RBI sets limit on banks investment in DoMFs

The Reserve Bank of India (RBI) on June 05, 2011, issued a circular quoting that the investments in liquid scheme of debt oriented mutual funds (DoMFs) with weighted average maturity of not more than one year will be capped at 10 percent of banks' net worth. A decision that can impact adversely the assets under management (AUM) of fund houses that rely heavily on money flows from banks.
 
The central bank said, “it has been decided that the total investment by banks in liquid/short term debt schemes (by whatever name called) of mutual funds with weighted average maturity of portfolio of not more than 1 year, will be subject to a prudential cap of 10 percent of their net worth as on March 31 of the previous year”.

Banks generally invest their surplus funds in liquid schemes of mutual funds, which invest in debt securities having maturity within 90 days, which is expected to be around 1 lakh crore. The Apex Bank’s decision is expected to take out around 50-60% of this, affecting the total asset under management of Mutual Fund industry. Moreover, short-term debt schemes of duration of less than a year offer banks higher returns within a short period, sequentially DoMFs is invested heavily in Certificates of Deposit (CDs) of banks.

In the Monetary Policy statement for 2011-12, RBI had said, “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 DoMFs offer a regular and stable income to the investors, DoMFs schemes normally invest in fixed income securities such as bonds, corporate debentures, government securities and money market instruments.

'With a view to ensuring a smooth transition, banks which are already having investments in these (liquid) schemes of mutual funds in excess of the 10 percent limit, are allowed to comply with this requirement at the earliest but not later than six months from the date of this circular,” RBI added.

The mutual fund industry is expected to witness some redemption in liquid funds on the back of RBI's decision. However, industry players feel that the central bank's decision will strengthen the money market by forcing banks to participate more in this segment, which is currently dominated by mutual funds.