Banks, mutual funds in a liquidity cat & mouse

Tightening liquidity is forcing banks to withdraw short-term monies parked with mutual funds.

This, in turn, is forcing fund houses to sell extremely short-end papers at high yields, even as others liquidate some investments to garner cash.

But guess who’s buying in the distress sale? The banks themselves, who put the squeeze on fund houses in the first place.

In the last one month, three-month certificates of deposits (CD) and commercial paper (CP) rates have risen by almost 150 basis points. Six-month CD rates rose by almost 70 basis points and CP rates by over 100 basis points in the same period.

Clearly, the Reserve Bank of India’s (RBI) apprehensions over the repercussions of excessive bank investments in mutual funds are coming true.

“Banks can always go to the RBI repo window and pick up cash at 5.25%, but no, they are squeezing the funds,” said an analyst.

“This circularity of money flows in these times is not good, and adds to volatility. It’s quite a Ponzi scheme, actually,” said a fund manager not wishing to be named.

“Also, bank money is overnight money whereas funds, to generate excess returns, have to buy longer-term paper. This creates volatility,”

Many fund houses are also selling own investments to tank up on cash.

“A lot of papers we invested in are maturing in June, which will fetch us cash. In the last few days many mutual funds have redeemed papers for cash. We may not be investing in fresh assets at this moment. We will wait and watch how the liquidity situation pans out and then decide,” said Lakshmi Iyer, vice-president and head of fixed income, Kotak Mahindra Mutual Fund.

Last Friday, there were no issuances of certificate of deposits as fund houses, which are the largest investors in the instrument, preferred hard money.

“Liquidity is tight. There are redemption pressures and rates of commercial papers (CP) and certificate of deposits (CD) harden in such times,” said Juzer Gabajiwala, head of mutual funds distribution at Ventura Securities.

Liquidity started shrinking due to the Rs 67,000 crore outgo on May 31 towards payment of 3G spectrum fees by auction winners.

Experts said about Rs 30,000 crore may additionally be drained by mid-June towards the payment of first instalment of corporate advance tax for the current fiscal.

“The tighteness in liqudity will continue till the end June due to these factors and the system will continue to borrow under the repo,” said Nirav Dalal, managing director, debt capital markets at Yes Bank.

On Friday, banks parked Rs 2,070 crore under the reverse repo and borrowed Rs 18,945 crore under the repo window of the Reserve Bank of India.