With the rapid increase in credit demand, Indian banks request easing of liquidity regulations

The funding allocation challenges faced by India’s banking sector have become increasingly apparent over the past few weeks. Amid a situation where loan demand necessary for business expansion far exceeds deposit growth rates, multiple financial institutions are urging the Reserve Bank of India (RBI) to review the implementation of current liquidity regulations.

Structural Issue: Loan Demand Outpacing Deposit Growth

As credit demand accelerates across the banking sector, the traditional funding model is beginning to show cracks. As households shift more funds into the stock market, the most stable source of funds—deposits—are rapidly declining. This outflow of funds has created a new challenge for banks: a shortage of funds needed to sustain lending.

Changes in Household Fund Flows Pressure Bank Management

Behavioral changes among Indian individual investors are shaking the bank’s traditional business foundation. As investment in stocks becomes more prominent, the reduction in savings deposits is no longer just a temporary trend but is becoming a structural shift. In this environment, to address short-term liquidity pressures, banks are requesting permission from the RBI to utilize some of the funds they are required to hold as reserves.

Specific Proposals for Regulatory Easing Discussed with the RBI

Recently, the RBI has been engaging in discussions with several financial institutions regarding the credit supply challenges faced by the Indian banking industry. According to Jin10, multiple liquidity regulation improvement proposals have been presented by banks during these discussions.

Among these, the most notable is the review of the government-held bond holding requirements. Banks argue that relaxing the current restrictions that lock up funds in government bonds would allow these funds to be redirected toward lending, thereby enabling greater credit supply.

Additionally, there are requests to shorten the minimum holding period for infrastructure bonds, currently set at seven years. Reducing this period would increase the flexibility of banks’ asset portfolio management and enable more timely lending responses.

How the RBI responds to these proposals will significantly influence future regulatory reforms and will be a crucial factor in determining the credit supply capacity of India’s banking sector.