Heavy Load on Mutual Funds

Mutual funds in India have a tall hurdle to cross. The Securities Exchange Board of India (SEBI) wants the net worth of companies that manage mutual funds to be five times larger than it currently is. Recently, the sub-group headed by Roopa Kudva, managing director and chief executive officer of credit rating agency CRISIL, has recommended that the net worth requirements of asset management companies (AMCs) be increased to Rs. 50 crore from Rs. 10 crore. According to the committee, this will signal the AMC’s seriousness of intent in setting up the business, and also bear the AMCs initial losses without facing serious financial strain.

The Issue
Naturally, this has not gone down well with AMCs having a low capital base. They fear these norms favour big mutual funds that are part of the committee and can easily meet the net worth requirement of Rs. 50 crore. The SEBI group, on its part, feels that a net worth requirement of Rs. 50 crore is just 0.33 percent of Rs. 15,000 crore, which is the average capital under management for Indian mutual funds. Hence, although the new norms will hurt small players, this number is not high enough to deter serious contenders.

Our Take
An AMC is not like a bank. A bank is in the business of taking and lending deposits. If the borrowers default then the bank has an obligation towards the deposit holders. An AMC works differently. It simply collects funds and buys stocks. If people want their money back, it can sell the stock and return the money. Investors in mutual funds know that the value of their investment can decrease. One key logic behind the SEBI proposal is that a higher net worth will enable AMCs to be better placed to obtain liquidity lines from banks, in case they suddenly need to draw cash to meet investor redemptions. This may not be the case.

At Rs. 50 crore net worth, the mutual fund will perhaps get a Rs. 80 crore short term credit line from the banks. In reality, this is of very little use because a fund might have raised and deployed anywhere between Rs. 500 to Rs. 1,000 crore in the market. The recent crisis has shown that even the best run bank with the highest capital reserves cannot withstand a run without government guarantees. If customers lose confidence in a mutual fund scheme, even a net worth of Rs. 100 crore will be insufficient to stem the tide of customer redemptions. The cost of starting and managing an AMC is very low worldwide. The SEBI sub-group appointed for this task itself states that in the USA, an AMC can be started at as low as $100,000. In the Euro Zone, AMC capital is linked to assets under management.

Indian AMCs need a healthy environment to compete. Competition should be encouraged by allowing all kinds of players to get into the AMC market, else it will lead to a situation where three to four AMCs will dominate the entire mutual fund market and this will be a huge disservice to the investors. Thus, instead of concentrating on net worth criteria for AMCs, it is important to concentrate on investor protection and risk management systems without hurting the spirit of competition.