THE drop in banking system liquidity and the concurrent rise in demand for credit may result into tightening of credit in the financial system, a report said on Wednesday.

The liquidity condition is expected to become even more challenging over the coming months, owing to an expected seasonal pick-up in cash-in-circulation caused by the festive season, India Ratings and Research said in a report.

In addition, the net Balance of Payment (BoP) could remain in deficit during the same period, which will drain out more liquidity from the banking system, it said.

“The ongoing sharp drop in the banking system liquidity and the concurrent rise in the credit demand could lead to tightness in the financing system amid the prevailing uncertain business environment,” the agency’s Director Soumyajit Niyogi said in the report.

Moreover, a sudden spike in the short-term interest rate cannot be ruled out, he said.

The report said that the demand for credit is expected to stay strong, driven by higher Working Capital Requirements (WCRs) as well as seasonal factors. Banking system liquidity came down to Rs 50,500 crore on July 27, compared to the average of Rs 7 lakh crore in February 2022 and Rs 4.5 lakh crore in May 2022.