The Reserve Bank of India (RBI) has given banks more time to meet the stricter capital market exposure norms that were imposed when the Sensex crossed the 20000-mark in December last year. As against the earlier circular which required banks to bring down lending to mutual funds by June 2008, the new circular gives banks till September 2008 to meet the stricter guidelines.

In December 2007, RBI had taken steps to reduce bank exposure to capital markets. This was done by widening the definition of stock market exposure to 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).

In terms of the December circular, banks, which exceeded the exposure limits after applying the wider definition, were required to bring down their exposure within six months from June 2008. In a circular issued to all banks on Monday, the central bank said, On a review of the matter, it has been decided to extend the transition period to comply with the requirements contained in the circular by another three months till September 13, 2008.

In the past too, the central bank had tightened exposure to the capital market, when it was worried about overheating. The central bank had also eased the investment limits when there was a fear of liquidity crunch. Mondays relaxation comes on a day the Sensex dipped by 506 points and downside concerns persist on account of high oil prices.

Until then, there were no explicit guidelines for grant of loans and advances to fund houses for their short-term liquidity requirement. The wider definition was applied after it was found that banks had extended loans to various mutual funds and issued irrevocable payment commitments to stock exchanges on behalf of mutual funds and foreign institutional investors.

RBIs justification for imposing the new guidelines was that mutual funds should normally meet their repurchase/redemption commitments from their own resources and resort to borrowing only to meet temporary liquidity needs and any bank lending should be only to meet temporary liquidity needs.

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 banks previous years net worth.