Major Sources of Funds for Commercial Banks

When you deposit your salary into a savings account or take out a home loan, you are plugging into a much larger financial engine. Commercial banks do not lend out money they conjure from nowhere – they depend on very specific funding sources to stay liquid, profitable, and solvent. Understanding where a bank’s money actually comes from is essential to understanding how the entire banking system, and by extension the economy, functions. This post breaks down the five major sources of funds for commercial banks: deposits, reserve funds, retained earnings, shareholders’ capital, and borrowings from other banks.

Deposits: the lifeblood of banking 🔗

Deposits are, by a wide margin, the largest source of funds for commercial banks. Data cited by Business Standard from a Reserve Bank of India Deputy Governor’s speech shows that deposits at scheduled commercial banks stood at around ₹217 lakh crore at the end of FY2024, accounting for roughly 77% of total liabilities, while capital funds and borrowings each made up about 9%. This dominance explains why banks compete so hard for your savings account, fixed deposit, or salary account – deposits are the raw material their entire lending business runs on.

Demand deposits 🔗

Demand deposits are funds customers can withdraw at any time without giving prior notice – savings accounts and current accounts fall into this category. Because customers can pull this money out instantly, banks pay little to no interest on it, particularly on current accounts. What makes demand deposits usable for lending is behavioural stability: not everyone withdraws at the same time, so a predictable core balance remains available, letting banks safely deploy a portion of it even for medium-term loans.

Term deposits 🔗

Term deposits, also called fixed or time deposits, are locked in for a specified period ranging from a few days to several years. Since customers commit not to withdraw before maturity, banks pay a higher rate of interest and can use these funds more confidently for longer-duration lending, such as auto loans or working capital finance. Interestingly, the composition of India’s deposit base is shifting. As household savings increasingly move into mutual funds and equities, the Reserve Bank of India has been in direct discussions with banks on how to attract larger, more stable deposits rather than relying on institutional money that can move out quickly.

Reserve funds: a statutory safety cushion 🔗

Beyond deposits, banks are legally required to set aside a portion of their profits into a reserve fund. Under Section 17 of the Banking Regulation Act, 1949, every banking company incorporated in India must transfer at least 20% of its annual net profit to this reserve fund before declaring any dividend. This is a statutory reserve, not part of divisible profits, which means it cannot simply be handed out to shareholders. The rule exists to force banks to build a financial cushion strong enough to absorb unexpected losses and protect depositor money. A bank can only be exempted from this requirement if its accumulated reserve fund, together with its share premium account, already equals or exceeds its paid-up capital – a signal that it is already well-capitalised.

Retained earnings: profits ploughed back 🔗

Retained earnings are profits a bank chooses not to distribute as dividends, reinvesting them into the business instead. These profits typically come from two places: net interest income, which is the spread between what a bank earns on loans and what it pays out on deposits, and fee-based income such as processing charges, account maintenance fees, and transaction commissions. Retained earnings quietly strengthen a bank’s net worth over time without requiring it to approach shareholders or debt markets for fresh money.

Under the Basel III capital framework that Indian banks now follow, retained earnings and other disclosed free reserves are classified as part of Common Equity Tier 1 (CET1) capital – the highest-quality, most loss-absorbing form of capital a bank can hold. This is one reason profitable banks that retain a larger share of their earnings, rather than paying out large dividends, tend to have stronger capital ratios and more headroom to grow their loan books.

Shareholders’ capital: equity ownership 🔗

For banks structured as public limited companies – which includes most private sector banks and several listed public sector banks – shareholders’ capital is another critical funding source. This is money raised by issuing equity shares, whether through an initial public offering, a follow-on public offer, or a rights issue to existing shareholders. Unlike deposits, shareholders’ capital does not need to be repaid on demand, and it is the first layer of capital used to absorb losses if a bank runs into trouble. That is precisely why regulators watch it so closely.

The Reserve Bank of India requires commercial banks to maintain a minimum Capital to Risk-weighted Assets Ratio (CRAR) of 9%, a stricter benchmark than the 8% minimum prescribed under the global Basel III framework. Shareholders’ capital, together with statutory reserves and retained earnings, forms the core Tier 1 capital banks use to meet this requirement. A bank that falls short on capital adequacy can face restrictions on further lending and dividend payouts, which is why raising fresh equity is often the fastest way for a bank to fund rapid growth in its loan book.

Borrowings from other banks: managing short-term liquidity 🔗

Even well-funded banks occasionally face a temporary mismatch between the cash they need on a given day and what is actually sitting in their accounts. This is where interbank borrowing steps in. A bank facing a shortfall can borrow overnight, or for a few days, from another bank with surplus funds through the call money market, which functions under close Reserve Bank of India oversight and lets institutions manage day-to-day liquidity without disturbing their core deposit base or selling off investments in a hurry.

These borrowings are not unlimited. Prudential norms cap how much a bank can borrow through this route relative to its own capital funds, precisely to prevent excessive dependence on short-term interbank money. Notably, interbank trades now account for only about 2% of total money-market turnover in India, down sharply from roughly 20% a decade ago, as banks increasingly turn to alternatives like the repo market and collateralised repo instruments for short-term funds. Even so, the call money rate remains a closely tracked benchmark that the RBI monitors while transmitting monetary policy through the banking system.

Putting it all together 🔗

Each of these five sources plays a distinct role in a bank’s balance sheet. Deposits provide the bulk of low-cost, everyday funding. Reserve funds and retained earnings build internal strength over time without external fundraising. Shareholders’ capital brings in fresh, loss-absorbing money, especially useful during expansion. Interbank borrowings offer short-term flexibility when day-to-day cash positions run tight.

Together, this funding mix determines how much a bank can lend, how resilient it is during downturns, and how quickly it can grow. A bank overly dependent on deposits alone may struggle if depositor behaviour shifts; one that leans too heavily on borrowings risks liquidity stress if wholesale funding dries up. The balance between these sources is a core part of what commercial banking, and by extension corporate accounting for banks, is really about.

What do you think? If Indian household savings keep moving from bank deposits into mutual funds and equities, how should banks redesign their funding strategy to stay competitive? And should a bank facing this shift lean more on shareholders’ capital or on interbank borrowings to fill the gap?

References

1. https://www.business-standard.com/amp/markets/capital-market-news/deposits-continue-to-be-primary-source-of-funds-for-scbs-while-nbfcs-depend-primarily-on-borrowings-125012100533_1.html
2. https://www.bloomberg.com/news/articles/2026-04-15/india-s-rbi-holds-talks-with-banks-on-ways-to-boost-deposits
3. https://indiankanoon.org/doc/569017/
4. https://bankopedia.co.in/banking/capital-adequacy-norms-indian-banks-rbi-basel-iii
5. https://agrudpartners.com/prudential-norms-for-banks/
6. https://www.bajajamc.com/glossary/what-is-call-money
7. https://www.business-standard.com/finance/news/rbi-pushes-lenders-to-revive-funding-market-vital-for-monetary-policy-125051500096_1.html