RBI caps bank investments in liquid, short-term debt funds

The Reserve Bank today extended the 10% ceiling of bank investment in liquid schemes of mutual funds to include short-term debt funds.

The bank investment in such debt schemes of mutual funds with weighted average maturity of portfolio of not more than 1 year, would be subjected to the cap, RBI said in a notification.

"With a view to ensuring a smooth transition, banks which are already having investments in these (liquid) schemes of mutual funds in exces of the 10% limit, are allowed to comply with this requirement at the earliest but not later than six months from the date of this circular," it said.

The Reserve Bank in its 'Monetary Policy Statement for 2011-12 had directing banks to cap their investments in the liquid schemes of mutual funds at 10% of their networth.

"This an effort to increase the purview of earlier circular. RBI is focusing on stability of banking and mutual fund industry," SMC Global Securities Strategist & Head of Research Jagannadham Thunuguntla said.

The RBI said same money was circularly moving between banks and the debt-oriented mutual funds (DoMFs), which could potentially lead to systemic risk.

Banks normally put in their surplus funds in liquid schemes of mutual funds, which invest in debt securities having maturing within 90 days. Also short term debt schemes of duration of less than a year gives banks higher returns within a short period.

In turn, DoMFs invest heavily in certificates of deposit (CDs) of banks.

"Such circular flow of funds between banks and DoMFs (debt-oriented mutual funds) could lead to systemic risk in times of stress or liquidity crunch. Thus, banks could potentially face a large liquidity risk," the RBI had said.

Experts said the fund flow into the over 7.43 lakh crore mutual fund industry, which is still battling with the entry load ban of 2009, could further slowdown with the implementation of this circular.

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.