India’s banking system is seeing uneven cash availability. While large banks use foreign deposits to lower funding costs, smaller lenders are increasingly relying on expensive market borrowing. This trend may create margin pressure for mid-sized institutions.
The Indian banking sector is currently facing a sharp divide in liquidity, the amount of cash available to meet daily requirements and lending needs. While a significant influx of foreign currency deposits has provided relief to some of the country's largest institutions, this cash is not flowing evenly across the entire system. As a result, many smaller and mid-sized banks are struggling to fund their operations without turning to costlier, short-term sources of money.
Data indicates that banks are becoming more reliant on issuing certificates of deposit, a common tool used by lenders to borrow money from the market. In September, the volume of these issuances spiked to ₹1.15 lakh crore, a significant jump from ₹56,271 crore in August. This heavy reliance on market borrowing signals that a large portion of the banking system is facing a liquidity shortfall and must pay higher interest rates to secure funds.
Larger banks have navigated this environment more effectively. By leveraging recent large-scale foreign currency inflows, these institutions have managed to replace older, expensive deposits with cheaper foreign funds. For example, Canara Bank recently reported a successful reduction in its overall cost of deposits by 1% due to these inflows. Similarly, Punjab National Bank reported lowering its share of high-cost deposits to 17%, down from 19% in the previous quarter. This ability to manage the cost of funds is a major advantage during periods when money is expensive to borrow.
Conversely, smaller and mid-sized banks are under noticeable pressure. Institutions like Indian Bank have confirmed that they continue to tap market funds to meet credit demand because they do not have the same level of surplus cash. The Central Bank of India has also shown signs of strain, with its liquidity coverage ratio—a measure of how much cash a bank has to meet short-term obligations—dropping to 155% at the end of the second quarter, compared to 242% a year earlier. While some mid-sized players like RBL Bank report holding enough of a cash buffer, the broader trend shows that smaller banks remain more vulnerable to rising funding costs.
For investors, this uneven landscape is critical. The main concern is that if smaller banks are forced to rely on expensive market borrowing, their profit margins could come under pressure compared to larger peers who have access to cheaper capital. The key monitorable for the coming quarters will be how these banks manage their cost of deposits and whether they can continue to lend profitably if market interest rates remain elevated or if liquidity stays tight.