Banks and MFs Face Further Restrictions by RBI!

By BankBazaar | May 11, 2012

While the Mutual Fund industry was just recuperating from SEBI’s blow of banning entry loads on mutual fund units, they have been struck with another lightening. Now, RBI (Reserve Bank of India) has come up with a new regulation by which banks need to cap their investments in the liquid schemes of mutual funds at 10% of the banks’ net worth in six months.

Previously, banks gained on their savings deposited in liquid schemes, since they used to deposit about 80% of their funds. Now, they have to save only 10% of their total net worth of the last 6 months into liquid schemes, thereby creating wide gap in the previous and current profits. For example, according to RBI, banks’ investment in mutual funds aggregated Rs 1.11 lakh crore on April 6 against Rs 70,999 crore on January 14,

Understand the working

When banks invest their surplus funds in liquid schemes, they tend to generate returns overnight. This is because their surplus funds will be carried forward towards depositing in debt securities whose duration is less than a year. These deposits include banks’ certificates of deposits, companies’ commercial papers, treasury bills and the collateralized lending and borrowing obligation or CBLO market. The gains received from transactions in these above said categories will be transferred to the respective banks immediately.

With RBIs move, the banks have a restricted ability to generate gains on their surplus funds and are no longer in a position to invest 80% of their surplus funds into liquid schemes.  Most fund managers believe that Mutual funds can face high redemptions of almost Rs60000 crore over the next 5-6 months.

What this means for you?

You as a borrower of a loan can be definitely affected by this decision.  With the circular flow of income, from banks to debt-oriented mutual funds (DoMF) and vice versa, this decision will create a lot of difficulty during a liquidity crunch or when the nation is affected by a financial stress. Banks will be forced to increase the rates of interest at which they provide loans, thereby making it difficult for you to procure one. If you are a borrower of a home loan or a personal loan, and this decision just came while you were paying your EMIs, then you will have to pay higher EMIs or extend your loan tenor so as to write off your debt.

How banks may function now?

With this decision coming in order, banks have lost their ability to churn in easy money from their surplus funds that were parked in liquid assets by cutting it down from 80% to a mere 10%. Banks will be forced to raise their funds through the traditional retail fixed deposits, thereby reducing the banks dependence on mutual funds and vice versa. The main problem that can be cited here is that, most fund managers believe that, this decision apart from the reduction in banks’ profit’s, will lead to increased volatility in the short term rates. These short term rates range from a period of 3-12 months and thereby ensuring that lesser and lesser money be flown into them over a period of time.

As of now the interest rates are unperturbed, so for you, as a borrower, there is nothing to be very concerned about.  But make sure that you opt for a loan only when it is required and when you have exhausted all the avenues of procuring the required amount. The best way to avoid getting into any debt is by saving for a later date so that you have adequate funds for completing your financial requirements.

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