New Delhi: The official support measures announced for mutual funds in India may struggle to be effective, as under-capitalised banks are unlikely to be tempted to extend liquidity to the sector without capital relief on the facilities, said Fitch Ratings.

The announcement follows the implementation of support facilities in multiple jurisdictions in 2020 to date, highlighting global regulators' focus on providing liquidity support to financial markets during the coronavirus pandemic.

The Reserve Bank of India's (RBI) Rs 50,000 crore ($6.6 billion) Special Liquidity Facility for Mutual Funds (SLF-MF) will provide 90-day repo funding to banks, to extend liquidity to - or purchase commercial paper and debt securities from - local mutual funds.

This followed the suspension of redemptions (gating) in six Franklin Templeton bond funds, with combined assets under management (AUM) of approximately $4.1 billion equivalent, on April 23, 2020, and outflows from other funds in March 2020. The scheme will be available from April 27, 2020 to May 11, 2020, or until its funding is exhausted.

The success of the SLF-MF will hang on banks' appetite to take up the risks involved, against the system-wide backdrop of low capital headroom and a likely increase in fresh non-performing loans. The facility's structure places the onus on banks to absorb the associated credit and capital risk, which may hinder their willingness to participate.

If the SLF-MF does not achieve its aims of supporting liquidity or restoring market confidence, Fitch believes more fund gatings could occur. Indian open-end mutual funds saw aggregate outflows of almost 20 per cent in March. Within this, overnight funds, the most conservative variant in India, saw assets jump by almost 50 per cent, whereas most other fund types saw outflows.