The Reserve Bank of India has flashed the red signal on the circular fund movement between banks and mutual funds which could lead to systemic problems any time. Banks and mutual funds have been moving funds among themselves and making money in the process in the collateralised borrowing and lending obligation (CBLO) market.

“There has been some circularity in the movement of funds between MFs and banks. Banks invest a part of their resources in MFs. The MFs also lend funds to banks through CBLO and market repo,” the RBI said while releasing the second quarter review of the monetary policy last week. For instance, in Q2 of 2009-10, almost over 50 per cent of the banks’ investment in MFs was in turn lent to banks by the MFs in the collateralised segments.

As on September 11, 2009, MF lending in CBLO was Rs 59,899 crore and Rs 46,754 crore in the market repo while banks’ outstanding investment in mutual funds was Rs 1,56,573 crore. “As of now, everything is moving okay, but the situation can turn topsy-turvy during extreme circumstances,” said a banker.

According to the RBI, transaction volumes in CBLO and market repo segments continued to remain high during Q2 of 2009-10 reflecting the easy liquidity and active market conditions. Banks as a group are the major borrowers in the collateralised segment whereas mutual funds continue to remain the single largest lender of funds in that segment. “In fact, more than 75 per cent of the lending in the collateralised segment was contributed by the MFs in Q2, reflecting their continued enhanced lending capacity. The collateralised market remained the predominant segment of the money market, accounting for more than 80 per cent of the total volume in the money market in Q2,” the RBI said.

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