Banks finds more arbitrage opportunity in mutual funds, investment rises over 90% on-year in March

Banks left no stones unturned to earn arbitrage from their investments either in money markets or in mutual funds. This is because banks this time have found 50-60 basis point (bps) higher arbitrage opportunity from investments in liquid funds than in the Reserve Bank of India’s (RBI) Standing Deposit Facility (SDF), leading to the money being put into mutual funds rising by more than 90 percent in March over a year, fund managers and treasury heads have said.

According to RBI data, banks’ investment in mutual funds rose to 1.2 lakh crore as on March 21, 2025, compared to Rs 62,499 crore as on March 22, 2024.

This is the second instance when banks have seen an opportunity to garner some extra income from their investments in market instruments. Prior to this, banks were tapping the arbitrage between the SDF and TRePS market.

Usually, when banks have extra funds or when the liquidity in the banking system is in huge surplus, they prefer to park it in money market instruments or invest it in other instruments such as liquid funds. This helps them earn hefty treasury income or other income.

A fund manager with a mid-sized mutual fund said that banks have been parking money in liquid funds whenever they are in surplus, but this time they are earning over 6.25 percent returns on liquid funds and 5.75 percent in SDF, making a compelling case for them to prefer the former.

“Banks generally invest in liquid funds for shorter durations, typically until the month-end or quarter-end, to efficiently deploy short-term surpluses and capitalise on the arbitrage between the TREPS rate and liquid fund returns. These investments are further supported by their T+1 withdrawal facility, which aids in optimising liquidity coverage ratio computations,” said a treasury head with a state-owned bank.

The RBI’s liquidity operations in the last few months have led to the banking system being funds-flush. The central bank has injected funds heavily into the banking system through various instruments such as open market operation purchases and dollar-rupee buy/sell swap auctions, which added durable liquidity, and daily variable rate repo auctions, which provided one-day liquidity support to banks.

The heavy infusion was because the liquidity in the system had started drying up and falling into deficit from mid-December last year. Following the central bank’s moves, liquidity in the banking system is now in surplus of around Rs 3 lakh crore.