Recently, the Reserve Bank of India (RBI) announced a special liquidity window of Rs 50,000 crore to aid mutual funds experiencing turmoil in the debt fund segment. This has made headlines because it is the third time the RBI is providing liquidity for the financial sector in the last 15 years.
Repo Operations and Its Role
The special liquidity facility for mutual funds (SLF-MF), enables the RBI to conduct repurchase agreement (repo) operations of 90-day tenure at a fixed rate for banks. A repo is a short-term strategy where securities are sold with an agreement to repurchase them at a slightly higher price. The institution selling the repo essentially borrows and the other party lends.
Liquidity Provision for Mutual Funds
Funds acquired under the SLF-MF will be used exclusively by banks to meet the liquidity needs of mutual funds. Therefore, banks can provide loans to mutual funds or engage in outright purchase of investment-grade corporate bonds, commercial papers (CPs), debentures, and certificates of Deposit (CDs) held by mutual funds under the SLF-MF.
Features of the Liquidity Offer
For banks, any liquidity support availed under the SLF-MF can be categorized as Held-To-Maturity (HTM). The securities purchased under the SLF-MF are kept in the HTM bracket and would not contribute towards Adjusted Non-food Bank Credit (ANBC) computation for fixing priority sector targets. Furthermore, the support provided to Mutual funds is exempt from the banks’ capital market exposure limits.
Background and Necessity
Volatility in capital markets has multiplied the stress on mutual funds, spurred by redemption pressures following the closure of six debt schemes of Franklin Templeton. Although this stress is currently confined to the high-risk debt funds segment, the larger industry remains liquid.
Outcome and Expectation
This move by the RBI to inject liquidity intends to uplift investor confidence in the mutual fund sector. The liquidity offer is expected to introduce a degree of comfort in the debt market which is burdened with redemption pressure, especially in the credit risk fund category.
Essential Terms Defined
A Mutual Fund is an investment vehicle that collects money from investors and invests on their behalf in securities such as debt, equity or both. 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 a subtype of debt funds with at least 65% of their investments in lower-rated papers.
Held-to-maturity securities are those purchased with an intention to retain until maturity. Adjusted non-food Bank Credit comprises 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 proportion of a portfolio invested in a specific type of security, market sector or industry.
Large Exposures Framework is a structure that lays down prudent limits on large exposures of banks to prevent asset concentration to a single counterparty or a group of connected counterparties. To address this concentration risk, RBI has imposed limits on bank exposures. According to current RBI guidelines, a bank’s exposure to a single borrower is restricted to 15% and to a borrower group 40% of capital funds.