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May 17, 2010
CREDIT RATING AGENCIES IN INDIA TOO ON THE SCANNER.
Credit rating agencies are organizations that rate the creditworthiness of a company or a financial product, such as a debt security or money market instrument. SEBI recently issued a 15-page circular on the disclosure norms relating to rating agencies (CRA) that have generally been welcomed. 'Be a Roman while in Rome' the saying goes. When we have integrated with the financial system globally, we need to see what reforms are round the corner in making assembly line credit flows to the corporates and SMEs more effective. CRAs attracted the ire of the investors in the context of the global financial crisis and the Securities Exchange Commission of US also went into the act of reforming them. The reforms were voted by the Senate recently.
One may wonder why this worries more now. As a result of the overall economy growing steadily to near 8 percent and the manufacturing sector consistently looking northwards, corporate credit is surging ahead. Non-food Credit increased by Rs.1167crores between March 26 and April 9, 2010 (see RBI Weekly statistical supplement dated 30 April 2010). India topped the global confidence index reflecting that the job scare and the financial concerns are things of the past. Soothsayers of the Stock Markets say that the volatility of the type we saw in yesteryears would also be a thing of the past and that the market correction for the high rise in the index by more than 500 points on a single day on 11th May 2010 may not be needed.
In the past, critics accused the ratings firms of being hotbeds of conflicts of interests. They are paid by the companies whose investments they rate. The raters often defend themselves by saying they are simply providing an opinion. The three big credit-rating firms -- Moody's, Standard & Poor's and Fitch Ratings -- have faced stinging criticism in the past two years for giving high marks to mortgage-related securities that were backed by subprime or otherwise risky loans, helping instill a false sense of confidence among investors in the investments being sold by banks. "These rating agencies were falsely elevated to some god-like status that when they put a triple-A rating on something, you could take all of your mother's savings and invest it in there and you were doing the right thing," said Rep. Paul E. Kanjorski (D-Pa.), the sponsor of the US-Bill to reform the Credit Rating Agencies. In the US, ratings were issued on collateralized and other structured products that were based on very limited performance data. The Chartered Financial Analysts did a global survey last year to confirm that the ratings are not useful instruments to take investment decisions. Although debt rating started late in India, and these rating agencies with their compatriots, CRISIL, ICRA etc., were only rating investments in the past, they are the most respected rating agencies recognized by the regulator, RBI even in India. Most Banks, which are wont to go by the advisory of the RBI, have now come to swear by them. Most Indian Banks also moved to template lending or Assembly line approach to lending through the Centralized Processing Platforms redefining their approaches to do due diligence of the enterprises they finance. Speed has become the essence of the game of competition among banks. Now that the futures markets and derivative markets have become more active than before, and their late entry into debt rating is more by patronage of the Banks and FIs it is important that the other regulator - RBI - also looks at the Report Card on rating agencies and resolve certain inherent conflicts.
SEC resolved to create a stronger, more robust regulatory framework for credit rating agencies. SEC adopted rules to provide greater information concerning ratings histories - and to enable competing credit rating agencies to offer unsolicited ratings for structured finance products, by granting them access to the necessary underlying data for structured products. May be that we look at what SEC did vs what SEBI did to see what more actions are required in the Indian context. A few salient features can be viewed by clicking here.
In India, the track record of the Rating Agencies may not have much to show up in favour or against them. However, one needs to know that these Rating Agencies that have been rating the investments and investors also started rating the debt instruments and the vendors of the rated companies, who are mostly the SMEs. None of the rating agencies reduced the ratings to any large industrial enterprise on the ground that they owe monies to their vendor SMEs for more than the contracted period for all payments of more than Rs.2lakhs as required under the Companies Act, 2000. The RBI should actually insist on different rating agencies for rating the Corporates and their related SME vendors. It is also desirable that the payment for rating agencies should come from the institutions that seek rating. It is a different matter if such amount is later recovered from the liability firm. The Credit Information Services are at a nascent stage having entered the business just a few months ago - with the exception of CIBIL that was set up during the first decade of the millennium. Transparency in client information is a long way to go as unshared data is more than the shared data both about individuals and institutions. In this scenario, the RBI also should consider issuing more detailed instructions on rating agencies, their ways of assessment, forms and reports in the public domain.
In essence, there should be a mechanism to evaluate the performance of Rating agencies. Further the method of payment also needs to be linked to the extent possible to evaluation. Their services have value but to what extent one should depend on their rating also needs to be quantified. There should be a recompense clause and the rating agencies should be made to compensate may be, not to the full extent, but by way of penalty for wrong ratings or variance in rating on a large scale.
Their rating performance over a period has to be made transparent for the benefit of investors and for every one connected to evaluate.
CRISIL perhaps deserves some compliments in this regard for its most recent report on the defaults of corporate entities on their debt obligations. Notwithstanding the growth figures in manufacturing sector unleashed by the CSO and the laudatory surveys of the CII and FICCI in that direction, the Report attributed the slow recovery of fundamentals of Corporate India in 2009 to the liquidity crunch and a slide in their overall credit worthiness. This leads us to question the efficacy of the stimulus package announced by both the Government and the RBI. It is time that the Banks go back to basics and do due diligence and seek support from the CRA just as yet another support for their credit decision until full scale reforms in credit information and credit rating take off in the financial sector.
Posted by rajubehara at May 17, 2010 05:19 PM
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