The Reserve Bank of India has opened a special 90-day liquidity facility for mutual funds which are facing redemption pressure. The facility comes days after Franklin Templeton decided to wind-down six credit schemes, locking in nearly Rs 30,000 crore in investor funds.
The special facility will channel Rs 50,000 crore in liquidity towards mutual funds, should they choose to use it. Similar windows were opened in 2008 and 2013, when credit markets were under stress.
In its statement, the RBI said that it will:
- Conduct special repo operations of 90-days tenor at fixed repo rate
- The facility is on-tap and open-ended. Banks can submit their bids to avail funding on any day from Monday to Friday
- The scheme is available from April 27, 2020 till May 11, 2020 or up to utilisation of the allocated amount, whichever is earlier
- Funds availed under the liquidity facility shall be used by banks exclusively for meeting the liquidity requirements of mutual funds
- Banks can extend loans, directly purchase and/or conduct repo operations using investment grade corporate bonds, commercial papers, debentures and certificate of deposits held by mutual funds as collateral
Explaining the rationale behind the facility, the RBI acknowledged the liquidity pressures being seen in pockets but added that these were restricted to the high-risk debt mutual fund segment.
Heightened volatility in capital markets in reaction to COVID-19 has imposed liquidity strains on mutual funds, which have intensified in the wake of redemption pressures related to closure of some debt MFs and potential contagious effects therefrom. The stress is, however, confined to the high-risk debt MF segment at this stage; the larger industry remains liquid.RBI Statement
The central bank has also announced a number of steps to ensure adequate off-take of funds provided under this facillity.
Support extended to mutual funds under this facility shall be exempted from banks’ capital market exposure limits, it said. The central bank also said that exposures under this facility will not be reckoned under the large exposure framework.
Liquidity support availed under the facility would be eligible to be classified as ‘Held-To-Maturity even in excess of 25 percent of total investment permitted to be included in the HTM portfolio, the RBI said. This would help avoid the fear of mark-to-market risk for banks.
The amount raised under this facility will also be excluded for computation of adjusted non-food bank credit, which is then used for calculating priority sector lending targets.
Confidence Boosting Measure
Calls for a liquidity window from the RBI to ease any strain building up across mutual funds had grown over the last few days.
Former finance minister P. Chidambaram had urged policymakers to provide the liquidity support needed, as had been done in 2008. Former Securities and Exchange Board of India chairman UK Sinha, in an article in the Indian Express, cautioned that stress in the mutual fund segment could quickly spread if regulators don’t step in.
The facility announced by the RBI will help boost confidence and reduce the volatility seen in the corporate debt market, said NS Venkatesh, chief executive officer of the Association of Mutual Funds in India.
“The announcement from the RBI is a confidence boosting measure and will reduce the yield volatility being seen in the corporate debt market. Since it is repo facility, banks can borrow from the RBI window while entering into bilateral repo agreements with the mutual funds to channel the money to the fund,” Venkatesh said.
Ajay Manglunia, managing director and head of institutional fixed income at JM Financial Services said that the facility will help mutual funds who are facing large redemption pressures.
“This liquidity window provides a psychological comfort for investors as funds can borrow liquidity at a repo rate. Most mutual funds have banking lines and can borrow upto 20 percent of their AUM. So this facility will help mutual funds that are facing large redemption pressure as they can borrow at a lower cost compared to their banking lines,” Manglunia said.
In 2008, similar liquidity support provided by the RBI saw very limited utilisation but proved to be a confidence boosting measure.
Arvind Chari, head of fixed income and alternatives at Quantum Advisors Pvt. Ltd, however, cautioned that the situation today and in 2008 or 2013 is different.
Today we have a risk aversion issue amidst redemption pressure for the mutual fund industry, Chari said. “If the redemptions are restricted to credit risk funds and other such funds which have a higher share of lower rated assets, I don’t see the liquidity facility solving the risk aversion issue. This is because that fund/ scheme will need to provide collateral in the form of securities and these might not meet the banks criteria,” Chari said.
Mahendra Jajoo, head of fixed income at Mirae Asset Management does not see that as a problem.
Mutual funds have enough securities against which banks would be willing to lend. For example, mutual funds have five-times the amount of the liquidity facility being offered in AAA-rated PSU debt alone, Jajoo said. “They can borrow against that if needed. Credit quality will not be a challenge.”
Sunil Subramaniam, chief executive officer at Sundaram Mutual Fund added that since the RBI has specified that banks can accept ‘investment grade’ paper as collateral, lenders are not being asked to take on excessive credit risk in providing support to mutual funds.
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