Overzealous Regulator

Credit ratings are a subjective opinion of the creditworthiness of a firm and its ability to repay its liabilities. The best of these ratings anywhere in the world are an informed, considered, logical and rational opinion based on assiduously examined facts and figures. But in the end, every credit rating cannot but be a subjective view of a group of persons and their perceptions of a company. This implies that just as a group of banks could study the financials of a firm and come up with different funding limits, credit ratings are subjective because of the different weightages agencies put on different factors affecting businesses. This subjectivity makes credit rating agencies difficult to regulate. And while Sebi can put up entry barriers in the industry and ensure that there is no mass proliferation of rating agencies, it will be near impossible to continue to police the agencies and the ratings it issues.

 

And as for plans to avoid a conflict of interest between agencies and their promoters, the three concerned promoters ICICI, IDBI and IFCI already ensure that their public issues are rated by more than one rating agency.

What Sebi can do is make the relationship between the agencies and their corporate clients more transparent. In the past, there have been many instances where firms, including some high-profile players like Bank of Baroda and Lloyds Finance, have switched agencies to get a better rating taking advantage of the competition between the rating agencies for bigger market shares. Sebi needs to ensure that a company rated by more than one agency is compelled to publicise all the ratings it has received. It should also be told to keep both ratings alive for at least five years by giving the same quantity and quality of information to both agencies. This will stop firms from changing the rating agencies at will if they are not happy with the rating given. The additional expenditure of paying for a second rating may also deter some firms from changing agencies.

This forced disclosure of all ratings will have a salient effect on credit rating agencies too. If companies are forced to display all their ratings, credit rating agencies will be more circumspect when it comes to building business volumes by promising better ratings. This is because the market will begin to discount some ratings and not accept them at face value if they see that one agency consistently gives higher ratings than its competitors. But what is more imperative than trying to regulate rating agencies is for Sebi to convince retail investors that ratings are only one of the criteria to examine before investing in an instrument and not the sole criterion.