RBI Criticizes Credit Rating Firms

Credit rating firms got beneath harsh critique from the Reserve Bank of India (RBI) for failing to distinguish financial difficulties in several companies, particularly in the matter of IL&FS.

In a conference with prime credit rating officials on Thursday, central bank governor Shaktikanta Das and the deputy governors worded solicitudes over rating agencies’ incompetence in evaluating credit risk and taking timely rating actions, said people who accompanied the meeting.

“RBI said that ratings are deemed to be forward-looking, but they are always a laggard,” said one of the people cited above. The central bank is said to have told credit rating officials that the sudden rating declines in recent months have damaged investors and banks.

Credit Rating agencies have been scrutinized for being delayed in recognizing the tension in the IL&FS Group, which defaulted on its loans from banks, mutual funds, and provident funds. Various debt mutual fund projects saw depletion in their net asset values, or NAVs, because of the defaults. The crisis soon expanded to other non-banking finance corporations — principally housing finance — which has been fighting to sort out their asset-liability mismatches.

“RBI said one-third of the entire NPAs (non-performing assets) in the system derived from investment-grade ratings,” said one of the persons quoted above.

Total stressed assets are nearly Rs 12 lakh crore in the banking system. Das was worried over the “conflict of interest” in the country’s credit rating agencies, the person said. Globally, rating agencies restrict themselves to ratings and analysis related to credit ratings. All other trades like market research, training, risk solutions are carried out under separate entities with no common directors, employees, and shareholding from the rating entity.

In India, the same rating agency rates and provides estimate opinions to the same set of securities to investors like mutual funds and provides consulting services.

“In many cases, the business origination employees are also common. In RBI’s opinion, this is the disagreement of interest and RBI is examining at proper regulations to discuss this issue,” said one of the persons cited above.

The central bank governor opposed the tradition of “rating shopping”— where companies relocate from one rating agency to another for high-grade ratings. “RBI was also worried about issues such as rating agency CEOs being part of rating committees and rating advisors who ensure favorable ratings to an issuer due to their relationship with rating firms,” said the second person cited above.

RBI is investigating the affair, and along with Sebi, it will bring out commands to approach this, the person said. Though credit rating firms are recorded with the capital market regulator Sebi, they are mutually monitored by both Sebi and RBI as these firms rate bank loans which comprise 70% of their business.

On short-term tools like commercial paper, RBI believes that the ratings do not show the pricing these papers command.