RBI Governor flags emerging financial vulnerabilities, urges vigilance

₹1 trillion. That is the RBI’s net sale of bonds—tradable debt securities—this financial year, the first such tally in a decade. While a central bank bulletin was explaining why deposits need not come before loans, the central bank’s market operations were removing cash from the banking system. There is no contradiction here. But the distinction matters enormously to anyone setting a lending target or deciding what a bank should pay to attract money.

The week’s most useful banking argument was not whether banks can lend. It was what that lending will cost to sustain. The RBI bulletin challenged the familiar idea that a bank must first collect customer deposits and only then extend credit. Banks can create loans and subsequently obtain the reserves or funding they need: reserves being the money they hold with the central bank. That is a clarification of how banking works, not a promise that funding will always be plentiful or inexpensive.

Think of it as the difference between placing an order and settling the bill. The sequence matters, but changing the sequence does not make the bill disappear. A bank’s ability to create a loan does not exempt it from managing the cash needed to honour payments and meet its obligations. The bulletin puts central bank liquidity—the cash available to the banking system—at the centre of that process. This week’s operations supplied a rather pointed illustration of why that qualification deserves as much attention as the headline claim.

The RBI has been reducing liquidity while recording those ₹1 trillion in net bond sales. When the central bank sells securities, the money paid for them is drawn out of the system. Market analysts think the net sales figure could double by December. That remains a forecast, not an announced RBI commitment, but it gives bank funding managers a clear reason to plan for less comfortable conditions rather than assume that cash will be readily available when loan growth requires it.

There was a second drain. Bankers said the RBI’s recent foreign-exchange sell/buy swaps—transactions in which it sells currency and agrees to buy it back later—had removed almost $20 billion from surplus liquidity. The operations also pushed up dollar-rupee forward premiums, the difference between exchange rates for immediate transactions and those agreed for a future date. The one-year premium climbed approximately 50 basis points this month; a basis point is one-hundredth of a percentage point. These are not just numbers for a specialist dealing room. They affect the cost of protecting businesses and banks against movements in the dollar.

That protection, known as hedging, is meant to make future payments more predictable. It is now becoming more expensive, according to the supplied reporting on the swaps. For a banker, the consequence is two-sided: there is less surplus cash in the system, while clients managing dollar exposures face a higher price for certainty. Neither development says lending must stop. Both say that the price and structure of a loan cannot sensibly be separated from the conditions under which the bank and its customer obtain money.

The bond market was delivering much the same message through another channel. The benchmark ten-year government bond yield—the market return on the debt used as a reference for other borrowing costs—reached 7.19%, its highest since April 2024. The reported drivers were sharply higher global oil prices and rising global bond yields. Existing bonds lose market value when yields rise, and traders were already facing losses. For bank treasury teams, which manage cash and securities, the discomfort is immediate: a security bought earlier is now competing with debt offering a better return.

This is where an apparently abstract debate about deposits becomes practical. A bank can understand perfectly well that deposits need not precede credit creation and still have excellent reasons to compete for them. Stable funding has value when market conditions tighten. At the same time, a higher government bond yield can make those securities more attractive to savers, potentially intensifying competition for money. The bulletin does not make deposit gathering obsolete. It asks us to stop confusing one important source of bank funding with the sole mechanical permission to lend.

Nor should the rise in yields be pinned entirely on the RBI’s cash withdrawal. The reporting points explicitly to oil and global bond markets. That distinction matters because it prevents an easy but misleading story in which every movement in borrowing costs is a direct expression of domestic policy. Bankers are dealing with several pressures at once. The central bank can influence liquidity decisively; it cannot make the external pressures cited in this week’s bond report irrelevant to Indian borrowing costs.

The next test comes at the RBI Monetary Policy Committee (MPC), the body that decides policy interest rates, meeting on October 5–7. Economists widely expect a 25-basis-point increase in the repo rate—the rate at which the RBI lends to commercial banks—to 5.5 per cent. That is an expectation, not a decision. Persistent inflation and global monetary tightening underpin the forecast. If it happens, banks would face a higher policy borrowing cost alongside the liquidity withdrawal and the market losses already confronting their treasury teams.

The honest reading is neither that banks are running out of permission to lend nor that deposits no longer matter. It is that the ability to expand lending and the economics of doing so are separate questions. The RBI bulletin explains the first; this week’s bond and currency operations sharpen the second. A lending plan that celebrates capacity while treating funding costs as an afterthought is missing the expensive half of the argument.