Credit cycle slowing down? Banks park ₹1.71 lakh crore with RBI, signal lending caution

Even as net outflows threaten to pull banking liquidity lower this week, the Reserve Bank of India’s (RBI) Variable Rate Reverse Repo (VRRR) auction on July 4 saw a sharp spike in participation—a signal that banks are growing cautious.

According to the Bandhan Mutual Fund Money Market Weekly report dated July 7, the central bank received tenders worth ₹1.71 lakh crore, more than double the ₹ 85,000 crore tendered in the previous auction. This comes despite the RBI rolling over the VRRR for the same amount of ₹1 lakh crore.

VRRR is a tool used by the RBI to manage excess liquidity in the banking system. Under this, banks park their surplus funds with the RBI for short periods in return for interest, determined through auction. It is called a “variable rate” because the interest rate is decided based on bids placed by the banks. The high demand in the latest VRRR suggests that banks preferred to park funds with the RBI rather than lend or invest, likely due to near-term uncertainty.

There are several important reasons why banks are showing a strong preference to park funds in the RBI’s VRRR auction, even though the space was limited, instead of lending or investing.

As highlighted in the RBI’s June 2025 Financial Stability Report (FSR), banks are increasingly cautious about lending going forward. This matches the findings in the VRRR report by Bandhan Mutual Fund.

For instance, despite having deposits, banks are not aggressively lending. RBI data reveals that NBFCs are undergoing a retail stress test as banks grow increasingly cautious about lending to those exposed to unsecured and microfinance borrowers. Lending by banks to NBFCs had seen robust growth: rising from around 9% in March 2021 to over 35% by March 2023. But by March 2025, that growth rate plunged to just 5.9%, signalling a sharp pullback. This dramatic slowdown suggests heightened risk aversion among banks or emerging regulatory constraints, leaving NBFCs more vulnerable to funding pressures.

Many banks are showing risk aversion, likely due to concerns over future repayments, the quality of borrowers, or the overall economic conditions.

This cautious behaviour is exactly why banks are more willing to park their funds in RBI’s reverse repo auctions; it’s safer than lending in uncertain times.

Secondly, the surge in VRRR demand reflects a shift in bank behaviour, coinciding with tightening liquidity conditions in the system. The headline liquidity stood at ₹4.11 lakh crore (adjusted for Cash Reserve Ratio imbalances) as of July 4. With net outflows worth ₹17,588 crore projected between July 7-13, the liquidity cushion appears to be eroding. “The net impact on liquidity for the upcoming week is expected to be negative due to higher outflows (₹65,300 crore) than inflows (₹47,712 crore),” the report noted.

With more outflows than inflows, banks sense that liquidity may become tighter in the coming weeks, so they are locking in safe returns now through RBI tools rather than lending, which may expose them to higher risk or lower returns later.

The heightened response to VRRR also comes at a time when the credit cycle is showing signs of weakness. According to the report, credit offtake rose only 9.6% year-on-year as of June 13, well below last year’s 15.5% growth. In contrast, deposit growth stood at 10.4% y-o-y, totalling ₹230.7 lakh crore, a decrease from 12.1% the previous year (excluding merger impact). This imbalance has pushed the credit-deposit ratio below 80% for six consecutive fortnights, reflecting subdued credit appetite in the system.

That means a lot of money is just sitting idle or being parked safely, not being circulated productively in the economy. Hence, banks rush to deploy them safely with the RBI.

In short, banks are hedging against uncertainty, locking in safe returns from the RBI through VRRR auctions. The combined impact of weak credit demand and economic caution is driving this behaviour.