Credit risk funds may not have enough quality papers to use RBI’s liquidity window

Mumbai: The Reserve Bank of India’s decision to launch a Rs 50,000-crore liquidity window for mutual funds in the wake of the Franklin Templeton fiasco may not be enough to resolve the concerns engulfing the credit risk schemes, say industry officials.

The central bank’s facility allows mutual funds to borrow from banks by keeping securities that are of investment grade as collateral.

But, with many credit risk schemes running out of top-rated papers after fund houses offloaded them in the past two months to meet the redemption pressure, industry officials are sceptical if banks would accept majority of the remaining lower-rated securities held by this fund category as collateral.


In the past couple of months, appetite for risky papers has shrunk because of worries about the ability of the issuing companies to repay the money on account of the downturn sparked by the Covid-19 turmoil. Credit risk funds — which invest in such lower-rated papers — have been most hit by the outflows. Initially, these schemes, including the ones run by Franklin, sold the stronger securities to service the redemptions. Now, many of them have run out of top-rated bonds in their portfolios. Franklin was forced to shut six schemes because it was unable to meet the redemption pressure.

Some industry officials say banks will be hesitant to lend to debt mutual funds with securities other than top-rated as the collateral. “This liquidity window via banks may not be effective to resolve the problem,” said Arvind Chari, head — fixed income, Quantum Advisors. “I don’t see them (banks) taking lower-rated corporate debt as collateral, which have been lacking in liquidity. If we see heavy redemption in schemes which carry large exposure to lower-rated corporate debt, liquidity will remain a problem.”

The scheme is available till May 11, said the RBI release on Monday morning. Banks are averse to holding risky papers for such a short period.

“Most credit risk funds have already sold their good quality paper to meet redemptions in the last one year. What is left behind is unrated and low-grade paper, which given the economic environment no bank would want to touch,” said the product head at a foreign fund house.
Not Enough Quality Papers

The advantage of this RBI liquidity window is that mutual funds will not need to rush to sell their best papers. They can raise money by pledging them.

Fund managers say lenders have been unwilling to buy bonds of most corporates barring a few top-notch ones under the recent targeted long-term repo operations (TLTROs) for companies and finance firms.

Credit risk schemes run by fund houses owned by banks could be in a better position to meet redemption pressures.

“AMCs which are backed by banks will not have much of a problem unless the quality of paper is bad. The parent will buy it through the TLTRO route,” said the chief investment officer of a wealth management firm.

Credit risk funds with bank promoters account for Rs 39,000 crore of the total AUM of Rs 55,521 crore or 71% of the total credit risk space as of March 31, 2020.

Wealth managers continue to advise investors to stay away from credit risk schemes.