RBI cuts capital charge on banks’ investments in debt MF schemes

The Reserve Bank of India (RBI) on Thursday eased the capital charge that banks were required to maintain when investing in debt mutual funds (MFs). Banking officials and MF players say this could lead to improved allocations from banks into such schemes and reduce quarter-end churning by banks.

“Every quarter end, banks would either lighten their investments in debt MF schemes or refrain from such investments. The capital consumption for investing in debt MFs was ten-times the requirement on directly investing in bonds,” said the treasury head of a bank. Capital charge is the capital that banks are required to set aside against their investments.

In ‘Statement of Developmental and Regulatory Policies’, that was released along with monetary policy RBI said, “If a bank holds a debt instrument directly, it would have to allocate lower capital as compared to holding the same debt instrument through a MF/Exchange Traded Fund (ETF)”.

“This is because specific risk capital charge as applicable to equities is applied to investments in MFs/ETFs; whereas if the bank was to hold the debt instrument directly, specific risk capital charge is applied depending on the nature and rating of debt instrument,” it added.

As a word of caution RBI also pointed out that a debt MF/ETF also has features akin to equity, since in the event of default of even one of the debt securities in the MF/ETF basket, there is often severe redemption pressure, notwithstanding the fact that the other debt securities in the basket are of high quality. “This move could potentially curb the large fall in assets under management (AUM) of liquid funds seen at the end of every quarter,” said Arvind Chari, head of fixed income and alternatives, Quantum Advisors.

Banking officials say earlier debt MF investments were treated on a par with equity investments, which attracted capital charge up to 18 per cent.

“RBI has now harmonised this, which would mean that banks will be charged at 9 per cent on debt MF investment or lower depending upon the rating of the debt scheme,” the official said. “However, we need to wait for final guidelines for clarity,” he added. Meanwhile, experts say it is to be seen whether banks deploy the savings on capital requirement on incremental investments in debt MFs or keep the surplus to conserve capital amid concerns around asset quality due to the pandemic.

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