The Reserve Bank of India on Tuesday extended the 10 per cent ceiling of bank investment in liquid schemes of mutual funds to include short-term debt funds.

Bank investment in such debt schemes of mutual funds with weighted average maturity of portfolio of not more than one year, would be subjected to the cap, RBI said in a notification.

“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 per cent limit, are allowed to comply with this requirement at the earliest but not later than six months from the date of this circular,” it said.

The RBI in its Monetary Policy Statement for 2011-12 had directed banks to cap their investments in the liquid schemes of mutual funds at 10 per cent of their net worth. The RBI said same money was circularly moving between banks and the debt-oriented mutual funds (DoMFs), which could potentially lead to systemic risk.

Banks normally put in their surplus funds in liquid schemes of mutual funds, which invest in debt securities having maturity within 90 days. Also short-term debt schemes of duration of less than a year give banks higher returns within a short period. In turn, DoMFs invest heavily in certificates of deposit (CDs) of banks.

“Such circular flow of funds between banks and DoMFs could lead to systemic risk in times of stress or liquidity crunch. Thus, banks could potentially face a large liquidity risk,” the RBI had said.

The aim of DoMFs is to provide regular and steady income to investors. Such schemes generally invest in fixed income securities such as bonds, corporate debentures, government securities and money market instruments.

More In: Economy | Business