Big Trouble Coming for Banks: How will Banks manage Liquidity Crisis after Repo Rate Cut?
The RBI has cut the repo rate by 25 basis points, bringing it down to 5.25%. This is good news for borrowers because home loan and other loan interest rates will fall. But the other side of the story is more worrying — FD interest rates will also come down, and this may worsen the liquidity crisis that banks in India are already struggling with.
Recently, many banks have been facing a shortage of funds. Liquidity in the banking system has been tight because of advance tax payments, GST outflows, and government cash movements. At times, banks have even slipped into liquidity deficit. To prevent the situation from getting worse, RBI had to step in with heavy liquidity support, including buying government bonds and conducting a large $5 billion forex swap to inject money into the system.
Why FD rates falling is a problem right now
As the RBI has decreased Repo Rate, the interest rate on loans will decrease. This is good news for loan borrowers, but this is also an issue for deposit customers. The interest rate on deposits will also decrease. Banks are already facing a liquidity crisis, and people are depositing less money in banks and investing more money in mutual funds and the stock market.
Banks decide FD rates based on how much it costs them to borrow money. When RBI cuts the repo rate and pumps money into the market, banks’ cost of funds goes down. This means banks usually reduce FD interest rates. But here’s the problem:
When FD rates fall, fewer people want to keep money in the bank.
Depositors look for better returns elsewhere — gold, mutual funds, corporate bonds, small finance banks, or even just holding cash for now. This means banks receive less fresh deposit money. And when deposit growth slows, banks start to struggle because:
- Banks need deposits to give loans
- No deposits = no cheap funds
- Banks must then borrow expensive money from RBI or the market
- This increases pressure on their balance sheets
So even though loan interest rates are coming down, banks may not have enough funds to lend smoothly.
Why banks were already low on funds
In recent months, liquidity has tightened for several reasons:
- Advance tax payments drained money from banks
- Big GST outflows weakened liquidity
- Government spending patterns caused temporary shortages
- Demand for credit has been strong, but deposits are not growing at the same speed
This mismatch creates a liquidity crunch, and now this liquidity gap can worsen. If FD returns fall, depositors may avoid fixed deposits altogether. That means banks lose their cheapest and most stable source of funds.
What happens next?
- Borrowers will enjoy lower EMIs
- But banks may not pass the entire rate cut quickly because they don’t have enough funds
- Banks may become more cautious about giving new loans
- The gap between loan demand and deposit growth may increase
- RBI may have to keep injecting liquidity to support the system
Some smaller banks and NBFCs may face the most pressure because they depend heavily on deposits to run their operations.
The repo rate cut is great for borrowers, but it creates a major challenge for banks at a time when liquidity is already tight. Lower FD rates could make deposit growth even weaker, adding more strain to banks’ finances. Unless liquidity improves or deposit inflows rise, banks may continue facing a fund shortage in the coming months.
