Banks Could See Funding Costs Fall by Up to 50 Basis Points as Liquidity Pressure Eases
Indian banks spent much of the recent funding cycle competing for deposits and paying relatively high rates for short-term money. A large influx of foreign-currency funds has begun to change that equation.
Banks mobilised $127.23 billion in foreign currency non-resident, or FCNR(B), deposits by August 31 under the Reserve Bank of India's special facility. Once overseas foreign-currency borrowings and external commercial borrowings are included, total inflows reached $136.38 billion.
That money has given lenders considerably more room to manage their balance sheets. Banks that might otherwise have relied heavily on certificates of deposit, particularly around quarter-end, can now reduce those borrowings or raise them at substantially lower rates.
Senior banking officials estimate the resulting reduction in overall funding costs could reach as much as 50 basis points, although the benefit will vary across lenders and may be concentrated over a relatively short period.
Banks pull back from short-term borrowing
The clearest evidence of the change is visible in the certificate of deposit market.
Banks issued ₹68,130 crore of CDs in August, according to Prime Database. That was the lowest monthly total since April 2026, when issuance stood at ₹45,700 crore.
The decline followed several months of much heavier borrowing. CD issuance reached ₹1.11 trillion in May and ₹1.80 trillion in June before falling to ₹95,945 crore in July.
Five institutions accounted for most of the August activity. HDFC Bank, Small Industries Development Bank of India, Bank of Baroda, Canara Bank and Central Bank of India together raised ₹46,770 crore, or 68.7% of the month's total.
CDs are useful when banks need funds quickly, but they can become expensive when several lenders are competing for the same pool of money. The FCNR(B) inflows have reduced that urgency.
Market rates reflect the shift
Short-term borrowing costs have fallen sharply since the RBI announced the FCNR(B) swap facility on June 8.
The three-month CD rate, which stood at 7.16% on June 8, had dropped to 5.86% by September 3. That is a decline of 130 basis points.
Six-month rates fell from 7.45% to 6.46%, while the nine-month rate eased from 7.47% to 6.94%. One-year CD rates declined 50 basis points to 7.02%.
At the shortest end, the one-month rate moved from 6.26% to 5.52%.
Jefferies calculated that the three-month CD rate fell by roughly 90 basis points during August alone, reaching about 5.9% on September 3. The six-month rate declined by approximately 50 basis points during the month.
Those moves matter because they lower the price banks pay when they do need additional wholesale funding.
How much can banks actually save?
A senior banking official estimated that the overall reduction in funding costs could reach a maximum of about 50 basis points.
The benefit is unlikely to be uniform.
Large banks with greater access to FCNR(B) deposits may have more scope to replace high-cost bulk deposits and other expensive liabilities. Industry estimates suggest larger lenders could save roughly 25 to 60 basis points on incremental deposit costs by making that substitution.
The duration of the benefit also matters. Banks may enjoy considerably cheaper funding at the margin without seeing an equivalent decline across their entire deposit base.
That makes the headline reduction in CD rates different from the actual change in a bank's overall cost of funds.
Why the $136.38 billion inflow matters
The size of the mobilisation sets the latest programme apart.
Of the $136.38 billion in total inflows, FCNR(B) deposits contributed $127.23 billion. Overseas foreign-currency borrowings accounted for another $5.26 billion, while external commercial borrowings added $3.89 billion.
Jefferies estimates that the total is equivalent to about 5% of banking-system deposits and 6% of credit.
For comparison, mobilisation under the 2013 FCNR(B) programme amounted to approximately 3.2% of deposits and 4.1% of credit.
Under the latest arrangement, banks could mobilise fresh FCNR(B) deposits, including renewals, with maturities of three to five years until August 31. The RBI's swap mechanism allowed eligible foreign-currency funding to generate rupee liquidity for lenders.
The mobilisation window has closed, but the money raised during it remains available to banks.
The next question is where the liquidity goes
With funding pressure easing, lenders have several choices.
They can use the additional liquidity to support new loans, refinance higher-cost liabilities or reduce their reliance on bulk deposits. Surplus money can also be placed with the RBI through the Standing Deposit Facility.
Quarter-end credit demand could provide one outlet. Banks typically look to strengthen loan books during this period, while companies with short borrowing requirements may find cheaper funding more readily available.
Public-sector enterprises that borrow for 30, 60 or 90 days could also use lower-cost loans to refinance older debt carrying higher interest rates.
That would turn what began as a bank funding story into a potential borrowing-cost benefit for parts of the corporate sector.
Liquidity ratios could strengthen
The inflows may also improve banks' liquidity coverage ratios.
Banking officials estimate the increase could be as much as 1 percentage point.
At the end of the June quarter, Kotak Mahindra Bank reported an LCR of about 144%. State Bank of India's ratio was approximately 125%, followed by ICICI Bank at around 122%, Axis Bank at 119%, Bank of Baroda at 116% and HDFC Bank at roughly 115%.
The additional liquidity gives lenders more flexibility in balancing regulatory requirements with credit deployment.
Cheaper funding does not guarantee an immediate margin boost
The impact on profitability is less straightforward than the decline in borrowing rates suggests.
Jefferies expects the first leg of the FCNR(B) transactions to put some near-term pressure on net interest margins because the initial spread on those funds is relatively narrow. The effect could begin appearing in banks' second-quarter results.
Over time, however, banks can use the new funding to replace more expensive liabilities and improve the economics of their balance sheets.
Jefferies expects margins to normalise over the next two to four quarters. It estimates that FCNR(B) deposits could eventually add ₹100 billion to ₹110 billion a year to the banking industry's profit pool, equivalent to roughly 2% of sector profit before tax.
That creates an important distinction between margins and absolute earnings. A bank can experience temporary pressure on its margin while still generating more net interest income if it has a larger pool of funds available to deploy profitably.
From a funding shortage to a deployment challenge
For much of the previous cycle, deposit mobilisation was one of the industry's central concerns. Strong credit demand forced banks to compete for funding, pushing up deposit and wholesale borrowing costs.
The latest foreign-currency inflows have altered that balance, at least for now.
Falling CD issuance and sharply lower short-term rates show that banks no longer need to compete as aggressively for incremental funds. The more consequential question is how effectively they use the liquidity they have accumulated.
Banks that replace expensive liabilities and find suitable lending opportunities stand to extract the greatest benefit. Those unable to deploy the surplus efficiently may end up parking more of it with the RBI, limiting the earnings advantage.
The banking system has therefore moved from a period dominated by the cost of raising money toward one increasingly shaped by the economics of putting that money to work.
