Banking and PSU Funds: Features, Advantages, Taxation & More

Banking and PSU funds are open-ended debt funds. 

According to SEBI guidelines, these funds invest at least 80% of the corpus in debt and money market instruments that banks or public sector undertakings issue.

Among all the other debt fund categories, Banking and PSU funds are known to have superior credit quality. 

Investors wanting to explore debt funds with decent returns and lower credit risk can consider these funds.

But before you invest, here are some facts about these funds.

Top 3 Advantages of Investing in Banking and PSU Funds

1. Low Credit Risk

One of the biggest perks of investing in these funds is minimal credit risk. These funds strictly invest in Maharatna and Navaratna companies with AAA ratings on underlying instruments.

These companies have years of performance history and deliver consistent returns.

2. Risk

As mentioned above, these funds have underlying assets having AAA ratings. Investors do not have to worry about credit risk as most instruments are government-backed.

And as far as the interest rate risk is concerned, it’s just a temporary phase. The interest rate can fluctuate the NAV of the debt fund. But the loss you may face during the rising interest rate cycle can be recovered during the falling interest rate cycle. Make sure you hold your investment for a longer duration to surpass the interest rate cycles. 

3. High Liquidity

Banking and PSU funds are often in demand among investors. Due to stable returns and safer investments, many are interested in buying these funds.

It enables higher liquidity for these funds. You can sell them off in case of emergencies.

Things To Consider Before Investing In Banking And PSU Funds

1. Returns on Investment

Debt funds may or may not deliver as much return as equity funds. But they generate superior returns than FD or savings accounts. 

Banking and PSU funds ensure higher security but may not deliver higher returns.

Our advisors would recommend holding your investment for more than 3 to 5 years to earn decent returns.

2. Investment Portfolio

Banking and PSU funds would be a great addition to your portfolio to balance the risk. 

If your portfolio is more inclined towards equity, debt funds can safeguard you from volatility. While equity funds deliver superior returns, Banking and PSU funds offer security. 

3. Investment Tenure

Banking and PSU funds have underlying assets with 1-2 years of tenure. Investors who want to invest in a fund with short-term underlying assets and lower risk can invest in these funds.

Though, irrespective of the tenure of the papers held under these funds, you can hold the investment for a longer duration. Align the investment horizon with your financial goals. In fact, holding your investment for more than 3 years makes you entitled to tax benefits with indexation. 

4. Expense Ratio

The expense ratio is the fee the fund house will charge you for managing your funds.

There is often a misconception that- a lower fee will leave you with higher returns. In reality, it doesn’t work like that.

Often, fund houses may charge a slightly higher fee but will deliver superior returns than other funds in the same category.

While investing in any mutual funds, don’t forget to compare the expense ratio. 

Tax Implications

Tax implications on debt funds have changed since April 2023.

Similar to all pure debt funds, investors have to pay tax on both short and long-term capital gains as per their tax slab. 

The indexation benefit on LTCG will only be applicable to hybrid debt funds with more than 35% exposure to equity.

Who Should Invest In Banking and PSU Funds?

Banking and PSU funds are suitable for investors looking for low-risk short-term investments. These funds are safer than Dynamic Bond Funds or Credit Risk funds.

These funds are also suitable for investors who are not fond of FD but would like similar security. Though these funds could be slightly riskier than FD, they may deliver superior returns too.


All the underlying assets in Banking and PSU funds are government-backed. These funds are also less volatile than equity funds, enabling maximum security. 

You can explore various state-owned companies from various sectors via these funds to diversify your portfolio.

Investors looking for decent returns along with lower risk can go with Banking and PSU funds.

Get a complimentary portfolio analysis with VNN Wealth to see if these funds are suitable for your portfolio. 

Also Read

Types of Debt Funds

Dynamic Bond Funds