RBI extended 10 % ceiling of Bank Investment in Liquid Schemes of Mutual Funds

The Reserve Bank of India on 5 July 2011 extended the 10 per cent ceiling of bank investment in liquid schemes of mutual funds to include short-term debt funds. Bank investment in debt schemes of mutual funds with weighted average maturity of portfolio of not more than one year, would be subjected to the cap. The RBI in its Monetary Policy Statement for 2011-12 had directed banks to cap their investments in the liquid schemes of mutual funds at 10 per cent of their net worth.

The central bank noted that with a view to ensuring a smooth transition banks which have investments in these schemes of mutual funds in excess of the 10% limit, could comply with this requirement at the earliest but not later than six months from 5 July 2011.

RBI’s decision to extend the ceiling was aimed at ensuring a smooth transition. Banks which already have investments in liquid schemes of mutual funds in excess of the 10 per cent limit, are allowed to comply with this requirement at the earliest but not later than six months from the date of this circular.

RBI pointed out in the money policy statement that banks’ investments in liquid schemes of mutual funds grew manifold and that liquid schemes continued to rely heavily on institutional investors such as commercial banks whose redemption requirements are likely to be large and simultaneous. The RBI opined that money which was circularly moving between banks and the debt-oriented mutual funds (DoMFs) could potentially lead to systemic risk.

Banks normally put in their surplus funds in liquid schemes of mutual funds, which invest in short-term debt schemes of duration of less than a year. Such schemes give banks higher returns within a short period. DoMFs on the other hand invest heavily in certificates of deposit (CDs) of banks. 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. Such circular flow of funds between banks and DoMFs could lead to systemic risk in times of stress or liquidity crunch.

The RBI observed that the weighted average maturity would be calculated as average of the remaining period of maturity of securities weighted by the sums invested.