Opinion | A much-needed revamp for rating agencies
Article:
- The article discusses the issues with credit rating agencies in the backdrop of the recent IL&FS crisis
Important Analysis
Credit ratings and Credit Rating agencies
- Credit ratings provide retail and institutional investors with information that assists them in determining whether issuers of bonds and other debt instruments and fixed-income securities will be able to meet their obligations.
- the credit rating agencies (CRAs) by issuing “grades” provide objective analyses and independent assessments of companies and countries that issue such securities.
Issues with Credit Rating Agencies
- Conflicts of interest from non-rating business: When CRAs have other non-rating businesses that they are marketing to the same corporates who they are rating, there is conflict of interest and concern over impartiality of credit quality
- Issuer-pay model: The rating agency acts as seller trying to entice the buyer (the borrower) into buying its rating service and thus the impartiality is highly questionable.
- Over-reliance on ratings in regulations: The main source of power for the rating agencies is over-reliance on ratings in regulations. For example, the Basel capital adequacy norms allow banks to decide on their capital allocation based on loan ratings. Note: India has adopted the Basel Capital adequacy norms
Solutions
- Rating agencies should be compelled to divest from non-rating business.
- The regulator (RBI or SEBI) should select the rating agency and not the company. Further, steps should be taken to ensure transparency and impartiality in the rating process
- To curb over-reliance on ratings, alternatives to ratings should be provided. For example, banks should have a minimum amount of capital based on the total assets, and not just on risk-weighted assets. This will reduce the importance of ratings for bank capital.