Facing a significant liquidity shortfall in the banking system, the Reserve Bank of India (RBI) held its largest variable rate repo (VRR) auction in nearly a year on Friday. With a notified amount of ₹2.25 lakh crore, the auction was met with substantial demand, as cash-starved banks submitted bids totaling ₹2.77 lakh crore.
To address the persistent cash squeeze, the RBI conducted a second VRR auction worth ₹50,000 crore, which also saw strong participation and received bids of approximately ₹75,000 crore.
Deepening Liquidity Deficit
The banking system’s liquidity deficit, which stood at around ₹1.4 lakh crore in early January, surged past ₹2 lakh crore by Thursday. This tightening liquidity prompted a sharp rise in the interbank call money rate, which climbed 55 basis points above the RBI’s repurchase rate of 6.50%. 
“Liquidity has tightened significantly due to the RBI’s forex interventions and currency in circulation (CIC) outflows,” said Nathan Sribalasundaram, rates strategist at Nomura. “With large bond redemptions behind us and CIC outflows expected to persist in the first quarter, the banking system will likely remain in deficit for the next two months.”
Measures Proposed by Banks
Amid rising borrowing costs, banks have urged the RBI to adopt durable liquidity-injection measures, such as:
- Open market bond purchases.
- Foreign exchange swaps.
- Long-term repurchase operations.
Such measures, bankers argue, would provide more sustained relief than short-term VRRs.
Liquidity Trends in January
RBI data indicates a fluctuating liquidity situation:
- On January 1, the liquidity deficit stood at ₹1.04 lakh crore and remained below ₹1 lakh crore until January 6.
- By January 7, the deficit climbed to ₹1.44 lakh crore and continued to grow, reaching ₹1.81 lakh crore on January 8 and ₹2.01 lakh crore on January 9.
Despite the RBI’s ongoing VRR operations to inject liquidity, market participants, including Nathan Sribalasundaram, believe these measures have failed to address the market’s broader liquidity needs.
Challenges for the Banking Sector
Experts caution that frequent volatility in banking liquidity could destabilize financing conditions. High liquidity fluctuations may hinder commercial banks from efficiently managing adverse loan-to-deposit ratios and asset liability pricing.
“The current environment is already challenging, and such liquidity pressures further complicate the outlook for banks and broader financial markets,” noted market analysts.
The situation underscores the need for a more robust and lasting approach to address liquidity shortages and support the financial system in managing funding pressures.
