Indian banking’s held back by inadequacy of long-term funding

To address the liquidity shortfall, the RBI injected more than ₹8 trillion into the system using various tools - variable rate repo auctions, open market purchases of government securities, and rupee-dollar swaps.

These interventions weren’t just short-term fixes; they were essential to support monetary policy transmission at a time when the RBI has been cutting rates to bolster growth. A surplus liquidity environment is key for lower policy rates to translate into easier lending conditions.

However, this strong defence of liquidity has taken attention away from a deeper, long-term issue-—the shrinking gap between credit growth and the availability of stable funding.  Even as short-term liquidity pressures fluctuate, Indian banks face a more persistent and worrying challenge: a sustained slowdown in deposit growth.

Fallout of a weak deposit growth

In recent quarters, deposit growth has lagged behind banks’ funding needs. While credit growth has slowed—from about 15 percent in FY2024 to 11 percent in FY2025—easing the pressure for now, this balance is unlikely to last. Now that the post-pandemic lending boom has faded away and credit demand has stabilized, banks are finding it harder to grow their loan books, largely due to weak deposit growth.

What seems like a healthy balance between credit and deposit growth hides deeper fragility. Indeed, some banks have slowed credit disbursal—not due to weak demand, but because of lack of stable, long-term funding.  The weak credit growth currently helps banks match their assets and liabilities, but it comes at the expense of future lending capacity. This is worrisome especially because India remains predominantly a bank-dependent economy.

The situation raises a key policy question: how should regulators and policymakers address the structural weakness in deposit growth?

Too often in this discourse, the distinction between liquidity support and funding capacity gets lost. While the RBI has eased short-term liquidity pressures through various tools, these are no substitute for the stable, long-term funding banks need to support credit growth.

Tools like variable repo rate auctions are short-term and reverse once the repo ends, while OMOs involve relatively small sums. The core issue isn't short-term liquidity, but the long-term availability of stable funding—mainly through deposits or long-term bond issuance.

This distinction is especially important in light of the post-pandemic funding trends. From FY2022 to FY2024, Indian banks extended ₹49.34 trillion in credit, while deposits over the same period rose by only ₹45.51 trillion—creating a funding gap of ₹3.83 trillion. FY2025 saw some correction, with deposit growth outpacing credit, but the four-year cumulative gap still exceeds ₹1 trillion. This persistent shortfall highlights the limits of relying solely on liquidity-focused policy measures.

Ripple effect of structural changes in household balance sheets

The root of this shortfall goes beyond monetary policy and liquidity management. Structural changes in household balance sheets and broader macroeconomic factors are weakening the traditional deposit base. Stagnant nominal wage growth, persistently high food inflation, and rising household debt have together reduced financial savings. This has translated into a steady decline in household net financial savings as a share of GDP.  This shrinking pool of savings limits the funding available for intermediation through the banking system.

This challenge is beyond the RBI’s reach. Liquidity injections and policy rate changes can influence borrowing costs and boost market confidence, but they are ineffective in encouraging household saving behaviour or in incentivizing individuals to deposit funds in banks. Expecting the RBI to drive a structural rebound in deposit growth misjudges the limits of monetary policy.

Tackling these issues requires a broader and coordinated policy approach. Key steps include boosting household incomes through job creation, increasing real wage growth through effective inflation control, and restoring household purchasing power. Additionally, enhancing financial inclusion and making formal savings instruments more appealing are crucial. Developing alternative funding channels should be a priority. Promoting infrastructure bonds, expanding securitization markets, and deepening the corporate bond segment could diversify long-term sources of capital for banks.

Regulators might also consider allowing banks to issue long-tenor bonds, at least for a limited period, to ease funding pressures and strengthen their credit creation capacity.

In summary, India’s banking system is in a delicate balance—supported by liquidity interventions but hindered by long-term funding gaps. While the RBI’s actions have been timely and essential, they alone cannot help sustaining credit growth. It’s crucial to distinguish between temporary liquidity relief and the more complex task of rebuilding structural funding foundations. Without this clarity and a corresponding policy response, the banking sector may become a bottleneck rather than a driver of India’s economic ambitions.

Rajeswari Sengupta is an Associate Professor of Economics at IGIDR, Harsh Vardhan is a management consultant and also serves as an Independent Director on the board of Karur Vysya Bank. Views are personal and do not represent the stand of this publication.