India's banking system is currently experiencing a significant liquidity surplus, amounting to nearly ₹10 lakh crore. This surge is primarily attributed to robust inflows from Foreign Currency Non-Resident (Bank) or FCNR-B deposits, a scheme initiated by the Reserve Bank of India (RBI). According to an analysis by Jefferies, this abundant liquidity, coupled with declining money-market rates, is poised to reduce short-term interest rates and potentially lower wholesale funding costs for banks.
FCNR-B Deposits Drive Forex Inflows
FCNR-B deposits have emerged as the dominant channel for foreign exchange inflows under the RBI's 2026 scheme. By August 31, total inflows from FCNR-B deposits, overseas foreign currency borrowings, and external commercial borrowings reached $136.4 billion. A significant portion, $127.2 billion, came directly from FCNR-B deposits, significantly bolstering the system's liquidity.
For instance, ICICI Bank alone mobilized approximately $17.88 billion (₹1.70 lakh crore) through FCNR(B) deposits under the RBI's special forex swap facility by the August 31 deadline. These funds allowed the bank's international branches to extend about $9 billion in loans and issue $3.63 billion in standby letters of credit.
Impact on Bank Funding Costs and Rates
The increased liquidity is already influencing the money markets. Three-month certificate of deposit (CD) rates saw a 90-basis-point decline in August, while six-month CD rates fell by 50 basis points. As of September 3, the three-month CD rate stood at 5.9%, down from 6.8% a month earlier.
Jefferies anticipates that banks will respond to these softer liquidity conditions and falling money-market rates by reducing their wholesale funding rates. This development is particularly beneficial for banks that have historically relied on more expensive wholesale deposits, potentially helping them normalize margins over the next two to four quarters by shifting away from such high-cost funding sources.
RBI's Liquidity Management Challenge
The substantial liquidity surplus presents a challenge for the Reserve Bank of India, which must prevent excessive short-term liquidity from driving market rates too low. Jefferies suggests that the RBI is likely to absorb this excess short-term liquidity, possibly through open market operations (OMOs), and then gradually re-inject it into the system. The brokerage believes OMOs are a more probable tool than a cash reserve ratio (CRR) hike, as CRR is typically viewed as a policy instrument rather than a day-to-day liquidity management tool.
Near-Term Margin Pressure, Long-Term Profitability
While the liquidity boost offers long-term benefits, Jefferies projects a near-term trade-off for banks. Net interest margins (NIMs) are expected to decline in the second quarter, partly because banks raised bonds and loans before fully deploying the FCNR-B deposits. However, the brokerage estimates that the FCNR-B inflows could ultimately generate an additional annual profit pool of ₹10,000–11,000 crore for the banking sector, as lower funding costs and increased volumes are expected to outweigh any temporary margin pressures.