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PSU banks make the most of repo arbitrage

MUMBAI: PSU banks are raking it in by borrowing cheap funds from RBI and placing the same in liquid mutual fund schemes. Banks are borrowing overnight funds from the central bank at the repo rate — the rate at which the central bank lends to banks against securities — which is fixed at 6.5%. They are in turn investing in liquid mutual fund schemes, which typically give them a return of 8.5% on redemption, much to the discomfort of RBI. “Banks are earning around 2% return on such arbitrage. It’s generally the public sector banks investing in these instruments. There are not any private sector bank active here yet,” says Sunil Zaveri, chairman of MSJ Capital and Corporate Services.

Banks on Tuesday borrowed Rs 117,325 crore from RBI through its repo window — a facility through which RBI lends to banks against securities also because of tight liquidity on account of advance taxes outflows. Analysts say banks with surplus funds (ultra floats), instead of going to the call market, are putting the funds in liquid-plus funds, where they are making higher arbitrage. But RBI has asked banks to be wary of investing in ultra-liquid schemes, or schemes where the underlying paper is for a period of less than a year.

“The underlying papers in liquid MF is for a shorter period, virtually less than a year. But RBI directs that non-SLR investments of banks, except in commercial papers (CPs) and certificate of deposits, or CDs, have to be for more than a year,” says, AY Shedshale, deputy GM-treasury , Bank of Maharashtra. As on January 31, of the total AUM of Rs 570,000 crore, bank investments in liquid and money market instruments were about Rs 162,000 crore. As of September 31, 2010, banks had invested around Rs 17,500 crore in liquid schemes and money market instruments and another . 17,500 crore in debt-oriented funds or liquid-plus funds.

According to RBI data, banks have investments around Rs 85,717 crore with mutual funds and a majority of the investments is in liquid schemes. Pure liquid schemes generally invest in papers below 91 days whereas liquid-plus funds invest in papers with tenors between 90 and 120 days. The liquid-plus funds are called ultra bond short-term plans to dodge regulatory hitches. “These liquid funds are being preferred for an arbitrage over the certificates of deposits because these funds are more liquid in the CD markets as there are fewer buyers,” said a treasurer of a midsized local bank.
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