The Reserve Bank of India has raised concerns on the increase in assets of money market mutual funds (MMMFs) in the past few months. The central bank observed that the infusion of liquidity in the wake of the pandemic had led to a sharp decline in term rates. Even as deposit yields fell, assets under MMMFs have grown, indicative of a search for yield.
“Such risk taking among institutional investors, specifically in illiquid investments to earn targeted returns, may lead to build-up of financial vulnerabilities, with adverse implications for financial stability,” the RBI said in its financial stability report released on Monday.
Average net assets under management of such money market funds rose to Rs 96,210 crore in December, up 61 per cent over Rs 59,512 held in April, the data from Association of Mutual Funds in India shows.
The central bank said excess returns of MMMFs had started to normalise after turning negative in the previous quarter, reflecting increased proportion of liquid assets in their investment corpus. The share of liquid assets in debt mutual funds’ portfolios has surged since March and constitutes 39 per cent of the aggregate AUM by end-November 2020, reflecting precautionary allocations, it observed.
The RBI said MFs showed a marked preference for long-term debt while also holding equity shares. Such simultaneous holdings in debt and equity allowed transmission of risk from equity market sell-off to the debt markets and vice versa. Given their interconnected nature, however, such sell-offs can potentially transmit asset market shocks across the financial system.
The central bank reiterated that the dominant positions occupied by mutual funds and insurance companies in the non-banking space needed to be assessed as NBFCs and housing finance companies remain the largest borrowers, with systemic implications.