RBI tightens norms on banks' market play

MUMBAI: With the Sensex crossing the 20,000 milestone, the Reserve Bank of India (RBI) is not taking any chances with banks’ exposure to stock markets. The central bank has widened the definition of stock market exposure and has given banks six months to bring down exposure to equities.

In a circular, RBI has told banks that exposure to stock markets will now include lending by banks to mutual funds and also payment commitments made to stock exchanges on behalf of mutual funds and foreign institutional investors (FIIs).

Until now, RBI had announced the exposure limit for loans and advances to individuals against units of mutual funds. However, there are no explicit guidelines for grant of loans and advances to fund houses for their short-term liquidity requirement.

“The annual inspection of certain banks and an analysis of the consolidated prudential return (CPR) of some banks show that they have extended large loans to various mutual funds and have also issued irrevocable payment commitments (IPCs) to stock exchanges (BSE & NSE) on behalf of mutual funds/FIIs. These exposures have, however, not been included by the banks for computation of their capital market exposure,” the circular said.

It goes on to add that after examining these loans, the central bank had decided that they constitute capital market exposure.

According to Sebi regulations, mutual funds can borrow to meet temporary liquidity needs for repurchase, redemption of units or payment of interest or dividend to unit holders. However, this borrowing is limited to 20% of the net asset of the scheme and for a duration not exceeding six months.

“The Sebi guidelines imply that mutual funds should normally meet their repurchase/redemption commitments from their own resources and resort to borrowing only to meet temporary liquidity needs. In view of the above, banks are advised to be judicious in extending finance to mutual funds and grant loans and advances to mutual funds only to meet their temporary liquidity needs,” RBI said. Irrevocable payment commitments are issued by banks to enable mutual funds transact in stock exchanges.

According to RBI, these commitments are to be reckoned as guarantees issued for the purpose of capital market operations and should, therefore, form part of capital market exposure.

Stock market exposure along with real estate and commodities comprise exposure to sensitive sector. Last year, the central bank had cracked down on banks’ exposure to real estate after it doubled in 2006-07. The regulator also widened the scope of real estate during the year.

It has also asked banks to treat loans extended for setting up special economic zones (SEZ) as real estate loans. Capital market exposure, in addition to exposures to shares and mutual funds, also include investments in convertible bonds, debentures, and all exposure to venture capital funds. The overall exposure (fund and non-fund) cannot exceed 40% of the bank’s previous year’s net worth.