Signalling support

#GS3 #Economy

RBI’s liquidity facility for mutual funds still hinges on banks’ willingness to lend

  • The Reserve Bank of India’s decision to open a special facility to ensure the availability of adequate liquidity for the mutual fund industry is a timely move in signalling to investors that the central bank is alert to the need to preserve financial stability in these challenging times. 
  • In assigning ₹50,000 crore exclusively for commercial banks to lend to mutual funds, the RBI made clear that it wants to tamp down on any build-up of liquidity strains at mutual fund houses in the wake of heightened volatility in the capital markets and increased redemption pressures as a fallout of the COVID-19 pandemic. 
  • The RBI has rightly recognised the urgent need to ward off any incipient contagion impact from the closure of these six funds. 
  • The Association of Mutual Funds in India (AMFI) had, sought to assure investors that a majority of debt fund schemes had “invested in superior credit quality securities” and had appropriate liquidity to back their normal operations.
  • RBI was cognisant of this is evident in the way that the norms have been tailor-made to incentivise the banks to lend.
  • From allowing banks to breach their 25% ceiling on held-to-maturity investments as a consequence of lending to mutual funds, to exempting the support extended from banks’ overall capital market exposure limits, the central bank has sought to ease the flow of credit to the fund houses. 
  • Still, if the recent experience of getting lenders to support the non-banking financial companies through a targeted long-term repo operation backed by ₹50,000 crore is any pointer, clearly the banking industry — beset by bad loans — appears to have little appetite for adding any credit that it deems risky. 
  • The Centre may need to be ready to step in with direct intervention if the RBI’s gambit fails to ease the pressure on mutual funds.
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