The central bank explained that as per the existent 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 or ETF.
The Reserve Bank of India (RBI) in its monetary policy on Thursday harmonised the capital charges for market risk for banks holding debt instruments through mutual funds or exchange traded funds (ETFs), which is expected to bring substantial capital savings for banks while providing a boost to the bond market.
Market experts believe that the step is positive for mutual funds and ETFs and could possibly result in relatively more fund flows from banks to these asset classes in coming times. The central bank explained that as per the existent 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 or 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 has therefore been decided to harmonise the differential treatment existing currently,” the RBI said.
Ashutosh Khajuria, executive director and CFO at Federal Bank, explains that since the capital charge on MF investments earlier had been quite high (18%), the banks either used to refrain from investing in debt MFs or, used to redeem their debt MF or ETF investments towards end of the quarter for capital conservation.
“As a result of these redemptions, mutual funds also faced a lot of liquidity pressure towards end of the quarter. The differential capital charges for debt mutual funds and direct holding of bonds was very capital inefficient for banks. With the harmonisation of charges, banks may consider investments in high quality and low cost ETFs based on the merits of the schemes and their own risk appetite without being concerned about high capital consumption. If banks feel somebody is managing a fund or an ETF efficiently at a lower cost, there is a likelihood that they may consider investing here rather than taking the pain of individually evaluating every bond,” Khajuria stated.
In a separate notification, the RBI said that investment in debt mutual fund/ETF for which full constituent debt details are available shall attract general market risk charge of 9%. In case of debt mutual fund/ETF which contains a mix of bonds belonging to central government, state government, foreign countrys’ governments, banks and corporates, the specific risk capital charge shall be computed based on the lowest rated debt instrument/ instrument attracting the highest specific risk capital charge in the fund.
“Debt mutual fund/ETF for which constituent debt details are not available, at least as of each month-end, shall continue to be treated on par with equity for computation of capital charge for market risk,” the RBI said.
Radhika Gupta, MD and CEO at Edelweiss AMC, said the RBI’s harmonisation of capital charges will definitely help in the growth of bond ETFs and will help develop corporate bond market in the long run.
“Earlier there was a separate capital charge that used to be applicable for bank holdings of debt mutual funds and bond ETFs. This capital charge was significantly higher than what was applicable to banks while holding bonds directly. Now, the RBI has harmonised the capital charges which means it will become more efficient for banks to hold mutual funds and ETFs, especially the high quality ones. We hope that this should support more fund flows from banks into high quality mutual funds and ETFs,” Gupta said.