Indian banks are increasing issuance of certificates of deposits (CDs) to secure cheap funding. The other option would be to raise deposit rates more sharply.

Indian private and state-run banks have raised around Rs 300 billion ($3.76 billion) through two-month to one-year CDs in the two weeks to 19 August, sharply higher than the roughly Rs 50 billion in the previous two weeks, data compiled by Reuters showed.

This route of fundraising for banks may continue for the next few weeks.

“Banks are not raising deposit rates, as they are able to get funds easily from money market by issuing CDs, and that too cheaply, and they may continue to opt for this route of fundraising for next few weeks," Reuters quoted Raju Sharma, head of fixed income at IDBI Mutual Fund, as saying.

Larger lenders, such as Punjab National Bank and Bank of Baroda, have also jumped the bandwagon and are actively borrowing funds through three-month and one-year notes. These lenders are paying around 6.60%-6.74% for one-year funds, and keen to tie up funds for a year in anticipation of policy tightening in the near future, Reuters reported.

The Reserve Bank of India's repo rate currently stands at 5.40%.

Liquidity surplus in the banking system has dropped below Rs 1 trillion, and has averaged around Rs 1.40 trillion in August, falling further from Rs 1.90 trillion in July and Rs 2.92 trillion in June.

"With liquidity getting drained out of the banking system, we expect banks to continue to raise funds through CDs as well as bonds," Reuters quoted Venkatakrishnan Srinivasan, founder and managing partner at debt advisory firm Rockfort Fincap, as saying.

Once credit growth picks up as the economy revives, there  will be need for a steady flow of funds at banks. Mutual funds have been happy to park funds in CDs, thus making it a win-win for issuers as well as investors.

"Debt funds that are mandated to invest in shorter duration are always on the lookout for investment opportunities, and that is the major reason, banks are able to get large quantums without any major difference on rates," IDBI Mutual Fund's Sharma told Reuters.

Kotak Mahindra Bank chief economist Upasna Bhardwaj expects the liquidity tightness to lead to an effective policy rate hike of 60-75 basis points.