Our view on the Liquidity Window

By Morningstar |  27-04-20 | 

The Reserve Bank of India, or RBI, announced a Rs 50,000 cr liquidity facility for mutual funds. The stress right now only exists in the higher risk paper. However, facing the possibility of a threat of a contagion to other parts of the market, the RBI decided to step in.

“Heightened volatility in capital markets in reaction to COVID-19 has imposed liquidity strains on mutual funds (MFs), which have intensified in the wake of redemption pressures related to closure of some debt MFs and potential contagious effects therefrom. The stress is, however, confined to the high-risk debt MF segment at this stage; the larger industry remains liquid," is what the press release stated.

Banks can borrow "on tap" (whenever they need) at the repo rate (4.4%) from April 27, 2010 to May 11, 2020.

They can utilize this money to lend to mutual funds (at higher than 4.4%) or purchase investment grade paper held by mutual funds.

Mutual funds facing redemption pressure and in need of cash now have some recourse. The debt market for non-AAA securities is not very liquid;  this helps ease the liquidity pressure. And would prevent more AMCs from freezing their funds.

Morningstar’s view.

Liquidity is constrained in the debt markets, especially lower down the credit spectrum. Debt funds have witnessed redemptions, but most have a significant amount of liquid securities to meet redemptions. This has been in play since March, given the pessimism around the economy slowing down due to the lockdown.

The immediate concern of the central bank is to assuage investors and ensure that they don’t panic post the winding up of six funds from Franklin Templeton India. The liquidity window will certainly help improve investor confidence. Mutual funds can use this window in case there is any redemption pressures.

Having said that, mutual funds have ample AAA-rated exposures which can be used for this purpose. But, it will be interesting to see if banks are willing to lend lower down the credit curve, should it come to that.

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