Opinion | A much-needed revamp for rating agencies

Opinion | A much-needed revamp for rating agencies

Article:

  1. 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

  1. 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.
  2. 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

  1. 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
  2. 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.
  3. 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

  1. Rating agencies should be compelled to divest from non-rating business.
  2. 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
  3. 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.
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