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RBI: Banks Can't Invest >10% of Net Worth in Liquid Funds

In the Monetary policy yesterday (see longer post) RBI has said that Banks can’t invest more than 10% of their net worth into liquid mutual funds.

ET has some data:

Banks’ investment in mutual funds aggregated Rs 1.11 lakh crore on April 6 against Rs 70,999 crore on January 14, according to RBI. Fund managers said over 80% of banks’ money in mutual funds is in liquid schemes. The investment restriction will limit banks’ surplus money coming into mutual fund schemes at Rs 30,000 crore. The total net worth of the banking system is around Rs 3.13 lakh crore as March 31, according to fund managers.

How Much Goes Out?

So Investment in Liquid funds = approximately 90,000 cr.

Net worth = 3.13 lakh cr. and 10% of that = 31,300 cr.

So 60,000 crore will flow out. When? Not immediately – banks are given six months to ease out the transition.

How much do mutual funds lose?

Assuming liquid funds charge 0.25% as management fees, the total loss will be around 150 crores. This may not sound like much but it is, I think, a reasonable chunk of MF profits.

Why did RBI do this?

Banks would put money into liquid funds which would in turn buy bank Certificates of Deposit, sometimes of the very banks they got the money from. That’s circular. And because of it there is a risk that if one bank starts withdrawing a lot of money, it will hurt the liquidity and capital raising ability of other banks (since CDs will be sold and prices fall) which will also start selling their liquid fund holdings and so on.

The other reason banks might happily do this is that if they couldn’t really take on exposures of certain corporates beyond a limit, they could buy liquid funds that could in turn buy the same companies’ commercial paper.

The overall impact is negative for mutual funds, surely. It’s negative for banks in that they need other ways to get the easy 9% they were getting from the mutual fund route. The days of easy spreads are over?

  • Anonymous says:

    >@deepakshenoy why do you believe banks will move monies out of MFs. They may just shift to liquid plus funds. That is not under cap of 10%

    @deepakshenoy Shyamala Gopinath in papers said around 50K wud be the new limit at the 10% cap of liquids. I wud tend to believe her

  • Px says:

    >What will be the impact on the small investor who has put money in liquid mfs … wont the sell off hurt the last person invested as it happened in the fmp run the last time there was a bear market

  • Px says:

    >i think it makes no sense asking questions !

  • Deepak Shenoy says:

    >Px: Sorry – this post has missed my mailbox 🙂 I don't think the sell off is a problem because it will happen over six months. and like anon said, they might just move to liquid plus funds instead!

    Anon: Good points. 50K is probably right, ET might have had it wrong. Effectively about 50 cr. will leave liquids in my opinion. The only reason that liquid plus funds have a potential issue for banks is if they get hammered by short term liquidity pressures (liquid plus funds may not be deeply liquid)