Introduction

• From recent the IL&FS crisis, it is evident that credit rating agencies failed to warn investors about the forthcoming risk.
• The SEBI has issued guidelines to credit rating agencies to improve the quality of their disclosures.

Do you know?

Credit Rating  

• Credit rating is an assessment of the probability of default on payment of interest and principal on a debt instrument.
• These debt instruments can be in the form of Bond, Commercial Papers or treasury bills, etc.

Credit Rating Agencies

• A credit rating agency is an entity which assesses the ability and willingness of the issuer company for timely payment of interest and principal on a debt instrument.
• The rating is assigned to a security or an instrument. The Credit rating agencies are regulated by SEBI.

New norms

• Based on the new norms issued by the SEBI, the credit rating agencies will have to inform investors about the liquidity situation of the companies such as their cash balance, liquidity coverage ratio, access to emergency credit lines, asset-liability mismatch etc.
• Further, rating agencies will have to disclose their own historical rating track record by informing clients about how often their rating of an entity has changed over a period of time.

Concerns to be addressed

• A lot of the problems with the credit rating industry have to do with structural issues rather than the lack of formal rules.
• The “issuer-pays” model where the entity that issues the instrument also pays the ratings agency for its services often leads to a situation of conflict of interest.
• The credit rating market in India has high barriers to entry leading to lack of competition and hence adversely affects the interests of the investors.
• Better disclosures can increase the amount of information available to investors, but without a sufficient number of alternative credit rating providers, quality standards in ratings will not improve.
• Another severe problem plaguing the industry is rating shopping and the loyalty of credit rating agencies in general. In other words, it favours Borrowers over investors.

Conclusion

• While rating agencies already make at least some of these disclosures one way or the other, mandating the formal disclosure of these facts is still welcome. The ready availability of information can help investors make better decisions.
• The Credit rating agencies have to come up with lucrative business models which put the interests of the investors above the interests of borrowers.
• Such a change requires a policy framework that allows easier entry and innovation in the credit rating industry.