Bank investment in such debt schemes of mutual funds with weighted average maturity of portfolio of not over year, would be subjected to the cap, RBI said in a notification.

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

The objective of DoMFs is to provide regular & steady income to investors. Such schemes usually invest in fixed deposit securities such as bonds, corporate debentures, government securities & funds market instruments.

The RBI in its Financial Policyowner Statement for 2011-12 had directed banks to cap their investments in the liquid schemes of mutual funds at ten % of their net worth. The RBI said same funds was circularly moving between banks & 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 maturity within 90 days. Also short-term debt schemes of period of less than a year give 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 & DoMFs could lead to systemic risk in times of stress or liquidity crunch. Thus, banks could potentially face a gigantic liquidity risk,” the RBI had said.

Source: [The Hindu]