The Accuracy of Agency Ratings

The external rating is an opinion of an independent external agency, which does not have a business interest or relationship with the borrower. The rating agency assesses the creditworthi­ness of the borrower or issuer based on a number of financial and non-financial aspects. Their role is to evaluate and quantify credit risks, within a context of effective benchmarking of risks across industries and countries. These metrics have evolved over a period and each rating agency has its own unique method of arriving at the credit rating. Credit ratings give investors/lenders an indication of a financial institution’s/borrower’s relative strength, the likelihood that it will default and fail to repay investors. It also enables the regulator to proactively monitor the shift in the portfolio risk positions over time. In India, investors as well as banks are questioning the validity of agency ratings since they are slow to react to market changes. The Infrastructure Leasing & Financial Services (IL&FS) crisis created a scare in the financial markets and short-term borrowings started drying up. This is threatening to turn into a contagion, with many non-banking financial companies (NBFCs) facing a liquidity crisis. A big name in the housing finance industry is now being seen as a defaulter which was in the investment category one year ago. A major NBFC was given AAA rating by some of the leading rating agencies which was, all of a sudden, downgraded by nine notches to BB (which is a non-investment grade [NIG]) when this infrastructure finance com­pany defaulted last year. It is, therefore, essential to specify the type of disclosures that credit rating agencies (CRAs) will provide so that the market participants can properly read their signals.

Corporate Risk Profile