Banks can now invest up to 10% of the net value of the funds as on March 31 of the previous year.
The sole reason behind putting this cap is that according to RBI, due to the fact that the investment money kept on revolving between the banks and the DoMFs which might result in systematic risk.
After receiving huge amounts of investments worth around Rs. 3.70 lakh crore from the banks, DoMFs utilise the same in investing in certificates of deposit (CD) of the banks and this is how the money keeps circulating between the two parties.
"Such circular flow of funds between banks and DoMFs could lead to systemic risk in times of stress/liquidity crunch. Thus, banks could potentially face a large liquidity risk. It is, therefore, felt prudent to place certain limits on banks investments in DoMFs," the RBI said.
"It is likely that debt MF market will become smaller and some PSU banks will have to unwind their position in DoMFs," SMC Global Securities Strategist & Head of Research Jagannadham Thunuguntla said.
Out of the overall investment done by the banks, 40% belong to the commercial banks and thus they have been given a notice period of 6 months to reduce their investments to the 10% limit as per the requirement.
Thunuguntla said," majority of investment in debt-oriented MF schemes are done by the PSU banks and private sector banks have only limited exposure."