RBI Governor Sanjay Malhotra has scrapped the Investment Fluctuation Reserve (IFR), a move that allows greater flexibility in use of accumulated buffers. Prior to this prudential reform, banks were mandated to park a portion of investment gains into the IFR to absorb mark-to-market losses during interest rate volatility. RBI views that current capital buffers are adequate to cover such risks and hence lenders can now redeploy this buffer into Tier 1 capital thereby strengthening the lending capacity.

The continuous mark-to-market tracking of the IFR tied up capital and drove up operational costs. For commercial banks that already hold the standard Capital Conservation Buffers and Countercyclical Capital Buffers, the 5% IFR merely sidelined productive use of excess capital. Even specialized and regional lenders retaining the IFR will now benefit from simplified and centralized rules, as figures are now only required to be presented on official balance sheet dates.

While this exemption provides Commercial banks a costless windfall to expand credit and risk absorption, the analysis reveals an uneven sector-wide impact. To pinpoint the actual beneficiaries, the data employs the ‘Influx Ratio’, a ratio of a bank’s IFR to its Tier-1 capital to quantify the proportion of new funds each bank is ready to utilize. This ratio measures the proportionate increase in usable capital that a bank could receive from IFR. A greater ratio suggests that the RBI’s decision has increased relative capital.

In FY24, there is a near-equal split amongst private and public sector banks. Kotak Mahindra Bank led the sector with a massive influx ratio of 3.98%, followed closely by private peers Dhanlaxmi. Bank (3.29%) and Nainital Bank (2.99%). However, public sector banks are heavily accumulated just behind, led by Central Bank of India (3.55%), State Bank of India (3.00%) and Punjab and Sind Bank (2.87%).

By FY25, while the the equal split between public and private sector banks remained at face value, public sector banks became much more concentrated at the top. CSB Bank topped the list with an influx ratio of 4.05%, followed by private peers Kotak Mahindra Bank (3.65%) and Nainital Bank (2.57%). The PSB leaders were Indian Bank (3.08%), Central Bank of India (2.92%) and Punjab and Sind Bank (2.87%). Most notably, in both years, the largest private lenders (HDFC Bank, ICICI Bank, Axis Bank) have constantly showcased low influx ratios ranging just between 1.18% to 1.80%.

There are a host of possible reasons that could explain these results.

How PSBs might come out as the biggest winners

Massive deposit requirements push PSBs to park vast sums into Government securities (G-Secs) to meet the 18% SLR mandates, with public and private banks parking over 85% into G-Secs in 2024, per a KPMG study. DBIE data showed on average, public banks in 2025 held 85% of their investments in India under G-Secs, their absolute holdings being thrice as large as those of private banks. This was exacerbated by ‘lazy banking’, a post-NPA strategy wherein PSBs voluntarily held excess G-Secs to earn minimum interest rather than lending out. Furthermore, the 2019-20 mega-mergers involving massive banks like SBI, Bank of Baroda and Punjab National Bank forced these institutions to absorb hefty G-Sec portfolios and corresponding IFR buffers of smaller banks. The NPA crisis in the 2010s largely impaired PSB profitability, forcing them to use up profits for loan provisioning. Since PSBs struggled to generate retained earnings, their Tier-1 capital base was thin and reliant on government injections. A constrained Tier-1 denominator and massive IFR buffers give PSBs a disproportionate capital advantage compared to private peers.

Why private banks might lag and a mid-cap spike?

Private banks, on the other hand, experience a different reality due to their treasury strategies and organic capital generation ability. A Care Ratings report (2023) explained how private banks aim to minimize exposure to bond yield volatility by maximizing the permitted limit of 19.5% Held-to-Maturity holdings, reducing the need to maintain large IFR buffers. Larger private lenders rely on building Tier-1 capital via retained earnings. They are more profitable than PSBs, with better performing metrics such as return on assets, return on equity and net interest margins on average in 2025. With a massive capital base, the IFR injection is diluted, reiterated by a Kotak Institutional Securities report estimating a mere 1%-3% rise in CET1 of banks post the IFR discontinuation. However, Influx Ratio spikes amongst mid-cap private banks showcases a different phenomenon. They may be channelling profits into the IFR to build it up and smoothen earnings. For example, Kotak Mahindra Bank in FY25 showed a profit of Rs 4,539 crore on sale of investments and balanced it by hiking provisions and contingencies by nearly 40%, keeping net profit smooth at 19.3%. The bank absorbed this windfall by hiking up provisions for investments at 18% and advances by 73%. The RBI’s decision rewards defensive strategies of such lenders.

Indian banks face surging credit-deposit ratios, as massive credit growth outpaces deposit mobilization and causes liquidity constraints. In this environment, this non-dilutive capital injection grants PSBs crucial lending headroom while mid-cap private lenders benefit as well. These lenders will be empowered, at least in the short term, to sustain credit flow to the broader economy without immediately requiring high-cost deposits. As a long-term implication, PSBs may rearrange treasury portfolios by moving some surplus G-Sec holdings into higher-yielding credit assets or State Development Loans in order to improve Net Interest Margins while adhering to SLR limitations now that IFR is no longer continuously tying up capital.