The cut in savings rate below 4% may result in emergence of liquid mutual funds as a direct alternative to savings deposits and lead to greater individual investor participation in this asset class.
The growth in the individual investor base for mutual funds had hitherto driven the growth in equity assets under management (AUM) while the individual investors’ interest in liquid schemes was limited.
The rating agency ICRA said that a cut in savings rate is expected to create an opportunity for liquid mutual funds to tap into retail savings, by providing an avenue for parking surplus liquidity while earning a premium over the savings rate.
“With the arbitrage between liquid mutual funds and bank deposits likely to continue, the pace of incremental inflows into liquid mutual funds is expected to increase over the near to medium term as some part of the surplus funds are moved away from bank deposits as investors look to improve returns without taking too much risk,” said Karthik Srinivasan, senior vice president and group head, Financial Sector Ratings, ICRA Limited.
On July 31, State Bank of India announced a 50 basis points reduction in the interest rate on savings deposits of less than ₹10 million in value, to 3.5%. Following SBI’s lead, many other public and private sector banks have reduced the interest rates on saving deposits.
Post demonetisation, liquidity in the banking system is abundant due to a surge in deposits and continued slack growth in credit offtake.
The credit to deposit ratio for banks has reduced from 71.83% as on March 31, 2016 to 67.01% on June 30, 2017.
ICRA estimated that a reduction of 50 basis points could lead to a 12-15 bps reduction in the cost of interest-bearing funds for the banking system and support the net interest margins or provide room for lending rate cuts at a later date.
Corporates, institutional investors and business houses have been deploying surplus funds in low risk products such as liquid schemes of mutual funds for a short duration in addition to bank deposits. With the reduction in savings rate, liquid funds, which offer the advantage of liquidity and flexible maturity with easy redemption, are expected to gain prominence as an alternative tool as retail investors also increase usage of the available benefits of liquid schemes.
‘Declining repo rates’
“Liquid schemes have reported annualised returns in the range of 6.5% to 7.0% over the last one year; the returns have however moderated to 6.25% to 6.50% over the last five months on the back of declining repo rates. These schemes have provided 2.75% to 3.00% higher pre-tax returns, on an annualised basis, than savings accounts,” said Mr. Srinivasan.
However, he said, “accounting for income tax benefits associated with interest in savings deposits, the difference between annualised returns of liquid funds and savings accounts moderates to 0.87% to 1.63% for an individual at the highest tax bracket.”
Though liquid mutual funds are subject to market risk, the shorter maturity profile of the underlying investments of around 1-2 months and the high credit quality of the underlying portfolio alleviate credit risk to some extent.