In the financial sector, structural problems have a way of announcing themselves quietly, through incremental data, technical jargon, and central bank circulars buried in the weekend briefing. Then, one day, the accumulated weight of those problems demands a policy response that is anything but quiet. India’s banking sector appears to be at exactly such an inflection point.
Several stress points have converged in a relatively short period: a yawning credit-deposit gap, a skewed and fragile deposit base, a fiscally stretched government, a weakening rupee, and balance of payments pressures that have forced the Reserve Bank of India’s hand. The RBI’s latest set of measures — including dollar-rupee swaps and an unconventional FCNR(B) deposit scheme — are its response to a multi-pronged challenge.
The Credit-Deposit gap: A problem that would not go away
For much of the post-pandemic period, Indian banks grew their loan books at a pace that comfortably outpaced deposit mobilization. Credit growth averaged north of 15% year-on-year through FY23 and FY24, fueled by a recovering economy, retail borrowing, and robust corporate demand. Deposits, however, did not keep pace. Indian households, increasingly sophisticated in their financial behavior, began gravitating toward mutual funds, equity, and insurance products that offered inflation-beating returns. Bank deposits — stodgy, taxed, and offering real rates that were often negative — lost their relative appeal.
The result was a relentless rise in the system-wide Credit-Deposit (CD) ratio. From a historical average closer to 74%, the ratio climbed to 82.5% by May 2026 — a level last seen over six decades ago. The HDFC-HDFC Bank merger in mid-2023 provided a mechanical push of about 2.2 percentage points, but the underlying trend was independent of that event.
A CD ratio in the low 80s is not, in itself, catastrophic. Banks in developed economies routinely operate at higher ratios. The concern in India’s context is the speed of the ascent and the structural nature of the constraint. Banks cannot simply decree that households return their savings to fixed deposits. They can only raise rates, which compresses net interest margins, or curtail lending, which slows economic activity. Neither is a comfortable choice.
The wholesale deposit trap
Faced with the deposit shortfall, Indian banks did what bankers typically do under pressure: they improvised. Over the past two years, banks have aggressively mobilized wholesale deposits — large-ticket certificates of deposit (CDs) and bulk fixed deposits typically placed by corporates, mutual funds, and other institutional investors. These deposits are easier to raise, faster to mobilize, and carry no branch overhead. They are also deeply problematic.
The IMF, in its Article IV consultation and Financial Sector Assessment Programme (FSAP) report for India in 2025, flagged systemic risks from concentrated deposit structures and wholesale funding reliance among Non-Banking Financial Companies (NBFCs). The same logic applies, with some modification, to commercial banks. When a bank’s deposit book is dominated by a small number of large depositors, its vulnerability to liquidity stress increases dramatically. A handful of institutional depositors pulling funds — in response to a market event, a rating action, or simply a better rate elsewhere — can create an outflow event of a magnitude that retail deposit bases rarely produce.
As per the latest data, 0.05% accounts hold ~35% of India’s term deposits. All these deposits are Rs5cr and above. Deposits of Rs1cr and above are now ~46%. Moreover, Term deposits paying below 7% are now up at ~62% from ~27% a year earlier.
The concentration problem is further compounded by the incentive structure. Wholesale depositors are rate-sensitive and relationship-agnostic. They move quickly and in large sizes. Banks that have used wholesale deposits to bridge the CD gap have, in effect, borrowed structurally short to lend long. This is the classical maturity mismatch that precedes funding crises. The risk is not imminent, but it is real and growing. The RBI has taken note.
A material rise in yields in alternative sources could potentially see a sharp deceleration in the bank’s deposit base.
The fiscal overhang: crowding out and indirect pressure
The banking sector does not operate in a fiscal vacuum. The state of government finances has direct implications for banking system liquidity, the level of interest rates, and the depth of the bond market.
India’s fiscal trajectory has been broadly disappointing relative to its consolidation targets. Tax revenue shortfalls have been a recurring theme — FY26 saw a significant contraction in net tax revenues in the early months, compounded by a one-off extension of income tax return filing deadlines. Disinvestment, a perennial underperformer relative to budget targets, has once again failed to deliver meaningful receipts. Subsidy spending, including food and fertilizer, continues to exert pressure on the expenditure side.
April 2026 fiscal deficit accounted for 21.4% of FY27BE (vs 11.8% in April 2026). Though the higher April 2026 could be attributed, to a large extent, timing-related moderation in receipts, rather than a broad-based deterioration in government finances, higher subsidy bill due to the West Asia crisis, and potentially lower tax revenue cloud the overall fiscal strength of the government.
For banks, a wider-than-expected fiscal deficit matters in at least two ways. First, higher government borrowing pushes up sovereign yields, which compresses the mark-to-market value of banks’ bond portfolios (held as SLR assets) and limits their appetite for further bond holdings. Second, and more indirectly, a government that struggles to raise non-tax revenues via disinvestment or other asset sales becomes more dependent on deficit financing, which crowds out private credit at the margin. The RBI’s job of managing system liquidity becomes correspondingly harder.
The RBI’s toolkit: Swaps, Liquidity, and the Rupee
Against this backdrop of a stretched banking system and a weaker rupee — which breached the 90-per-dollar mark in early 2026 and touched unprecedented levels amid geopolitical pressures from the West Asia conflict and elevated crude oil prices — the RBI has been unusually active.
The central bank executed a $5 billion, three-year USD/INR buy-sell swap in May 2026, at a total premium of 9.1%. In this transaction, banks sell dollars to the RBI and receive rupees at the spot rate, committing to reverse the transaction three years hence. The swap injected approximately Rs 42,000-43,000 crore of durable rupee liquidity into the banking system. It is worth noting that this was one in a series of such operations — the RBI had also conducted a $10 billion three-year swap in early 2025, which saw demand of more than twice the amount offered, underscoring the system’s liquidity thirst.
These swaps serve multiple purposes simultaneously. They inject rupee liquidity without the RBI having to run down its foreign exchange reserves through outright sales. They also improve the forex reserve position at least technically — the RBI receives dollars which bolster reserves, while providing rupees that ease banking sector tightness. The premium paid by banks represents the carry cost, and at 9.1% for three years, the implied 2.95% annualized cost signals the degree of tension in the system..
The FCNR(B) Gambit: A 2013 playbook, revisited
The most consequential of the RBI’s recent measures, however, is the revival of the FCNR(B) deposit scheme with full hedging support. This is a page directly from 2013, when then-Governor Raghuram Rajan deployed a similar instrument to arrest a rupee freefall during the taper tantrum-induced BoP crisis.
The mechanics are straightforward. The RBI has permitted authorized dealer banks to raise fresh three-year and five-year FCNR(B) deposits from Non-Resident Indians (NRIs) and is bearing the full hedging cost — estimated at approximately 2.5% per annum for the contract period — until September 30, 2026. Since banks no longer need to absorb the hedging cost, they can offer NRI depositors rates that are 150-200 basis points higher than currently available, making Indian FCNR(B) deposits more attractive in a global context.
However, it may be little early to estimate the scale of inflows under this route. The market estimates of US$50bn might be a little optimistic, considering that unlike 2013, this time the deposit and lending rates in the key markets like the US, the UAE, Singapore etc. are much higher. Most large Indian banks are offering 6.0-6.15% interest rate on a 3-year FCNR(B) deposit.
…to continue tomorrow)
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