In a move that will further push mutual funds (MFs) to go retail, the Reserve Bank of India (RBI) has instructed banks to limit their investments in liquid MF schemes up to 10% of their net worth as on 31 March of the previous year. RBI has allowed banks to withdraw any excess investment from MFs over the next six months.
In his credit policy speech, the RBI governor reiterated the central bank’s long-time concern of money going from banks to fund houses and back to banks.
Banks invest in liquid MFs, which in turn invest this corpus in certificate deposits issued by banks. In times to meet sudden redemption, liquid funds are forced to sell their underlying assets in the market at throwaway prices (also called distress sale). “This is a systemic risk, much like what had happened in 2008,” says Shyamala Gopinath, deputy governor, RBI.
At present, she added, banks have been investing between 2% and 15% of their net worth in liquid MF schemes. “We are capping it at 10%, which comes to about Rs 50,000 crore,” she says.
“This is a very good move from the regulatory perspective. Fund houses have been dependant on institutional money so far,” says Devendra Nevgi, founder and principal partner, Delta Global Partners, an asset class and macroeconomic research firm that caters to foreign clients.
Banks and companies are the largest investors in liquid funds; rough industry estimates say that at least 95% of a liquid fund’s corpus comes from this institutional segment. As per RBI data, banks’ investments in MFs stood at Rs 1.06 trillion as on 11 March 2011. Between August 2010 and March 2011, banks invested Rs 54,425 crore on an average in MFs (a significant chunk of this is estimated to have gone to liquid funds).
However, this is expected to change soon. As per the balance sheets of listed banks (as on March 2010), their total net worth was about Rs 3,62,316 crore. About 10% of this would come down to Rs 36,231.6 crore; this is roughly the quantum of money that will now flow from banks to MFs, as per March 2010 figures.
“Roughly Rs 40,000 to Rs 50,000 is expected to move out over the next six months,” says Ganti N. Murthy, head (fixed income), Peerless Funds Management Co. Ltd. Nevgi adds: “Apart from banks availing of an arbitrage—they borrow money from RBI using the repo window and then invest the same in mutual funds—the risk that MFs used to take (by investing in risky scrips) used to get passed on to banks, which wouldn’t have otherwise invested in such scrips directly,” he adds.
Jimmy Patel, chief executive officer, Quantum AMC Ltd: “Volatility of inflows and outflows into liquid funds will come down. Limiting banks’ inflows in liquid schemes may not sound like a very good thing for MFs, but the new rule will now force the industry to mobilize money from other avenues.”
RBI’s latest move asking banks to limit their investment gives further impetus to what the Securities and Exchange Board of India has been telling MFs for quite some time now: go retail.