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Early today, the Reserve Bank of India moved decisively to nip the developing debt fund crisis in the bud. The central bank has opened a special line of credit that can be used by banks to lend to mutual funds against bonds that are facing a liquidity crunch and unable to meet redemptions.
This facility can be used by banks only for this purpose, and has been opened for 90 days at this point. The funds will be available at the existing repo rate, which is currently 4.4 per cent. The statement from the central bank also said that 'the Reserve Bank will review the timeline and amount, depending upon market conditions.'
Importantly, the RBI also stated that a set of conditions which essentially clarified that the quality of this exposure will not affect the bank's larger asset quality parameters. Specifically, the statement says, 'Liquidity support availed under the SLF-MF would be eligible to be classified as held to maturity (HTM) even in excess of 25 percent of total investment permitted to be included in the HTM portfolio. Exposures under this facility will not be reckoned under the Large Exposure Framework (LEF). The face value of securities acquired under the SLF-MF and kept in the HTM category will not be reckoned for computation of adjusted non-food bank credit (ANBC) for the purpose of determining priority sector targets/sub-targets. Support extended to MFs under the SLF-MF shall be exempted from banks' capital market exposure limits.' Coupled with the low repo rate, this should allay any fears that banks had about lending to mutual funds.
These measures will come as a great relief to debt fund investors. The central bank has recognised that just like other aspects of the Covid crisis, it's better to act early and decisively. There are some outstanding issues in this matter, for example, the status of the Franklin funds that were frozen. We'll update this article as that becomes clear.
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