Why India’s Banking System Is Facing a Liquidity Crunch
By Dwaipayan Roy | September 22, 2025, 07:11 PM
India’s banking system is currently experiencing a temporary liquidity shortage, driven primarily by recent tax outflows. The liquidity surplus has dropped to its lowest level since the end of March but is expected to improve significantly in the coming days, supported by government spending, bond redemptions, and policy adjustments.
Tax Outflows Impact Liquidity
On September 21, the liquidity surplus in the banking system fell sharply to ₹70 billion (approximately $794 million), marking the lowest level since March. This decline is largely due to an estimated ₹2.6 trillion exiting the system as taxpayers made income tax and Goods and Services Tax (GST) payments.
The amount of cash available in the banking system is crucial because it influences market interest rates, including those applied to consumer loans. Vivek Kumar, an economist at Quanteco Research, noted that this liquidity shortage is likely a short-term issue. He expects government spending to help offset the impact in the coming week.
Reserve Bank of India’s Perspective
The Reserve Bank of India (RBI) has indicated comfort with a liquidity surplus around 1% of banks’ deposits, which currently equates to roughly ₹2.5 trillion. In recent weeks, the liquidity surplus had consistently stayed above this level prior to the recent tax-driven outflows.
Gaura Sengupta, Chief Economist at IDFC First Bank, expects liquidity conditions to improve over the next few weeks as government disbursements increase and banks’ cash reserve ratio (CRR) requirements are eased.
Phased Reduction in Cash Reserve Ratio (CRR)
The RBI will begin cutting the CRR— the proportion of funds banks must park with the central bank— starting October. The total reduction will be 100 basis points, implemented in four equal installments between September and November. The next CRR cut is scheduled for October 4.
Vivek Kumar anticipates that the liquidity surplus will rebound to the ₹2 trillion–₹2.5 trillion range prior to the next CRR adjustment, further alleviating the current crunch.
Outlook
While the recent tax outflows have temporarily tightened liquidity in India’s banking system, experts and the RBI remain confident that supportive government spending coupled with forthcoming CRR cuts will restore healthy liquidity levels soon. Market participants should expect a normalization of liquidity flows in the weeks ahead.
