Cheaper overseas funding and stronger foreign-currency deposit inflows reduce reliance on short-term debt, potentially easing funding costs and supporting bank profitability

Indian banks are rapidly changing the way they raise funds after the Reserve Bank of India (RBI) introduced measures to encourage foreign-currency deposits. The central bank's recent decision to absorb hedging costs for eligible overseas deposits has made foreign-currency funding significantly more attractive, prompting lenders to scale back issuance of Certificates of Deposit (CDs)—a key short-term borrowing instrument traditionally used to finance credit growth.

The shift reflects an evolving funding landscape where banks are increasingly opting for longer-tenure, lower-cost overseas deposits instead of relying heavily on domestic money markets. Analysts believe this transition could improve liquidity management, lower funding costs and strengthen profitability for the banking sector in the coming quarters.

Certificate of Deposit Issuance Comes to a Halt

The impact of the RBI's policy became visible almost immediately.

According to data from the Clearing Corporation of India Ltd. (CCIL), Indian banks did not issue a single Certificate of Deposit during the three trading sessions ending July 2.

The slowdown follows a sharp moderation in issuance during the second half of June. Banks collectively raised ₹70,800 crore between June 16 and June 29, considerably lower than the nearly ₹1 trillion raised during the first half of the month.

The decline is particularly noteworthy because lenders generally increase CD issuances near the end of every quarter to strengthen liquidity and support regulatory balance sheet requirements.

How the RBI's Policy Changed the Funding Equation

The RBI's decision in June to absorb hedging costs associated with foreign-currency deposits has fundamentally altered funding economics for Indian banks.

Normally, banks raising dollar deposits from overseas investors or Non-Resident Indians (NRIs) incur hedging expenses to protect themselves from currency fluctuations. By taking over a substantial portion of these costs, the central bank has significantly reduced the effective cost of overseas borrowing.

Market participants estimate that the initiative could attract more than $50 billion in foreign-currency deposits over the next few months.

The measure forms part of the RBI's broader strategy to strengthen banking system liquidity while ensuring sufficient funding is available to support India's expanding credit demand.

Banks Prefer Longer-Term, Stable Funding

One of the biggest advantages of foreign-currency deposits is their longer maturity profile.

Certificates of Deposit generally mature within one year and require banks to refinance them frequently. In contrast, foreign-currency deposits typically carry maturities ranging from three to five years, offering lenders greater funding stability and reducing refinancing risk.

Bank treasury officials say this makes overseas deposits a more dependable source of capital, particularly at a time when loan growth continues to outpace deposit mobilisation across the banking sector.

Longer-tenure funding also improves asset-liability management and reduces pressure on short-term liquidity.

Funding Costs Begin to Decline

The shift toward overseas deposits has already started affecting borrowing costs.

The yield on one-year Certificates of Deposit has fallen to around 6.84%, compared with a more than two-year high of 7.96% recorded in May.

Meanwhile, banks are currently offering interest rates of up to 7.75% on foreign-currency deposits with maturities between three and five years.

Although the nominal interest rates appear comparable, the RBI's hedging support makes overseas funding considerably more economical from a total cost perspective.

Lower funding costs are expected to support banks' net interest margins (NIMs) over the coming quarters.

Banks See Overseas Deposits as a Strategic Funding Source

Leading lenders have already begun adjusting their funding strategies.

Axis Bank has indicated that it plans to utilise foreign-currency deposits mobilised from the Indian diaspora to replace more expensive domestic borrowings over the coming months.

Other banks have also reported the beginning of fresh foreign-currency inflows, suggesting the RBI's initiative is gaining traction.

Industry executives believe these deposits represent a more stable and permanent source of liquidity compared with Certificates of Deposit, which are largely dependent on short-term money market conditions.

Treasury Experts Expect CD Issuance to Stay Weak

Bank treasury officials expect Certificate of Deposit issuance to remain subdued until at least August or September.

Unless liquidity conditions tighten significantly or the RBI begins aggressively absorbing surplus liquidity from the financial system, banks are unlikely to return to heavy CD issuance.

Several market participants also expect CD yields to decline by another 20–25 basis points if foreign-currency deposit inflows continue to strengthen over the next two months.

Lower borrowing costs could further improve banks' funding efficiency and reduce pressure on interest expenses.

Positive Implications for the Banking Sector

The RBI's latest policy initiative could deliver multiple long-term benefits for Indian banks.

Lower Cost of Funds

Reduced dependence on expensive short-term borrowing should help improve profitability and support lending activity.

Improved Liquidity Management

Longer-tenure deposits provide greater certainty in funding, reducing rollover and refinancing risks.

Better Asset-Liability Matching

Stable funding enables banks to manage long-term loans more efficiently while maintaining healthier balance sheets.

Enhanced Earnings Visibility

Lower funding costs combined with sustained credit demand may improve earnings quality across both public and private sector banks.

Potential Risks to Watch

While the outlook remains positive, several factors could influence the success of the RBI's initiative:

• Global interest rate movements affecting foreign deposit inflows

• Currency volatility and hedging costs

• Domestic liquidity conditions

• RBI's future liquidity management operations

• Pace of loan growth relative to deposit mobilisation

• Changes in global financial market sentiment

Banks will need to carefully manage these variables while balancing domestic and overseas funding sources.

What It Means for Investors

The shift toward foreign-currency funding could improve earnings prospects for Indian banks by lowering interest expenses and enhancing funding stability.

Banks with strong NRI deposit franchises and international banking operations are likely to benefit the most from increased overseas inflows.

Investors should closely monitor quarterly results for signs of improving net interest margins, deposit growth, liquidity ratios and treasury performance as the benefits of the RBI's initiative begin to reflect in financial statements.

Key Highlights