RBI raises concerns about companies shopping around for favourable ratings

Non-disclosure of indicative ratings by agencies makes it difficult to identify such instances, according to the FSR

The Reserve Bank of India’s (RBI’s) Financial Stability Report (FSR) has raised concerns about rating shopping among companies.

This comes against the backdrop of instances of indicative ratings given by agencies, for which there are no written agreements. The indicative ratings are also not disclosed on the company websites.

“Since such ‘indicative ratings’ are not disclosed by CRAs (credit rating agencies) on their websites, it becomes difficult to identify instances of possible rating shopping,” said the FSR, a bi-annual report released by the RBI on Friday.  “The issue of possible rating shopping behaviour on the part of obligors clearly requires serious attention.”

Corporate executives do not agree to such an assessment.

“I strongly disagree with this assessment. After the IL&FS (Infrastructure Leasing & Financial Services) crisis, the rating agencies have become very cautious about rating assignments and sometimes the ratings assigned are very unfair and does not go with the fundamentals of the company,” said the chief financial officer of a mid-sized company.

According to another corporate executive, the rating committees have people with no experience of corporate business and they insist on a lower rating, being fearful of the regulators. The recent probes on rating agency executives have sapped the moral of the rating committees. Many rating agency executives did not want to comment. One executive said the number of companies considered in the report is too small, and can be explained by risk assessments methodology varying from one rating agency to another.

Some instances of such rating shopping can still be ascertained, according to the FSR, by looking at the dynamics around rating withdrawals where outstanding rating issued by a CRA was withdrawn and a new rating was provided by a different CRA.

The FSR said such new ratings were obtained within three months of each other; and in more than two-thirds of the cases new ratings were provided before the withdrawal of the old ones. This practice has been going on since April 2016, the FSR said.

For long-term bank loan ratings, which is used by banks for credit screening, it was observed that the screening mechanism adopted by investors in short-term instruments had a significant dispersion in the pricing of assets of equivalent tenor after accounting for all relevant factors with the same ratings.

“This implies that these investors must be adopting additional credit screening mechanisms apart from obligor rating during credit selection,” the report said.

“Clearly, for ratings that are withdrawn, the new ratings assigned are either the same or an improvement over the earlier ratings. Although replacement of withdrawn ratings by better or similar ratings by a different rating agency is visible across all rating grades, such instances are particularly pronounced at BBB and below ….” the FSR said. There are only nominal cases where withdrawn ratings were better than the assigned ratings.

The BBB and below category is where most of the Indian companies reside.

‘This is particularly relevant as some of the rating agencies have a much greater share in ratings assigned compared to their share in ratings withdrawn,” the FSR pointed out.

However, considering the rated companies number around 40,000, such rating shopping are only a small fraction of the rated universe and “may not make the external ratings based capital adequacy framework infructuous,” the FSR said.