Banking system cash squeeze sends overnight rates above RBI’s repo rate

The liquidity squeeze was triggered by advance tax payments by corporates, which typically lead to large outflows from the banking system and temporarily strain available funds. As a result, banks and other market participants were forced to borrow at higher rates to meet short-term funding requirements.

Overnight and other short-term money market rates surged by 10–15 basis points over the past three days as liquidity in the banking system slipped into deficit, largely due to advance tax-related fund outflows.

According to data from the Reserve Bank of India (RBI), overnight rates were trading 10–15 basis points above the policy repo rate of 5.25 percent, indicating tight liquidity conditions in the system. Market participants said the sudden cash drain pushed borrowing costs higher across the overnight segment.

The liquidity squeeze was triggered by advance tax payments by corporates, which typically lead to large outflows from the banking system and temporarily strain available funds. As a result, banks and other market participants were forced to borrow at higher rates to meet short-term funding requirements.

Weighted average call money rates were trading at 5.25 percent on December 15, aligned with the repo rate when liquidity was in surplus mode. The rates shot up to 5.41 percent on December 16, when liquidity fell in deficit. The rates stood at 5.46 percent on December 17, and 5.36 percent on December 18.

The liquidity in the banking system turned deficit on December 17, nearly after two months despite the continuous support provided by the RBI through variable rate repo (VRR) auctions, Open Market Operation (OMO) purchases of government securities and USD/INR Buy/Sell swap auction.

The banking system liquidity stood at Rs 60,787.81 crore deficit as on December 16, Rs 68,586.12 crore on December 17, and Rs 29,910.12 crore. This marks a deficit after October 28, 2025, when the deficit stood at Rs 8,083.79 crore.

This is the third instance in this fiscal year, when the liquidity has turned deficit in the banking system. Prior to this, the deficit was marked in late October, and on September 22.

The liquidity conditions eased after the OMO purchase auction held on December 18, which infused Rs 50,000 crore liquidity.

Money market experts expect the pressure on rates to ease in the coming days as liquidity conditions improve. They said the impact of advance tax outflows is usually transient, with funds gradually returning to the system through government spending and potential RBI liquidity operations.

“While the spike in overnight rates reflects near-term tightness, the situation is unlikely to persist,” a market expert said, adding that rates should moderate once liquidity normalises.

The RBI continues to closely monitor liquidity conditions and has reiterated its commitment to ensuring adequate liquidity to support orderly market functioning.

On December 18, Moneycontrol reported that RBI is unlikely to announce additional Open Market Operation (OMO) purchases of government securities this month and may instead rely more heavily on variable rate repo (VRR) auctions to manage liquidity in the banking system.

The view comes as the central bank has been actively conducting VRR auctions in recent days to modulate liquidity conditions. Experts noted that the second tranche of OMO purchases scheduled for December 18, coupled with ongoing VRR operations, is expected to help cushion the system ahead of heavy goods and services tax (GST) outflows on December 20.