Banking System Cash Squeeze Pushes Overnight Rates Above RBI’s Repo Rate
India’s money markets witnessed a sharp tightening in liquidity conditions over the past few days, with overnight borrowing rates moving decisively above the Reserve Bank of India’s (RBI) policy repo rate. The spike reflects a temporary cash squeeze in the banking system, largely triggered by advance tax payments by corporates, which drained funds and pushed short-term borrowing costs higher.
According to RBI data, overnight and other short-term money market rates rose by 10–15 basis points over three consecutive sessions as system liquidity slipped into deficit. Market participants said the sudden shortage of funds forced banks and other borrowers to access overnight markets at elevated rates to meet immediate funding requirements.
Call Money Rates Trace the Shift From Surplus to Deficit
The movement in weighted average call money rates clearly mirrors the shift in liquidity conditions. When the system was in surplus, rates hovered around the repo rate of 5.25 percent. As liquidity tightened, rates quickly moved higher.
Key rate movements over the week include:
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December 15: Call money rates at 5.25%, aligned with the repo rate
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December 16: Rates jumped to 5.41% as liquidity turned tight
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December 17: Rates climbed further to 5.46%
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December 18: Rates eased slightly to 5.36%, still above the repo rate
The sustained trading of overnight rates above the policy benchmark is a clear signal of stress in short-term funding conditions, even if the pressure is expected to be temporary.
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Advance Tax Payments Trigger Temporary Liquidity Drain
Market participants attributed the liquidity squeeze primarily to advance tax payments by corporates, a recurring phenomenon that periodically tightens banking system liquidity. During advance tax periods, large sums move out of bank accounts into government coffers, temporarily reducing the availability of lendable funds.
As a result:
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Banks faced reduced surplus cash positions
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Borrowing demand in the overnight market increased
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Short-term rates rose above the policy corridor
“The liquidity squeeze was triggered by advance tax payments by corporates, which typically lead to large outflows from the banking system and temporarily strain available funds,” dealers said, noting that such pressures are usually short-lived.
How Liquidity Turned Deficit Despite RBI Support
The liquidity in the banking system officially turned into a deficit on December 17, marking the first such instance in nearly two months. This occurred despite continuous support measures from the RBI, including variable rate repo (VRR) auctions, open market operation (OMO) purchases of government securities and USD/INR buy-sell swap auctions.
System liquidity levels over recent days show the extent of the squeeze:
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December 16: Deficit of ₹60,787.81 crore
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December 17: Deficit widened to ₹68,586.12 crore
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December 18: Deficit narrowed to ₹29,910.12 crore
This was the third instance in the current financial year when banking system liquidity slipped into deficit, following similar episodes in late October and on September 22. The previous deficit before this phase was recorded on October 28, 2025, when liquidity stood at ₹8,083.79 crore in the red.
RBI’s OMO Purchase Brings Partial Relief
Liquidity conditions showed signs of easing after the RBI conducted an OMO purchase auction on December 18, which infused ₹50,000 crore into the system. The infusion helped narrow the deficit and brought some relief to money market participants.
Dealers said the central bank’s timely intervention helped prevent a sharper spike in overnight rates, even as demand for short-term funds remained elevated due to tax-related outflows.
Will the Pressure on Overnight Rates Ease Soon?
Money market experts expect the pressure on overnight and short-term rates to ease over the coming days as liquidity conditions normalise. Historically, advance tax-related outflows tend to reverse gradually as government spending picks up and funds flow back into the banking system.
“While the spike in overnight rates reflects near-term tightness, the situation is unlikely to persist,” a market expert said. “Rates should moderate once liquidity normalises and the impact of advance tax payments fades.”
Experts added that additional liquidity support from the RBI, if required, could further stabilise rates.
RBI’s Liquidity Strategy: VRR Over Fresh OMOs
Market participants believe the RBI is likely to rely more on variable rate repo (VRR) auctions rather than announce fresh OMO purchases for the remainder of the month. The central bank has already been actively using VRR operations to fine-tune liquidity conditions on a day-to-day basis.
On December 18, it was reported that the RBI may avoid announcing additional OMOs this month and instead depend on:
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Ongoing VRR auctions to inject short-term liquidity
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The impact of the recent ₹50,000 crore OMO purchase
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Gradual liquidity return post advance tax outflows
This approach is also expected to help cushion the system ahead of heavy GST outflows scheduled for December 20.
What It Means for Banks and Markets
For banks, the temporary rise in overnight rates implies slightly higher short-term funding costs, though the impact is unlikely to spill over into longer-tenor rates or lending benchmarks if liquidity normalises quickly.
For markets, the episode underscores the RBI’s balancing act—managing transient liquidity shocks without distorting the broader monetary policy stance. The central bank has reiterated its commitment to ensuring adequate liquidity to support orderly market functioning.
As advance tax pressures subside and RBI operations continue, money market participants expect overnight rates to gravitate back towards the repo rate, restoring equilibrium in the short-term funding landscape.
