RBI’s Liquidity Offer for Mutual Funds

• 28 Apr 2020

Why in News

Recently, the Reserve Bank of India (RBI) announced a special liquidity window of Rs 50,000 crore to bail out mutual funds hit by the turmoil in the debt fund segment.

Key Points

• Repo Operations: Under the special liquidity facility for mutual funds (SLF-MF), the RBI will conduct repo (repurchase agreement) operations of 90 days tenor at fixed rate for banks.
  
  • A repurchase agreement, or 'repo', is a short-term agreement to sell securities in order to buy them back at a slightly higher price.
  • The one selling the repo (banks) is effectively borrowing and the other party (the RBI) is lending.
• Providing Liquidity to Mutual Funds
  
  • Funds availed under the SLF-MF will be used by banks exclusively for meeting the liquidity requirements of mutual funds.
  • Under the SLF-MF, banks can extend loans to mutual funds and undertake outright purchase of and repos against the collateral of investment grade corporate bonds, commercial papers (CPs), debentures and certificates of Deposit (CDs) held by mutual funds.
• Features of the offer
  
  • The RBI said liquidity support availed of under the SLF-MF would be eligible to be classified as Held-To-Maturity (HTM).
  • The face value of securities acquired under the SLF-MF and kept in the HTM category would not be reckoned for computation of Adjusted Non-food Bank Credit (ANBC) for determining priority-sector targets/sub-targets.
  • Support extended to MFs under the SLF-MF shall be exempted from banks’ capital market exposure limits.
  • Exposure under this facility would not be reckoned under the Large Exposure Framework (LEF).
• This is the third time the RBI is opening the liquidity window for the financial sector players in the last 15 years.
  
  • The RBI had opened a special liquidity repo window for mutual funds in 2008 at the time of the global financial crisis.
  • In July 2013 again RBI opened a special liquidity repo window, when returns on debt mutual funds dropped sharply after the rupee fell significantly against dollar.
• Background
  
  • Volatility in capital markets has intensified the stress on mutual funds due to the redemption pressures related to the closure of six debt schemes of Franklin Templeton and potential contagious effects.
  • The stress is, however, confined to the high-risk debt funds segment at this stage while the larger industry remains liquid.
• Outcome
  
  • The RBI move on pumping liquidity will boost investor confidence in the mutual fund industry.
  • The RBI’s liquidity offer is expected to bring some degree of comfort in the debt market which is under huge redemption (paying back) pressure, especially in the credit risk fund category.

Key Terms

• Mutual Fund: A mutual fund collects money from investors and invests the money, on their behalf, in securities (debt, equity or both). It charges a small fee for managing the money.
• Debt funds aim to generate returns for investors by investing their money in avenues like bonds and other fixed-income securities.
• Credit-risk funds are debt funds which have at least 65% of their investments in less than AA-rated (i.e. in lower-rated) papers.
• Held-to-maturity securities are purchased to be owned until maturity. E.g bonds.
• Adjusted non-food Bank Credit includes non-food bank credit and total non-statutory liquidity ratio (SLR) investments of banks in commercial papers, shares and bonds/debentures.
• Capital Market exposure refers to the percentage of a portfolio, invested in a particular type of security, market sector or industry
  
  • It is also known as the exposure amount an investor can lose from the risks unique to a particular investment.
• Large Exposures Framework: The large exposures framework sets prudent limits to large exposures of banks, which may result in a concentration of its assets to a single counterparty or a group of connected counterparties.
  
  • To address this concentration risk, RBI has fixed limits on bank exposures.
  • As per current guidelines of RBI, a bank’s exposure to a single borrower is restricted to 15% and to a borrower group 40% of capital funds.

Source: IE