By Satish Singh
The Reserve Bank of India (RBI) is buying government bonds to reduce banks’ borrowing costs and encourage economic growth. State and Central governments issue government bonds to raise funds for various projects and welfare initiatives, offering investors a fixed interest rate over the bond’s term. This approach helps the government finance essential programmes that promote development.
Since April 2025, the RBI has invested over Rs 5 lakh crore in bonds via Open Market Operations (OMO) to boost liquidity and lower lending rates. However, rising bond yields pose a challenge, as higher yields reduce the likelihood of rate cuts and hinder credit flows. Recent data reveal a 0.57% increase in 3-month government bond yields and a 0.80% rise in 10-year yields, with an average of only 6.7% in 2025, the lowest in three years. As yields climb, the expected reduction in borrowing costs remains unlikely.
Increased bond yields have raised banks’ operating costs, keeping interest rates high on loans such as home and auto loans, which negatively affects consumer spending and economic growth. In response, the RBI is considering further bond purchases to improve financial conditions. Additionally, rising gold and silver prices, along with geopolitical uncertainties and policies from international leaders such as President Trump, have led to foreign investors withdrawing capital, increasing pressure on RBI to provide additional liquidity.
OMO plays a crucial role in liquidity management. When market strains arise, RBI injects liquidity by acquiring government bonds, providing banks with capital to extend credit to businesses and individuals. Given global uncertainties and declining foreign investments, experts predict RBI may need to purchase bonds worth over Rs 2 lakh crore by March 2026. Since April 2024, the RBI has infused Rs 7.7 lakh crore into the banking system through OMOs and lowered the repo rate by 1.25% to support 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 Rs 10,000 crore, even as states aim to borrow an ambitious Rs 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, complicates banks’ lending, and raises loan interest rates.
Banks are currently facing a capital availability crisis for several reasons. Low deposit interest rates have made them less appealing to investors, and recent tax changes on deposits have discouraged savers. Furthermore, attractive stock market and mutual fund opportunities are drawing investors away from traditional savings. Bank staff selling insurance products has also led customers to use deposits for payments, further reducing available funds.
There has been a noticeable gap between the growth rates of bank deposits and loan issuance, with deposits lagging loans, creating a shortage of affordable capital for banks. As of December 12, deposit growth has slowed to 9.7% year-on-year, while loan growth has increased to 11.7%, creating a 200 bps gap between them.
According to RBI, total loans disbursed by banks reached Rs 196.5 lakh crore, up from Rs 175.86 lakh crore a year earlier, marking a rise of Rs 1.2 lakh crore in just two weeks. Total deposits rose to Rs 242.14 lakh crore from Rs 220.06 lakh crore a year prior, although they fell by Rs 45,344 crore in the same fortnight. For comparison, in the fortnight ending November 28, loans grew at 11.5% and deposits at 10.2%.
In light of these trends, to stimulate economic activity, raise growth rates, and realise India’s aspiration to become a developed nation by 2047, both the government and the RBI 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.
The writer is a Mumbai-based senior banker and columnist.
