribute this sharp improvement to inflows resulting from the USD/INR Buy/Sell swap auctions, with the first leg of settlement occurring on March 4.

“The liquidity shortfall has reduced from ₹1.01 lakh crore (on March 3) to ₹20,417 crore (on March 4), marking a decline of nearly ₹89,000 crore. This figure closely aligns with the expected liquidity inflow on the settlement date (March 4) of the three-year USD/INR Swap auction conducted on February 28,” said Mataprasad Pandey, Vice President at Arete Capital Service.

This marks the lowest liquidity deficit level since it first turned negative in December 2024. Economists had anticipated the auction to inject approximately ₹85,000-88,000 crore into the banking system.

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Impact of the RBI’s Liquidity Measures

In February 2025, the RBI conducted a three-year $10 billion buy/sell swap, with the first settlement phase executed on March 3. This was the second such auction by the central bank, following a $5.1 billion infusion through a six-month swap on January 31.

The RBI's USD/INR Buy/Sell swap auctions are aimed at providing durable liquidity to the banking sector, unlike daily Variable Repo Rate (VRR) auctions, which primarily address short-term liquidity needs. VRR auctions allow banks to borrow funds at market-determined rates to manage immediate liquidity pressures, whereas swap auctions ensure a more stable infusion of liquidity over a longer term.

Market and Economic Implications

A Kotak Mahindra Bank report dated March 3 projected that the liquidity deficit in the banking system would continue to ease in the week of March 1-7, supported by steady government spending and the impact of the RBI’s $10 billion three-year buy/sell swap. Analysts also believe that improved liquidity conditions could lead to reduced volatility in short-term interest rates and support lending activity in the broader economy.

Since November 2024, liquidity constraints have intensified due to multiple factors, including:

• Tax outflows, which have drained liquidity from the banking system.
• Heavy foreign portfolio investor (FPI) sell-offs in Indian equities, leading to capital outflows.
• RBI’s forex market interventions, where the central bank sold dollars to stabilize the rupee.
• Lower-than-expected government spending, which limited liquidity circulation.
   

These factors collectively put pressure on banking system reserves, making it necessary for the central bank to step in with liquidity-enhancing measures.

Additional Liquidity Measures by RBI

To address liquidity stress, the RBI has infused around ₹3 lakh crore worth of durable liquidity since late 2024, deploying a combination of:

Variable Repo Rate (VRR) auctions, providing short-term liquidity to banks.
USD/INR swap auctions, ensuring sustained liquidity inflows.
Open market operations (OMOs), which involve the purchase of government securities to inject liquidity into the system.

With these interventions, the RBI has managed to maintain financial stability, ensuring that banks have adequate reserves to support credit growth and economic activity.

Looking Ahead: Liquidity Trends and Policy Outlook

Economists expect liquidity conditions to improve further in the coming months as government spending picks up pace and the impact of RBI’s recent measures becomes more pronounced. The central bank is also likely to continue using a mix of liquidity tools, including VRR auctions, forex interventions, and OMOs, to manage liquidity effectively.

Market participants will be closely watching upcoming RBI policy decisions, as sustained liquidity improvement could have implications for interest rates, inflation, and overall economic growth. With the central bank's proactive stance, the banking system is likely to experience more balanced liquidity conditions, ensuring smooth financial market operations and supporting economic expansion.