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Credit rating industry

Kashmir Times. Dated: 11/17/2018 1:23:10 PM

Financial and structural reforms are required to be carried out to bring accountability to the credit rating industry

The BJP-government appears to have been caught off guard on the issue of credit rating of various public and private companies in the country, which has faced the heat due to failure of some of the private entities. As a result of this careless handling of some companies, the public money has gone down the drain creating a crisis for the investors and creditors, which had extended loans to private companies without taking into their working. It is unfortunate that the public money from the banking institutions and investors has been gobbled up by the management having no accountability to the people. In the absence of any credible monitoring of such private companies, the banks and private investors have lost their hard-earned money for no fault of theirs. It is now that after the Infrastructure Leasing &Financial Services (IL&FS) crisis, the Securities and Exchange Board of India (SEBI) is trying to increase the level of scrutiny on credit rating agencies that failed to warn investors about it. The SEBI has now come out with new guidelines to improve the quality of disclosures made by credit rating agencies mainly about the Indian companies. The new norms have suggested that the credit rating agencies will have to inform investors about the liquidity situation of the companies they rate through parameters such as their cash balance, liquidity coverage ratio, access to emergency credit lines, asset-liability mismatch, etc. Moreover, the credit rating agencies will have to disclose their own historical rating track record by informing clients about how often their rating of an entity has changed over a period of time. Besides this, the credit rating agencies will also have to take into account the functioning of the companies with their track record spanning over a decade or so. The SEBI has been working hard to improve transparency and credibility among rating agencies for some time now, including through a circular issued two years back calling for enhanced standards for rating agencies. The credit rating agencies already have a mechanism to make at least some of these disclosures one way or the other, but making the formal disclosure of these facts mandatory is welcome. The ready availability of information can help investors make better decisions about the companies. It has been felt for a long time that like the case of IL&FS, the information about its working and balance sheets may be put in the public domain for the information of the investors. It will also allow the investors to monitor the health of the companies after they have been advanced loans.
Apart from this, it is worth noting that the latest guidelines and regulations can help to some extent because a lot of problems with the credit rating industry emanate from structural issues rather than the lack of codified rules. Firstly, the flaw is 'issuer pays' model where the entity that issues the instrument also pays the credit rating agency for its services. This flaw leads to a situation of conflict of interest with a lot of potential for biases in rating. Secondly, the credit rating market in the country has numerous barriers to entry, which keep the competition at a distance which is important to protect the interests of the investors. It is also noteworthy that this is not very different from the cases in many developed economies where rating agencies enjoy the benefits of good and credible working. It is important that better disclosures can increase the amount of information available to investors but without a sufficient number of credit rating providers standards in rating are unlikely to improve. In the background of such working, it is not surprising that even after repeated failures for a pretty long time in their history, the credit rating agencies continue to stay put and flourish in business. The structural reforms should be aimed to solve another severe problem plaguing the industry, which has to do with rating shopping and the loyalty of credit rating agencies in general. The credit rating agencies will have to come up with lucrative business models that put the interests of investors above those of borrowers. This change requires a policy framework that allows easier entry and innovation in the credit rating industry and the government agencies have to facilitate such a change over.