The Indian banking system is suddenly flush with cash. Thanks to a number of reasons playing at home and abroad, an unprecedented deluge is sloshing around in the system.
This isn’t a distant technical aberration—it’s an economic reality that’s bound to affect the common man if left unmanaged. Such excess liquidity can change the cost of borrowing, return on savings and the purchasing power of money.
With the Reserve Bank of India mandated to manage the country’s money supply and keep headline retail inflation within a preferred range, it has got its task cut out. But this is giving rise to a number of uncommon questions about how it’s taking place.
Here are some of them answered.
Why would the RBI take money away when banks need cash to lend?
On paper, this may look odd. But the fact is that banks currently have too much spare cash, not too little. The RBI manages how much money moves through India’s banks and uses this to steer short-term interest rates. Banks take deposits and lend most of that money out, but they also lend to each other overnight to cover daily gaps.
What happens when banks have too much excess cash?
When banks are flush with spare cash, they compete to lend it out and interest rates fall. India’s banking system had a surplus of roughly ₹9.7 lakh crore in early September, and at one point crossed ₹10 lakh crore, even touching close to ₹11 lakh crore. If the call rate falls too far below the repo rate, the RBI’s grip on interest rates in the wider economy weakens.
Why did so much extra money build up in the banking system?
The surplus built up because Indian banks raised about $127 billion through a special foreign currency deposit scheme by August 31, and roughly $136 billion in total including other foreign borrowing. When that foreign money gets converted into rupees, it adds to the cash already sitting in Indian banks.
How exactly does selling bonds fix this liquidity surplus?
When a bank buys a bond from the RBI, it hands over rupees and receives a bond in return, so the cash leaves the banking system till the bond matures.
Is this why the RBI is taking ₹1 lakh crore out of banks?
Yes, the RBI is mopping up some of the excess money by selling ₹1 lakh crore of government bonds in three rounds starting September 17. Banks and other financial firms are paying the RBI to buy these bonds, and that payment directly pulls cash out of the banking system.
What is the exact schedule for these bond sales?
The bonds are being sold in three tranches:
September 17, 2026: ₹50,000 crore (First and largest tranche)
September 21, 2026: ₹25,000 crore (Second tranche)
September 28, 2026: ₹25,000 crore (Third tranche)
How have financial markets reacted so far?
Bond yields had already moved ahead of the first tranche, which was overbid. The week before, India’s 10-year yield rose above 7% for the first time since June 2026, and five-year yields jumped as much as 22 basis points in a single session. Higher yields can raise borrowing costs elsewhere, but loan rates do not rise automatically just because the RBI sells bonds.
Is the RBI raising interest rates?
No, this is not about changing RBI’s repo rate—at 5.25% now—which the central bank uses to set market rates. However, it can tighten market conditions indirectly, since banks with less spare cash may need to pay more to borrow from each other.
The rate on overnight loans between banks is termed the call money rate. The RBI wants this rate to stay close to its main policy rate, or the repo rate.
Does inflation play a role in this decision?
Inflation is not the direct trigger, but it shapes how much room the RBI has. Retail inflation rose to 4.82% in August from 4.45% in July, and food inflation climbed to 5.95%. While both are within the RBI’s preferred 2-6% band, they remain above its 4% target, especially because wholesale inflation has been climbing.
Has the RBI undertaken similar steps in the past?
Yes. Central banks routinely use open market operations, which involve buying or selling government bonds, to manage swings in bank liquidity.
What happened during the 2016 demonetisation?
India’s clearest precedent came after the November 2016 demonetisation, when the government withdrew ₹500 and ₹1,000 notes overnight. Cash poured into bank deposits so fast that liquidity swelled far beyond normal levels, threatening to push short-term rates toward zero.
The RBI first ordered banks to park all of their extra deposits with it, interest-free, under a temporary 100% cash reserve requirement. It then leaned on the Market Stabilisation Scheme, a tool that lets the government issue bonds specifically to soak up excess cash.
The government raised the ceiling for MSS bonds 20-fold, from ₹30,000 crore to ₹6 lakh crore, to give the RBI room to act. Short-term MSS bills outstanding peaked at more than ₹5 lakh crore in mid-January 2017, and the RBI kept selling bonds in the open market for a year afterward, including ₹90,000 crore in a single stretch, to fully drain the surplus.
Has the RBI ever used this tool to inject cash instead of taking it away?
Late 2018 and early 2019 saw the RBI using the same tool for the opposite purpose. After a series of IL&FS group defaults froze short-term lending, liquidity turned tight rather than surplus. The RBI responded by buying back bonds, injecting cash instead of withdrawing it in late 2018 and early 2019. Running the instrument in reverse proved that the RBI uses bond operations to correct liquidity either way, not only to drain a surplus.
How have other countries, like the US, handled similar situations?
The United States had a similar problem after its pandemic stimulus. The Federal Reserve’s balance sheet grew from about $4 trillion before 2020 to nearly $8 trillion by 2022 as it bought bonds to support the economy. That left banks and money-market funds holding far more cash than they had safe places to put it.
What tool did the US Fed use to absorb its excess cash?
The Fed’s Overnight Reverse Repo facility became the release valve. Funds parked cash with the Fed overnight in exchange for Treasury securities and bought them back the next day. Usage rose from almost nothing in 2021 to a peak of about $2.5-2.7 trillion at end-2022, then fell back toward zero as the Fed shrank its balance sheet.
What is the main takeaway from these central bank operations?
In each case, including India in 2016, India in 2018-19, and the US after the pandemic, the central bank used bond sales or purchases as a plumbing tool. The goal was not to change its main policy rate, but to keep cash in the banking system at a level that supports the target rate without fuelling inflation or instability.
What does all of this mean for ordinary bank customers?
For ordinary bank customers, the message from all these episodes is similar. There is no direct deduction from bank accounts and no automatic change in loan EMIs. What changes, sometimes with a lag, is the wider cost of borrowing and, potentially, deposit rates for savers, as bond yields and market interest rates adjust to less or more spare cash in the system.
