IndusInd Bank case: Who is India’s real lender of last resort?

On 10 March, IndusInd Bank disclosed that an internal review had uncovered a discrepancy in its rupee-dollar swap accounting. The irregularity would erode the bank’s capital base by 2.5%. The management sought to reassure investors and depositors, stating that the impact would not threaten the bank’s stability, and its promoter group bolstered confidence by offering to inject capital if needed.

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Still, the disclosure triggered concerns among corporate and institutional depositors. Given the size and concentration of their holdings, these clients were highly sensitive to market sentiment and some began to withdraw their funds. In response, on 15 March, RBI issued a public statement affirming the bank’s soundness—a move seemingly aimed at stemming further deposit flight and preventing a full-blown bank run.

Liquidity scramble and unconventional measures: Despite RBI’s assurance, IndusInd faced mounting pressure to maintain its liquidity buffers. To shore up liquidity, it issued certificates of deposit (CDs) worth nearly ₹16,000 crore in the weeks after the disclosure. Unusually, large PSBs were the primary buyers. State Bank of India (SBI) alone subscribed to over half the issuances. Media reports suggest RBI played a behind-the-scenes role, persuading PSBs to buy its CDs.

Two aspects of this intervention stand out. First, banks buying CDs issued by peer institutions is uncommon, especially at such scale. Second, the yields on these instruments were significantly higher—by around 30 basis points—than those on similar-tenor CDs issued by the bank before the incident. This reflected the perceived increase in risk.

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RBI’s indirect intervention: Pragmatic but problematic? Ever since Walter Bagehot articulated the principles of LoLR in the 1860s, the doctrine has guided central banks during liquidity crises. It stipulates that, in times of stress, central banks should lend freely against high-quality collateral, but at a penalty rate. Many jurisdictions empower their monetary authorities with discretionary powers to extend emergency liquidity assistance to solvent but illiquid banks.

In India, Sections 17 and 18 of the RBI Act grant the central bank broad authority to lend to distressed banks. Section 18 empowers RBI to extend on-demand or 90-day loans to “any person," not just banks, without collateral, on such terms as it deems sufficient. It just needs to believe “a special occasion has arisen making it necessary or expedient that action should be taken… for the purpose of regulating credit in the interests of Indian trade, commerce, industry, and agriculture."

RBI could thus have directly lent funds to IndusInd under its LoLR mandate. Instead, it orchestrated liquidity support through state-owned banks. This raises a fundamental question: why did the central bank avoid using its own balance sheet?

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Possible explanations: It is conceivable that RBI viewed IndusInd’s liquidity shortfall as a temporary funding gap rather than a systemic crisis. By relying on PSBs to plug the gap, it may have sought to avoid invoking the LoLR mechanism prematurely, preserving it for systemic events. But this raises the question of whether RBI has a clear threshold—based on the number of banks affected or the severity of stress—at which it would do so.

Another plausible explanation is that direct intervention could have spooked the market further. Invoking Section 18 may have signalled that IndusInd’s situation was more precarious than publicly disclosed—thereby accelerating deposit flight. This line of reasoning suggests that LoLR’s mere existence serves as a deterrent, akin to nuclear deterrence, rather than as an active policy tool. Yet, this is difficult to justify. After all, the very purpose of LoLR is to prevent liquidity stress and bank runs.

The most likely explanation, however, is that RBI relied on its informal influence over PSBs—effectively using them as a backdoor LOLR mechanism, without officially intervening. While expedient, this raises viability concerns. As private sector banks continue to gain market share, RBI’s ability to rely on PSBs as crisis-funding vehicles will diminish. It also raises questions of a conflict between the separate roles that RBI plays as a central bank and a banking regulator.

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RBI’s crisis-management playbook needs clarity. By opting for a behind-the-scenes liquidity injection rather than invoking its formal LoLR powers in IndusInd’s defence, RBI may have prioritized market confidence over transparency. However, this approach depends heavily on large state-owned banks being willing—and able—to absorb the financial implications of such interventions.

As India’s banking landscape becomes increasingly privatized, this form of regulatory ‘moral suasion’ may become less effective, underscoring the need for clearer policy signals on when and how RBI will invoke its LoLR authority. More broadly, we need to ask whether informal, opaque interventions can continue to substitute transparent, rule-based central-bank action during periods of financial stress.

These are the authors’ personal views.

The authors are, respectively, a doctoral scholar at the National University of Singapore, and a researcher and independent director with Karur Vysya Bank.