The Reserve Bank of India has come down heavily on banks for treating returns from liquid mutual fund investments as interest income and not as trading income.
During the annual financial inspection, the central bank found some public sector banks had done so. It has asked those lenders to treat such returns as trading income, making loss provisions where required. Banks have been told they must follow the norm from the second quarter.
When a bank invests in a mutual fund, the latter allots a certain number of units at a net asset value. When the bank redeems these, the fund house pays the NAV depending on the fund's performance. According to RBI, the difference of these two NAVs should be treated as either profit or loss on sale of investment. If there is a loss, the bank will have to make a provision.
The move comes at a time when a set of new norms for MFs takes effect from August 1. The Securities and Exchange Board of India has told fund houses that all money market and debt securities, including floating rate securities, would need to be valued at the weighted average price at which they were traded on the particular valuation day.
The move aims to ensure the value of money market and debt securities in the portfolio of MF schemes reflect the current market scenario.
According to the Sebi guidelines, in case there is no trading on a particular valuation day, securities with residual maturity of up to 91 days would be valued on an amortisation basis.
While those with residual maturity of over 91 days would be valued at benchmark yield/matrix of spread over riskfree benchmark yield, obtained from agencies entrusted for the said purpose by the Association of Mutual Funds of India.
The aim of income or debt-oriented schemes is to provide regular and steady income to investors. Such schemes generally invest in fixed income securities such as bonds, corporate debentures, government securities and money market instruments.
The NAVs of such schemes are affected because of changes in interest rates. If the interest rate rises, as is the case now, NAVs of such funds are likely to decrease in the short run and vice versa.
Money market or liquid funds are also income funds and their aim is to provide easy liquidity, preservation of capital and moderate income.
These schemes invest exclusively in safer short-term instruments such as treasury bills, certificates of deposit, commercial paper and inter-bank call money, government securities, etc. Returns on these schemes fluctuate much less compared to other funds.
