The Prime Ministers economic panel has cautioned banks against heavy dependence on mutual funds for meeting funding requirements, saying that the money from that source is volatile.

“Funding provided by mutual funds (MFs) can be volatile (as) the bulk of bank CDs has a maturity of three months or less,” Prime Ministers Economic Advisory Council Chairman C Rangarajan said in valedictory address at the annual bankers meeting in Mumbai on Saturday.

The former Reserve Bank governor pointed out that “mutual funds are major buyers of bank CDs and they hold more than 60 percent of the amount outstanding.”

The problem of volatility arises, he added, because these CDs are of short-term duration. Therefore, “this will be an area which will need to be watched”.

Rangaragan also warned banks against increasing exposure to the real estate and infrastructure, as it will lengthen the maturity of bank assets and lead to liquidity risk.

“While the economic recovery will contain the deterioration in NPAs, credit risk remains a major risk in the banking system,” he warned.

On the rising capital needs of the public sector banks, Rangarajan said, though they are well capitalised with a CAR of 13.6 per in the past fiscal, which is way above the 9 percent RBI mandate, “public sector banks would need to raise new capital to support credit growth over the medium term”.

He further pointed out that “according to an estimate, at a credit growth of 15 per cent, PSBs will require approximately 3 per cent of 2010-11 GDP in new capital in the next five years to maintain a capital adequacy requirement of 9 per cent. This rises to 4.3 per cent of GDP if the PSBs are to maintain a CAR of 12 per cent.”

Making a strong case for more new bank licences, amidst the call for more and deeper consolidation in the banking system, the noted economist said, “Entry of new banks is part of the process of maintaining a competitive system. Consolidation can happen even as new entrants make their appearance.”