Now, banks can invest 10% of networth in MFs

To stop the circular movement of funds between banks and debt-oriented mutual funds (DoMF), the Reserve Bank today limited bank investment in liquid schemes of such funds at 10% of their net worth.

"The investment in liquid schemes of DoMFs by banks will be subject to a prudential cap of 10% of their net worth as on March 31 of the previous year," the Reserve Bank said in its 'Monetary Policy Statement for 2011-12'.

The RBI said that same money was circularly moving between the banks and the DoMFs, which could potentially lead to systemic risk.

It said the liquid schemes continue to rely heavily on institutional investors such as commercial banks for investment. In turn, DoMFs invest heavily in certificates of deposit (CDs) of banks.

"Such circular flow of funds between banks and DoMFs could lead to systemic risk in times of stress/liquidity crunch. Thus, banks could potentially face a large liquidity risk. It is, therefore, felt prudent to place certain limits on banks investments in DoMFs," the RBI said.

Currently, debt oriented MFs manage assets worth about Rs 3.70 lakh crore, of which 40% comes mostly from commercial banks.

"It is likely that debt MF market will become smaller and some PSU banks will have to unwind their position in DoMFs," SMC Global Securities Strategist & Head of Research Jagannadham Thunuguntla said.

The central bank has given a six months time to the commercial banks, whose investments exceed the 10% limit, to comply with the requirement.

Experts said the RBI move could put some pressure on the assets under management of the debt-oriented MFs as banks would now limit inflow into their schemes.

Thunuguntla said majority of investment in debt-oriented MF schemes are done by the PSU banks and private sector banks have only limited exposure.

The aim of DoMFs is to provide regular and steady income to investors. Such schemes generally invest in fixed income securities such as bonds, corporate debentures, Government securities and money market instruments.