ICRA highlights opportunity for liquid mutual funds to tap into retail savings

In the wake of the State Bank of India (SBI) and other banks facilitating slashes on interest rates on savings deposits, credit rating agency ICRA highlighted an opportunity for liquid mutual funds to tap into retail savings, by providing an avenue for parking surplus liquidity while earning a premium over savings rate.

Liquidity in the banking system is abundant currently on account of the surge in deposits post demonetisation and continued slack credit growth.

The credit to deposit ratio for banks has reduced from 71.83 percent as on March 31, 2016, to 67.01 percent as on June 30, 2017.

ICRA estimates that a reduction of 50 basis points can lead to a 12-15 bps reduction in the cost of interest bearing funds for the banking system and support the net interest margins (NIMs) 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.

"Liquid schemes have reported annualised returns in the range of 6.5 percent to 7.0 percent over the last one year; the returns have however moderated to 6.25 percent to 6.50 percent over the last five months on the back of declining repo rates. These schemes have provided 2.75 percent to 3.00 percent higher pre-tax returns, on an annualized basis, than savings accounts," said Karthik Srinivasan, senior vice president and group head - Financial Sector Ratings, ICRA Limited.

"However, 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 percent to 1.63 percent for an individual at the highest tax bracket," he added.

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 the liquid schemes was limited. The cut in savings rate below four percent 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.

Though liquid mutual funds, like other mutual funds, are subject to market risk, the shorter maturity profile of the underlying investments of around one to two months and the high credit quality of the underlying portfolio, which comprises money market instruments like certificate of deposits, treasury bills, and high rated commercial papers alleviate credit risk to some extent.

In accordance with the Securities and Exchange Board of India (SEBI) regulations, securities with maturity of less than 60 days are amortised on a straight line basis to maturity from cost or last valuation price lending greater stability to the scheme NAVs.

The features such as no lock-in period, real-time credit of redemption amount in bank account, subject to certain conditions help allay concerns regarding liquidity for such schemes when compared to savings deposits.

"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," added Srinivasan.