The Reserve Bank of India (RBI) is actively purchasing government bonds to lower borrowing costs for banks and foster economic growth. Government bonds are financial instruments issued by both state and central governments, designed to facilitate their fiscal needs by raising funds. Investors, in return for purchasing these bonds, receive a predetermined fixed interest rate over the bond’s term. This mechanism allows the government to tap into market resources, financing a range of projects, welfare initiatives, and developmental activities that contribute to national progress.
Since April 2025, the RBI has significantly invested more than ₹5 lakh crore in bonds through Open Market Operations (OMO). This strategic move aims to enhance cheaper liquidity in the banking sector and, in turn, lower lending interest rates. However, despite these efforts, the rising bond yields present a formidable hurdle for the RBI. When bond yields are elevated, the likelihood of a rate cut diminishes, which in turn restricts the flow of credit in the economy. Recent data indicate that the yield on 3-month government bonds rose by 0.57%, while the yield on 10-year bonds rose by 0.80%. Notably, yields on government bonds have averaged only 6.7% in 2025, marking the lowest level in 3 years. As bond yields continue to climb, the anticipated reduction in borrowing costs remains elusive.
These increased bond yields have raised the operational costs for banks seeking low-cost capital. Consequently, interest rates for various loans, including home loans, auto loans, and corporate financing, remain high, which adversely affects consumer spending, investment activities, and overall economic growth. In light of this scenario, the Reserve Bank is contemplating further bond purchases to rectify these financial conditions. Rising prices of gold and silver in global markets, coupled with geopolitical uncertainties and policy shifts from international figures such as President of USA Mr. Trump, have prompted foreign investors to withdraw capital frequently, thereby amplifying pressure on the central bank to inject additional liquidity into the banking system.
OMO serve as a vital mechanism for managing liquidity in the economy. During periods of market strain, the central bank injects liquidity into the financial system by acquiring government bonds. This process enriches the banking sector with capital, enabling lenders to extend credit to businesses, individuals, and industries needing financial support. However, amidst global uncertainties and a drop in foreign investments, experts forecast that the central bank may need to purchase an excess of ₹2 lakh crore in bonds by March 2026. It is essential to highlight that since April 2024, the RBI has successfully infused ₹7.7 lakh crore into the banking system through OMOs, while simultaneously reducing the repo rate by 1.25%, reflecting a concerted effort to buttress liquidity.
On the other hand, state governments are persistently borrowing from the market, exerting additional pressure on overall liquidity. To tackle this escalating situation, the RBI has scaled back state borrowing plans by ₹10,000 crore, even as state governments aim to borrow an ambitious ₹5 lakh crore by March 2026. It is crucial to understand that a persistent influx of bonds can drain market liquidity. Excessive government borrowing reduces market liquidity, complicating banks’ lending and raising loan interest rates.
Banks currently face a crisis in capital availability for several reasons. One significant factor is the persistently low interest rates offered on bank deposits, which have diminished their attractiveness to investors. Additionally, recent changes placing bank deposits under the income tax purview have further dissuaded savers. Compounding this issue is the rise of enticing investment opportunities in the stock market and mutual funds, drawing potential investors away from traditional savings. Another critical element is bank staff actively selling various insurance products, resulting in customers using their bank deposits to pay lump sums or in flexible instalments, thereby reducing available deposits. This confluence of factors has led to a growing disillusionment among investors regarding the reliability of bank deposits. Additionally, the soaring prices of gold and silver in recent years have further contributed to the downturn in bank deposit growth.
A striking disparity has been evident for an extended period between the growth rates of bank deposits and loan issuance. Specifically, the growth rate of bank deposits has lagged that of loans, resulting in a significant shortfall in the availability of affordable capital for banks. Bank deposits can be categorised into three main types: savings accounts, current accounts, and fixed deposit accounts. Currently, banks provide interest rates on savings accounts that typically range from 2.5% to 7%. However, many banks are offering the minimum rate of just 2.5%. In contrast, no interest is accrued on current accounts, while fixed deposit accounts yield a more attractive average interest rate of between 5% and 8%.
As of December 12, the growth rate for deposits has softened to a mere 9.7% year-on-year, while loan growth has surged to 11.7%. This divergence has resulted in a notable 200-basis-point gap between the development of loans and deposits. According to data from the RBI, the total volume of loans disbursed by banks reached an impressive ₹196.5 lakh crore by December 12, a substantial increase from ₹175.86 lakh crore recorded during the same timeframe the previous year. This signifies a remarkable rise of ₹1.2 lakh crore in loans within just a fortnight. In tandem, total deposits stood at ₹242.14 lakh crore, up from ₹220.06 lakh crore a year earlier. Nevertheless, it is essential to note that total deposits declined by ₹45,344 crore during the same fortnight. For context, in the fortnight ending November 28, the growth rates were slightly better, with loans growing at 11.5% and deposits at 10.2%.
In light of these trends, to stimulate economic activity, elevate growth rates, and realise India’s aspiration of becoming a developed nation by the year 2047, both the government and the Reserve Bank of India must facilitate the provision of capital at more affordable interest rates. Additionally, banks must innovate and develop new strategies to attract deposits by offering lower interest rates, thus securing a more cost-effective source of capital.
Satish Singh serves as a Senior Banking and Economic Columnist located in Mumbai. Insights presented in the article reflect his personal viewpoints and analysis.
