By Joydip Gupta

India’s financial system is facing one of its toughest challenges in over a decade—a severe liquidity crunch. In January 2025, the banking system's cash deficit reached Rs 3.34 lakh crore ($40.5 billion), the highest in 14 years. This isn’t just a banking problem—it’s a systemic issue affecting the broader economy. While the Reserve Bank of India (RBI) has implemented measures like a $10 billion dollar-rupee swap in February 2025 and ongoing open market operations (OMOs), the liquidity gap persists. If rate cuts alone can’t solve this, what will?

The Liquidity Squeeze: A Systemic Challenge

Liquidity refers to the availability of cash and short-term funds to meet immediate payment obligations. When it tightens, financial institutions (FIs)—banks, NBFCs, MFIs, and fintechs—find it harder to lend. This slowdown ripples through the economy, stifling growth. For instance, small businesses, farmers, and MSMEs, which rely heavily on credit, face delays or denials in accessing loans.

To address the growing liquidity crunch, the RBI announced a $10 billion dollar-rupee swap in February 2025. This mechanism allows banks to exchange dollars for rupees, providing them with immediate liquidity while committing to reverse the transaction at a later date. Additionally, the RBI has purchased government bonds worth thousands of crores through OMOs to inject cash into the system. Despite these efforts, structural challenges such as weak deposit growth, elevated government borrowings, and tightening global liquidity conditions continue to strain the financial system.

For NBFCs and MFIs, which extend credit to underserved segments, the situation is dire. Forced to borrow at higher rates, they pass on these costs to end customers, making credit more expensive. This not only limits access to affordable loans but also slows down economic activity in critical sectors like agriculture, MSMEs, and low-income households.

Deposit Growth: A Structural Hurdle

While liquidity is an immediate concern, weak deposit growth is a deeper structural issue. Over the past year, credit growth has outpaced deposit growth by a significant margin—16% versus 11%. This imbalance forces FIs to offer higher interest rates on deposits, increasing their cost of funds and compressing net interest margins (NIMs).

Household savings have shifted from bank deposits to mutual funds, equities, and other high-yielding instruments. With inflation eroding real returns, savers are opting for alternatives, leaving FIs with a shrinking pool of low-cost funds.

Beyond Rate Cuts: Smarter Strategies for Growth

In this challenging environment, FIs need to look beyond traditional fixes and adopt innovative strategies to sustain credit growth. Here’s how:

1. AI-Driven Underwriting and Alternative Data

Artificial intelligence (AI) and machine learning (ML) are transforming how FIs assess credit risk. By leveraging alternative data—such as utility payments, GST filings, and digital transaction histories—FIs can build more accurate credit profiles, especially for borrowers with limited formal credit histories.

India’s digital infrastructure is a goldmine. The Unified Payments Interface (UPI) has created a rich trail of transaction data, while the Account Aggregator framework enables seamless sharing of financial data across institutions (with customer consent).

2. Agile Credit Business Rules Engines (BREs)

Economic conditions are constantly shifting, and rigid lending strategies won’t cut it anymore. Enter Credit Business Rules Engines (BREs)—digital toolkits that allow lenders to test and tweak credit policies in real-time. Think of BREs as a GPS system that recalculates routes instantly based on traffic conditions.

Whether it’s exploring new borrower segments, adjusting loan pricing, or responding to RBI’s regulatory changes, BREs enable FIs to adapt quickly without waiting for lengthy IT updates. Many leading lenders in India have already integrated BREs into their operations, using them to automate loan approvals, refine risk-based pricing, and speed up processing times.

3. Risk-Based Pricing

Not all borrowers are the same, so why should their interest rates be? Risk-based pricing tailors rates to individual risk profiles, charging higher rates to riskier borrowers and offering lower rates to those with strong credit histories. This approach balances risk and reward, boosting profitability while incentivising borrowers to improve their creditworthiness over time.

The Road Ahead

The lending slowdown in India isn’t just about high interest rates—it’s a complex puzzle with multiple pieces. Weak deposit growth, liquidity constraints, and structural challenges are all part of the picture. While the RBI’s efforts to balance growth and inflation are commendable, FIs need to step up their game.

By embracing AI-driven underwriting, leveraging alternative data through UPI and the Account Aggregator framework, and adopting risk-based pricing, FIs can navigate these challenges and keep credit flowing. The question isn’t just about rate cuts—it’s about smarter, faster, and more inclusive lending. And that’s where the real opportunity lies.

(Joydip Gupta, Head of APAC at Scienaptic AI.)

Views are personal, and do not represent the stand of this publication.