Banks that park its short-term surplus fund in mutual funds' liquid schemes are facing difficulties as two large fund houses have refused to accept subscription from banks.

Indian Overseas Bank executive director G Narayanan said, "Due to the liquidity overhang, mutual funds are reluctant to accept money from banks. This is largely because there are limited deployment avenues."

Mutual fund managers worry that the absence of good investment opportunities would make it difficult to manage new inflows. As a result the performance of the scheme would be impacted. On the other hand as banks are flooded with liquidity, it would be equally problematic for them if more funds houses deny to accept their funds.

The fund houses cannot refuse to accept deposits form retail customers but they can decline subscription from institutional investors. The fund houses that have refused to accept banks deposits are 100% subsidiaries of their foreign parents. The local fund houses are still accepting banks subscription. "While local MF houses are still accepting subscriptions from banks, there are not marketing their schemes aggressively any longer," said the treasurer from a PSU bank.

Not only are the funds houses declining to accept fresh deposits but even the banks are refusing to accept bulk deposits. "Banks are not encouraging bulk deposits due to surplus liquidity and poor demand for credit," said KR Kamath, Chairman of Allahabad Bank.

In fact banks have recently lowered the bulk deposit rate to discourage these deposits. Some lenders like Punjab National Bank are offering as low as 1% for one week and 5% on one-year bulk deposits.

The main problem for fund houses is that they offer the same net asset value or price per unit to all investors in contrast to banks that can offer differential rates to bulk and retail depositors. Therefore a large inflow of funds would reduce the net asset value of the scheme as the funds would have to be invested in low-yield bonds.

However the excess liquidity has remained the main cause of the problem. The ample amount of liquidity in the system can be witnessed through the money that banks park with the Reserve Bank of India (RBI) under the reserve-repo scheme. Recently banks have parked around Rs 1,22,000 to 1,32,000 crore cash under the reverse repo window.