A new threat emerged for rating agencies with thousands of rated entities not willing to cooperate with rating agencies. Collectively credit rating agencies (CRAs) like Acuité, Brickworks, Care, Crisil, Icra, etc. have rated 40,000+ entities, which are supposed to remain live today. A recent report, quoting Prime Database , claims more than 50 percent of all ratings are flagged 'INC' (Issuer Not Cooperating). Such ratings cannot be used for lending decisions or capital requirement purposes at banks as they are merely based on public information.
This is set to cause serious damage to India's financial system and capital market infrastructure.
What is non-cooperation by issuers?
A rating exercise involves continuous monitoring of everyday changes, which is called 'surveillance'. During the surveillance process, when new information arrives or the factors impacting the rating change, a need for a 'review' is triggered. The 'review' is a complete relook at the rating considering current factors at play.
Under the credit rating agreement, apart from fees, the borrower is obligated to provide all information—financial and non-financial along with management actions—to the rating agency on demand, till the rating and the rated debt remain alive.
This process can break due to two reasons. First, when the rated entity doesn't pay the annual surveillance fees to cover the cost of surveillance and periodic 'review', and second when the rated entity refuses to share information. Usually, non-cooperation leads to both.
Are there perverse incentives to not avail ratings?
It may be noted that a vast majority of these ratings are for bank facilities used by banks to arrive at capital requirements under Basel norms. While banks also have their internal rating models, such systems work better when benchmarked with external credit ratings, particularly in cases of overriding calamities, complex structures, or unique industries.
Since January 2019, we are seeing an alarming trend of large banks waiving off the requirement of credit rating in many cases. If a borrower's external rating is lower than BBB-, it's difficult for the bank to offer low-cost loans to such entities. Presumably, therefore, not having a rating acts as an incentive for borrowers and offers more degrees of freedom to bankers. Therefore, without a push from the bankers, borrowers happily renege from their obligations in the rating agreement.
What is at stake?
Giving low-cost loans to high-quality borrowers is not economically viable unless low-quality borrowers are charged a premium for being high risk. We may also see an unexplainable rise in rejection of loan applications in absence of a rating report as bankers start avoiding risk-taking.
Information availability in India is very low while, information asymmetry is very high, whereby the borrower and the lender have a different set of information to base their decision. This leads to an inefficient market. With more complex structures introduced in various debt instruments and the vast majority of investors, relying on tips and rumours, the system is prone to exploitation. Rating opinions of CRAs address this challenge.
Even if one ignores the value addition done by the rating agencies and goes by the sheer number of companies where basic information is made available, it's easy to infer that India's credit rating framework has brought out 35000+ hitherto 'unknown' companies. India's capital market is shallow and barely 5000-6000 companies access the same. Credit ratings have provided an opportunity for an additional 35000 companies to prepare themselves for accessing capital markets. It has provided researchers with quality information to analyse sectors and trends in the economy.
What is the way ahead?
Regulators, RBI and SEBI, have put in a lot of efforts to make rating agencies more transparent and accountable and will continue to push the envelope further. In this scenario, it is only reasonable to make external credit ratings complement the internal rating and appraisal system of the banks which will only strengthen both the systems.
Also, the convention of calling certain ratings 'non-investment grade' may be done away with. This poses a huge problem for the borrowers by closing all doors implying untouchability. Instead, banks should charge commensurate interest premium to such accounts. It may be noted that the bulk of the borrowings in developed nations like the USA is by such 'non-investment' grade issuers and they can access the capital market.
The banks, regulators, and rating agencies must come together to ensure that the established rating framework is not rejected altogether since it is the only tool to deepen and create an efficient capital market and provides an excellent opportunity for borrowers to prepare for that.
Finally, however, the buck stops with the rating agencies in making sure their services are valued by borrowers and lenders alike by being unbiased, incisive, and objective in their work.
—Sankar Chakraborti is CEO—Acuité Ratings & Research. The views expressed are personal
