Risk building up in mutual fund segment: RBI's Financial Stability Report

Report says there seems to be some risk migration from the banks to the mutual funds

The liquidity rush in the financial system since demonetisation has led to “unprecedented fund flows to both equity and debt mutual funds”, which is showing some signs of risk, according to the Reserve Bank of India’s (RBI’s) Financial Stability Report on Thursday.

Given the significant increase in the mutual funds (MFs) corpus and an excess monthly return of almost 250 basis points (annualised) from a representative money market fund, “there seems to be some risk migration from the banks to the mutual funds”, the FSR said.

The top five fund houses contributed about 50 per cent of the aggregate corpus of liquid and money market mutual funds. Since these funds invested in higher rated corporate bonds, the spread in these over central government bonds have contracted. However, there has been an unexpected rise in BBB corporate spreads on account of lack of liquidity in lower rated corporates.

“The effects of pervasive domestic liquidity in financial markets following demonetisation and abundant liquidity induced as a result of foreign exchange operations have pushed down borrowing costs for higher rated Indian corporates,” the FSR noted.

“The corporates might find it advantageous to place issues with MFs rather than accessing bank finance,” the report notes, as bank loans were competitive below the rating grade ‘AA-’.

The FSR also noted that there is a significant differential between the risk-free rate of treasury bond yields and bank Marginal Cost of Funds based Lending Rate (MCLR). And this is leading to disintermediation of bank financing by corporate bonds in case of quality corporates.

 “To stem the erosion in the quality of credit portfolios, some of the well-capitalised banks have reportedly started resorting to risk-free benchmark based pricing as opposed to MCLR linked pricing,” the report said.

According to the FSR, the risk appetite in foreign portfolio investors for unhedged government and corporate bond exposure has increased. The recent upgrade in India’s sovereign rating by Moody’s implies that Indian corporates’ dollar borrowing cost is likely to remain benign, it said.

However, the offshore market could be pushing down risk towards the local markets, it observed.

“The significant build up in offshore index futures relative to onshore can have spillover effects to related onshore markets during times of stress,” the report said.