4 min read.Updated: 02 Dec 2021, 12:52 AM ISTAjit Ranade
Innovations that reveal risks should be improved upon and not banned if we’re to gain from them
The mutual fund (MF) industry sells a category of funds called money market funds (MMFs). As they are a subset of debt funds, they are considered to be safe and liquid, just like ‘cash’. In terms of tax benefits, they have an edge over fixed deposits in a bank. Why park your cash in a bank when you can get better and equally-safe returns from an MMF? Such funds are an example and part of a steady pipeline of ‘innovations’ that keep popping up in financial services. In this case, liquid-fund instruments offer an advantage not just to investors/savers, but also to borrowers, for whom accessing these funds is easier than getting bank loans. This particular innovation is decades old, and a further innovative tweak was to consider issuing a cheque book or an ATM card against an MMF. Everything seemed hunky dory, until it received a big jolt one day in September 2008. Just a day after Lehman crashed in the US, redemption pressure on a renowned MMF called Reserve Primary Fund sank its net asset value (NAV) below $1. If a liquid fund is as good as cash, how can its unit value go below $1? This is called ‘breaking the buck’, and for the first time in history, a retail money market fund ended up with an asset value less than a buck. It was a wake-up call on the inherent risks embedded in MFs even as safe as MMFs. That incident led to heavier regulatory oversight, with more fine print and risk disclosure requirements for MFs. Notably, however, we did not ban MMFs. The MF industry has gone to great lengths to improve financial literacy and a surge in retail investments since then would testify to increasing retail interest and confidence. Innovations like these tend to highlight risks, which when addressed often improve the product. There’s constant race between innovation and regulation. Bans are mostly unthinkable.
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