The special liquidity facility for mutual funds (SLF-MF) announced by the Reserve Bank of India (RBI) on 27 April allows banks to borrow from the central bank at a fixed repo rate of 4.4% and use the funds to lend to mutual funds or buy investment-grade fixed income securities from them. Is this dedicated line of credit an adequate measure to meet the stress faced by the mutual fund industry in dealing with illiquidity and solvency issues in the debt markets, or is there more that can be done? Sunita Abraham spoke to four experts to understand what more the industry may need to weather this crisis
The liquidity facility for MFs is definitely positive, and is part of RBI’s attempt to ensure that financial conditions do not tighten and stability concerns are addressed.
The effectiveness of this measure in the absence of risk capital would mean that the liquidity would go towards AAA-rated and high-grade credits. What remains unaddressed is the question of risk appetite and the provision of liquidity and refinancing support for the large segment of India Inc. that sits between AAA and the non-viable segment at the bottom.
The need of the hour is for this facility to be accompanied with some first-loss protection feature or credit support from the government. The models adopted by the US Federal Reserve and Treasury, with most of the non-conventional market support actions of the Fed being accompanied with equity from the Treasury, could be adopted. RBI went for a similar route through the Stressed Asset Stabilisation Fund (SASF) of IDBI with government’s support during the 2008 crisis. Government participation can be accompanied by adequate safeguards and conditionality for entities accessing this window.
The liquidity window is a soothing balm, but not a cure
The SLF-MF is a factor that authorities have taken in view of recent developments and are initiating appropriate steps to restore stability and confidence in an otherwise strong and resilient industry. Today, credit concerns are overshadowing liquidity concerns, largely because the latter is an offshoot of the former. With the borrowing limit (20% of the AUM) largely unutilized and a banking system flush with liquidity and with many AMCs having banks or financial institutions as parents, the liquidity window would largely operate as a soothing balm than a proper curative.
A roadmap of an action plan from the government or RBI on a pre-emptive basis in case the crisis deepens—say, if a first-loss guarantee, like in last year’s post-IL&FS event, is in the offing—will help the industry make suitable contingency plans and prevent collateral damage due to uncertainty. Action from the mutual fund regulator such as new investment restrictions or changes in the concentration limits or the minimum credit ratings, or even discontinuing credit risk funds as a category may help to ensure that such situations do not recur.
SPV to fund NBFCs and MSMEs will alleviate stress
The SLF, apart from being a confidence booster, provides the much-needed borrowing facility to mutual funds to manage redemption pressure in this market that has turned illiquid because of the lockdown.
As per RBI data, funds availed of ₹2,000 crore from this facility on 27 April and the announced corpus of ₹50,000 crore is likely to go a long way in addressing liquidity concerns in the MF space. This is going to provide relief to the market and improve sentiment among debt fund investors, who have been hit by recent events.
Apart from this, the government and RBI can look to provide much-needed funding to non-banking financial companies (NBFCs) and micro, small and medium enterprises through a special purpose vehicle, which could improve the overall sentiment, while alleviating stress in some fund exposures. There are hopes that something like this is being worked out between the government and RBI for ₹3 trillion. This could restart the funding to stressed sectors like NBFCs and realty. As debt markets start to normalize and investor sentiment improves, stress on funds will reduce.
Govt can look to guarantee defaults on NBFC loans
The government and RBI have been making the right moves, but they are not having the last-mile connectivity—appetite for the lower-rated and smaller-sized NBFCs—to complete the impact of the special liquidity window for mutual funds.
To boost confidence, the government can guarantee defaults on NBFC loans and bonds to a certain extent, say, 20% or 30% of the quantum.
For the government, it will be a contingent expenditure and for the banks, as long as the delinquencies are within that limit, it will be like good credit.
Hiving off the risky exposures, the “lesser” NBFCs, to an SPV is one option, but it will create a bad precedent. At the height of the bank NPA (non-performing asset) issue, the “bad bank” concept was debated, but was not executed, rightfully. It would lead to complacency.
RBI buying bonds directly from the market is the last resort. Before we hit the fence, RBI can give some dispensation to NBFCs in line with the three-month moratorium. It will impact banks’ balance sheets, but that can be taken care of late