The role of credit rating agencies has been under the spotlight given the recent liquidity crisis that has hit the financial sector. While they can remain under pressure in the short-run given these developments, analysts remain optimistic on their long-term prospects. The optimism stems from the new set of guidelines set forth by the market regulator, which they believe, will tighten the weak links in their overall functioning and thus help in regaining the confidence from stakeholders.
Capital market regulator Securities and Exchange Board of India (Sebi) on Thursday introduced a “probability of default” mechanism to keep credit rating agencies (CRAs) in check. According to the new framework, rating agencies have to assign the default probability to each rated debt instrument, and disclose its benchmark by December-end. CLICK TO READ FULL REPORT HERE
The move holds significance given that it helps reduce recurrence of major default cases such as the Infrastructure Leasing & Financial Services (IL&FS) crisis, which brought rating agencies under the government’s and regulator’s lens.
IL&FS' commercial papers were downgraded from ‘triple A’ to ‘D’ (or, default grade) in just 40 days.
"Rating agencies are not important for cash-rich companies, i.e. those firms that have got huge cash in their balance sheet as they don't need borrowings and hence, don't need a rating backup. Heavy borrowers of funds need ratings and such borrowers - across the sector - will face a tough time, says G Chokkalingam, founder and managing director at Equinomics Research.
"The problem for them is repaying and for that they have to mobilise new money. But, due to the recent developments the confidence in these rating agencies has been shaken. So, in totality, the demand for service of ratings agencies in the short-to-medium term will be dull. Additionally, there will be some margin pressure as well, Chokkalingam adds.
In the past one year, stocks of all the listed players in the ratings segment have underperformed the benchmarks. For instance, CARE Ratings has slipped over 29 per cent whereas CRISIL has shed 19.5 per cent. ICRA, too, has fallen 11 per cent. In comparison, the Nifty50 index has risen 10 per cent while Nifty500 index has gained nearly 4 per cent during this period, ACE Equity data shows.
AK Prabhakar, head of research at IDBI Capital, suggests that investors, at large, have stopped trusting rating agencies given the turn of events in the banking and finance space. "The industry is undergoing a turbulent phase. Their revenue model is very simple - you rate it and you get money. Thus, I don't foresee their income scaling up in the near future," Prabhakar says.
However, it's not an end game as globally, too, credit rating agencies have faced question marks leading to the introduction of tighter norms. That said, analysts do not believe the rating agencies and the demand for their services will go out of fashion over the next few years.
"During the 2008 global financial crisis (GFC), global rating agencies drew a lot of flak. Post Lehman Brothers collapse, the credit rating concept itself faced a big question mark. But, given all the question marks, the pivotal role that credit rating agencies play cannot be ruled out. I think the new regulations is part of evolution process and will make the system more robust." explained Jagannadham Thunuguntla, senior vice-president and head of research at Centrum Broking.