Ratings Agencies Cannot Be Trusted...

Thu, 8 Sep Pre-Open

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Ratings agencies in the past few years have been in the limelight for the wrong reasons. First, there have been cases where rating firms have differed widely with respect to ratings assigned to the same company. The ratings companies have also failed in ascertaining the potential repaying capacity of the borrower resulting in huge downgrades in a very short span of time. These incidents have posed a question mark on the efficacy of these ratings that the companies carry.

Remember the case of Amtek Auto which exposed the limitations of credit rating companies in warning the debt investors against a possible default. CARE had rated Amtek Auto's non-convertible debentures as AA (Double A) in April 2015, which was changed to AA- (Double A Minus) in May 2015 citing decline in financial performance of the company. However, very conveniently the ratings agency then suspended the coverage of the firm citing noncompliance from the company with regards to sharing its data with the ratings agency in August 2015. The question to be asked under these circumstances is what was CARE doing all that while? Why weren't the ratings downgraded to reflect uncertainties surrounding the company? In fact, not just CARE but CRISIL too failed to forewarn about the impending default by the company. This was not just a one off case, Jindal Steel and Power ltd, Bhushan Steel and even Ricoh India are companies which the credit assessors failed to foresee adverse changes resulting in losses to all the stakeholders involved.

Market regulator, Securities and Exchange Board of India (SEBI) reportedly has launched a probe against these rating firms with regards to the ratings provided to companies which defaulted. The impact of these faulty ratings were felt even by large mutual fund houses like Franklin Templeton which had a large exposure to Jindal Steel and Power Ltd and had to face the heat with customer redemptions of its debt fund.

The main problem with the ratings agencies are that there is an inherent flaw in how the ratings are carried on, there is a huge conflict of interest since these rating companies are paid by the organization whom they rate.

These events have made extremely important for the regulator to step in and introduce tougher norms for ratings agencies. There is also a need for higher accountability, credit rating firms should be held accountable for their actions. Should all the blame be passed on to these ratings firms then? That would be unfair. However, as they are a first line of defense for someone who bases their decisions on the ratings published, the ratings firms definitely are expected to be more accurate and timely with their ratings.

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