The RBI has reduced the amount of capital that banks must set aside while putting money in debt mutual funds and debt exchange-traded funds (ETFs).

According to the current guidelines, if a bank holds a debt instrument directly, it has to allocate a lower capital compared with holding the same debt instrument through a mutual fund.

At present, bank investment in these instruments are treated on a par with that in equities in terms of providing a specific risk capital because of which they have to set aside more funds. However, if the lender was to hold the debt instrument directly, a lower risk capital must be provided against the investment as they are done on the basis of the rating of the debt instrument.

RBI will now harmonise this differential treatment.

Murthy Nagarajan, head-fixed income, Tata Mutual Fund, says: “The move should see good amount of flows in the mutual fund industry and stabilise bond yields. Mutual funds normally sell in quarter ends to meet redemption request of banks. However, no measures in terms of increasing held-to-maturity Limits or an OMO calendar is a negative for the bond market.”

The relaxation will not only lead to more bank investment in debt mutual funds, but will also have a positive impact on the corporate bond markets, feels Unmesh Kulkarni, MD of Julius Baer India.

“The announcement to harmonize the capital charge (for market risk) treatment of investment by banks in debt mutual funds or ETFs and direct debt instruments, augurs well for the bond market, as there could be higher participation by banks in the bond markets over a period of time’’ Unmesh Kulkarni, Managing Director Senior Advisor, Julius Baer India said.

However, the RBI pointed out that since in the event of default of even one of the debt securities in its investment basket of a debt mutual fund, there could be severe redemption pressure, banks will have to maintain a `general market risk charge of 9 per cent’.

Despite this, the central bank added that when it comes to the total computation of capital charge, there will be substantial capital savings for banks which will also give a boost to the bond market.