Liquid funds to lose two-thirds of bank money over next 6 months

Liquid mutual funds (MF), which account for at least a fifth of the 6 lakh crore MF industry, are expected to see a huge outflow of funds over the next six months after the central bank put a cap on bank investments in these funds.

RBI deputy governor Shyamala Gopinath said banks were using these funds as a current account yielding high interest. “We have seen bank investments in these funds falling as low as 1-2 per cent and then shooting up drastically, depending on liquidity conditions. MFs, in turn, used to deploy the money back into banks by way of certificates of deposits. This had to be addressed as it was raising systemic concerns,” said Gopinath.

“The investment in liquid schemes by banks will be subject to a prudential cap of 10 per cent of their net worth as on March 31 of the previous year,” the RBI said in the monetary policy statement.

Fund managers say banks have invested at least three times this number and will have to begin unwinding soon. Though official figures for April are yet to be out, fund managers estimate around 1 lakh crore of bank money invested in these funds. Estimates of the collective net worth of commercial banks put it between 3.5 lakh crore and 5 lakh crore.

This means about 50,000 to 65,000 crore or up to two-thirds of total bank investments in MFs will have to be repatriated. Rajat Jain, CIO, Principal Mutual Fund, said, the assets will shrink substantially over the next six months. “Though there are no official numbers on the net worth of banks, it is estimated to be around 4 lakh crore. This will cap liquid fund investments at around 40,000. The rest of the money has to flow out over the next six months.”

However, he expressed the loss would be partially recouped by the growth in net worth. “It will be gradual as banks’ net worth goes up with higher earnings growth and increase in profits,” Jain added.

Saurabh Nanavati, CEO, Religare Asset Management, estimates an outflow of close to 65,000 crore in the next six months. “But this money will find its way into the hands of corporates. This will not go out of the system,” he said.

Since at present many banks have invested up to three times this limit, the RBI has provided a six-month window for banks to unwind smoothly. Fund managers feel this window will ensure the system adjusts automatically. A Balasubramanian, CEO, Birla Sun Life Asset Management Company, said, “In our view, this will not disrupt the system as the transition period is close to six months. By that time, the system will adjust automatically. This once again emphasises the fact that going retail is the way to build mutual fund assets.”

The central bank said it has put the prudential cap in keeping with the increased inflows into these funds and concerns over round tripping. “Circular flow of funds between banks and debt-oriented mutual funds could lead to a systemic risk in times of stress or a liquidity crunch. Thus, banks could potentially face a large liquidity risk. It is, therefore, felt prudent to place certain limits on banks’ investments in debt funds,” the RBI said in the annual monetary policy statement.

During the credit crisis in 2009, mutual funds were flooded with redemption requests, forcing the Reserve Bank to open a special repo window for them.

Banks’ investments in liquid schemes have grown manifold over the past few years. According to Amfi figures, assets under management in liquid funds had hit a high of 1.71 lakh crore in February.