The problems with the Indian economy seem to be increasing. The latest news coming from the banking sector is that banks are running out of money. In a dramatic turnaround, the banks have gone from a position of surplus funds last week, to a position where banks have run out of headroom to borrow from the Reserve Bank of India (RBI) after collectively raising Rs 30,000 crore from the central bank. This has had an effect on the interest rates for money and they have breached the higher end of borrowing and lending rates of RBI to trade at 9 per cent.

There is also speculation that if these rates continue to run at their present level, bank interest margins would definitely come under danger. In addition to this, all those corporates which have borrowed at rates linked to money market rates will also see their funding cost rise.

Another problem for banks with cash shortage is that this is a highly unusual for it. It generally occurs at the beginning of a quarter since this is the time when money that has gone out of the system, by way of taxes, comes back in the form of government spending. This quarter, the government is yet to spend the Rs 16,613 crore of cash balances with RBI as of end-June.

Bankers are attributing this cash shortage to three main factors. First, banks have been asked to maintain higher cash balances with RBI. Second, the central bank has been selling dollars which results in a fall in rupee funds. And third, the government is yet to spend funds worth over Rs 16,613 crore, raised by way of taxes.

For most of the year, money market rates have been ruling within the bracket decided by the RBI. The repo rate determines the higher end of the floor and it stands at 8.5 per cent. Repo rate is the rate at which the central bank lends to banks. The lower point is fixed by the 6 per cent reverse repo rate — the rate at which RBI borrows.