Liquidity deficit: First VRR auction of 2025 sees heavy demand for funds from banks

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The banking system is facing liquidity tightness despite the cash reserve ratio (CRR) being cut in two equal tranches of 25 basis points each last month.

This is highlighted by the bids for funds placed by banks at the first variable rate repo auction (VRR) of the new calendar year conducted by the Reserve Bank of India (RBI) on Tuesday.

As against the notified amount of ₹50,000 crore at the three day VRR auction, banks placed bids for funds aggregating ₹92,670 crore. The central bank accepted bids aggregating ₹50,007 crore at the weighted average rate (WAR) of 6.57 per cent.

The liquidity tightness is possibly a manifestation of the RBI ‘s intervention in the forex market through Dollar sales to curb volatility in the Rupee. When the RBI sells Dollars, Rupee liquidity is sucked out.

Widening liquidity deficit

This demand for funds at the first VRR auction of 2025 came even as the banking system had borrowed 14-day money aggregating ₹1,28,323 crore (against notified amount of ₹1,50,000 crore) through VRR auction on December 27, 2024 at a WAR of 6.51 per cent.

That 3-day money was borrowed at a WAR of 6.57 per cent at the VRR auction on Tuesday as compared with 14-day money being borrowed at 6.51 per cent on December 27th is an indication of liquidity tightness in the market.

Nuvama Wealth Management, in a report noted that as on 6th January, the system liquidity deficit had widened to ₹97,800 crore (without adjusting for daily Cash Reserve Ratio/CRR imbalances). The liquidity deficit narrowed to about ₹29,000 crore on January 5, against about ₹1.05 lakh crore as on January 1, 2025.

Cash reserve ratio (CRR) is the slice of deposits Banks place with RBI. Last month, the central bank reduced this ratio to 4 per cent of banks’ deposits (from 4.50 per cent earlier) in two equal tranches of 25 basis points each with effect from the fortnight beginning December 14, 2024 and December 28, 2024. This reduction released primary liquidity of about ₹1.16 lakh crore into the banking system.

V Rama Chandra Reddy, Head – Treasury, Karur Vysya Bank, said: “Despite the 50 basis points CRR cut in December 2024, liquidity remains in deficit. Usually, at the start of the month, government spending and payments ease constraints.

“RBI’s interventions in the foreign exchange market may be contributing to this deficit. We expect liquidity to remain tight, with RBI managing it through Variable Rate Repo (VRR) operations. This trend is likely to persist until the budget and MPC (monetary policy committee) announcements, with interbank rates trading above the repo rate (of 6.50 per cent).”

BofA Securities, in a report, noted that banking system liquidity pressures have intensified through December, which can raise cost of credit and further impinge credit creation.