Indian government bonds experienced a notable decline in early trading on Wednesday following the Reserve Bank of India's decision to focus on illiquid securities for its upcoming debt purchase operation. The move has left market participants questioning the central bank's strategy as it sidesteps market demand for liquid note inclusion.

Bond Market Performance

The benchmark 10-year government bond yield demonstrated the market's reaction to the RBI's announcement:

Bond yields move inversely to prices, meaning the increase in yield reflects falling bond prices across the market.

RBI's Security Selection Strategy

The Reserve Bank of India's latest debt purchase operation will target bonds worth ₹50,000 crores, equivalent to $5.55 billion. However, the selection criteria have raised concerns among market participants:

• Maturity range: Securities maturing between 2029 to 2053
• Liquidity status: All selected notes are illiquid and infrequently traded
• Market expectation: Traders anticipated inclusion of the liquid 6.33% 2035 bond
• Consecutive pattern: Second week of avoiding liquid papers in open market operations

"For the second consecutive week, the RBI has been falling short of market expectations leaving us puzzled as to what could be the reason for not giving the 6.33% 2035 bond in OMO," commented a trader from a primary dealership.

Market Concerns and Implications

Traders have expressed significant concerns about the sustainability of bond market rallies under the current approach. The focus on illiquid papers means funds invested in liquid securities remain tied up, potentially limiting market momentum. This concern becomes particularly relevant given the substantial debt issuance pipeline ahead.

Upcoming Debt Supply Challenges

The massive debt supply from both state and central governments has created investor concerns about deteriorating demand-supply dynamics in the bond market.

Interest Rate Environment

India's overnight index swap rates are expected to remain range-bound during the current session due to lack of market triggers:

• Five-year OIS rate: 5.95% (little changed)
• One-year and two-year OIS rates: Not yet traded
• Market outlook: Thin trading range anticipated

The bond market entered 2026 with uncertainty surrounding investor appetite for increased debt supply, despite the RBI's continued support through regular bond purchase operations. The central bank's strategy of focusing on illiquid securities while maintaining substantial purchase volumes reflects a complex balancing act between market support and operational objectives.

Major non-banking finance companies have formally requested the Reserve Bank of India to permit retail deposit mobilisation, a move they believe would establish competitive parity with banks and enhance monetary policy rate transmission effectiveness.

High-Level Meeting with RBI Governor

The proposal was presented to RBI Governor Sanjay Malhotra during a closed-door meeting held on Monday. The session brought together chief executives of NBFCs, housing finance companies, microfinance institutions, and industry representatives to discuss sector-specific issues.

Currently, the regulatory framework restricts most NBFCs from accepting retail deposits, with only a select few companies holding legacy licences permitted to do so.

Current Regulatory Landscape

The existing deposit-taking framework shows significant restrictions on NBFC operations:

Among the few NBFCs authorised to accept retail deposits are Bajaj Finance, Shriram Finance, and Mahindra Finance. These companies operate under stringent regulatory oversight and face multiple operational constraints.

Regulatory Concerns and Challenges

The RBI has historically resisted expanding deposit-taking permissions to NBFCs, primarily due to consumer protection considerations. A key differentiating factor remains deposit insurance coverage.

"The critical issue here is that bank deposits, up to ₹5.00 lakh, are insured by DICGC or Deposit Insurance and Credit Guarantee Corporation, unlike NBFC deposits. That is one of the concerns preventing the regulator from issuing new deposit-taking licences to finance companies," explained an economist who requested anonymity.

This insurance gap creates a fundamental risk differential between bank and NBFC deposits, influencing regulatory policy decisions.

Market Concentration and Industry Dynamics

According to the RBI's annual Trend and Progress report, retail deposits represented approximately 12.50% of total resources raised by deposit-taking NBFCs as of March 2025. The market shows high concentration, with five major NBFC-Ds accounting for 96.90% of aggregate deposits in the sector.

Industry Perspective on Deposit Management

Jairam Sridharan, Managing Director of Piramal Finance, provided insights into the operational complexities of deposit management during a November 6, 2025 interview. He emphasised the fundamental differences between lending and deposit-taking operations.

"Few NBFCs have the skills to do deposit management. It's a very different ballgame than giving customers your money. Asking customers for their money requires trust and a certain level of fiduciary abilities internally in governance architectures," Sridharan noted.

He estimated that perhaps 10 to 12 NBFCs possess the necessary capabilities for effective deposit management, while the remaining approximately 9,500 NBFCs likely lack such operational expertise.

Implications for Financial Sector

The NBFC sector's push for retail deposit access reflects broader concerns about funding diversification and competitive positioning within India's financial services landscape. The outcome of these discussions could significantly impact how NBFCs structure their liability profiles and compete with traditional banking institutions for retail funding sources.