The circular flow of funds between banks and mutual funds is a source of systemic instability in times of stress/liquidity crunch, says RBI

The Reserve Bank of India has flagged the issue of strong interconnectedness among banks and mutual funds in India as a cause for concern. Debt mutual funds account for 70 per cent of the assets under management of the mutual fund industry.

Mutual funds have relied more on investments by banks and corporates in the backdrop of low retail participation.

The report said that due to their interconnectedness with banks, liquidity pressure is felt by the money market mutual funds whenever redemption requirements of banks are large and simultaneous.

Liquid debt mutual funds are large lenders in the overnight markets, such as collateralised borrowing and lending obligation (CBLO) and market repo, where banks are large borrowers. Various schemes of mutual funds also invest heavily in certificates of deposit (CDs) of banks.

The circular flow of funds between banks and mutual funds is a source of systemic instability in times of stress/liquidity crunch, etc., the RBI said.

Debt mutual funds, which had seen large inflows in 2012-13, saw a reversal when the sharp depreciation of the rupee began in response to the announcement of tapering by the Fed earlier this year in June 2013.

The RBI’s measures on tightening liquidity during July 2013 saw investments by banks as a percentage of total AUM (assets under management) of liquid/money market schemes declining from 21.14 per cent on July 15, to 13.02 per cent as on July 16, which further declined to 7.77 per cent as on July 31.

The RBI, however, noted that the special windows opened for refinance were not utilised, indicating an improvement in liquidity management by mutual funds.

vageesh.ns@thehindu.co.in

(This article was published on December 30, 2013)
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