The Securities and Exchange Board of India is keeping a close watch on banks' investment in the debt schemes of various mutual funds.

The markets regulator is looking for any relation between banks' investment in the debt schemes of mutual funds and the funds' buying of bank shares from the market through their equity schemes.

While Sebi has not launched a formal probe into the possibility, Sebi sources told Business Standard that it is keeping an eye on such developments to check on any possible quid pro quo arrangement between banks and the funds concerned.

As per the norms of the market watchdog, mutual funds have to maintain a Chinese wall between their clients and investments. If a relationship between a subscriber and portfolio investment is established, this would mean that the Chinese wall has been breached.

Mutual fund industry sources confirmed that banks - especially a few listed public sector banks - were investing a lot of money into the debt schemes of mutual funds, particularly money market schemes and short-term debt funds.

This is a part of their treasury management operations in order to streamline the volatility that exists in the government securities market. Money market schemes offer fairly steady returns.

At the same time, mutual funds have been heavily investing in banking stocks as the banking rally seems to be far from over. They are equally cautious in booking profits as prices appreciate, since fund managers are not certain as to when prices of bank stocks will decline.

Against this backdrop, Sebi's move assumes significance, especially since the price of some bank scrips have appreciated by over 100 per cent over the last one year.