In a move that would boost banks’ investment in debt schemes of mutual funds, the Reserve Bank of India (RBI) has removed the cost arbitrage between banks’ direct investment in debts and through mutual funds.

As per RBI’s extant Basel III guidelines, 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 mutual fund and exchange-traded fund.

This is because a specific risk capital charge as applicable to equities is applied to investments in MFs and ETFs. On the other hand, if banks were to hold the debt instrument directly, the specific risk capital charge is applied depending on the nature and rating of the debt instrument concerned.

Harmonised

Given the turbulence in the debt market and the subsequent impact on mutual fund schemes, the RBI has now decided to harmonise the differential treatment existing currently.

At the same time, it is observed that debt MFs and ETFs have features akin to equity, in the event of a default by even one of the debt securities in the MF and ETF basket, there is often a severe redemption pressure on the fund, notwithstanding the fact that the other debt securities in the basket are of high quality.

Hence, it has been decided that the general market risk charge of 9 per cent will continue to be applied. Thus, computation of total capital charge for market risk shall incorporate elements of both debt and equity instruments.

Capital savings for banks

This will result in substantial capital savings for banks and is expected to give a boost to the bond market, said RBI.

Mahendra Jajoo, head of fixed income, Mirae Asset Investment Managers, said the relaxation will help banks to further increase their investments in debt funds.

Further, he added, the released extra capital can be used by banks for their other lending business which will help bring down interest rates and improve monetary policy transmission.

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