The new regulations, which would end the practice of backing a corporate borrower’s credit rating on the back of mechanisms such as a “comfort letter” or “commitment letter” from the company or of its promoter or its parent company, comes into force from the end of January 2023.
Thus, in the last quarter of the financial year, many loans granted by banks may suffer a downgrade of at least one notch, forcing them to set aside additional capital because a lower rating means a higher risk weight. on a loan. According to banking regulations set by the RBI, a bank’s capital requirement increases with the increase in the number of “riskier” loan assets on its books.
According to RBI, some schemes aimed at raising ratings – and therefore reducing the cost of interest on loans – are “diluted or non-prudent support structures” which, unlike watertight collateral, cannot be legally enforced in the event of default. This exposes banks to greater risks.
“While this is understandable and we cannot question the wisdom of the regulator, the transition would be less disruptive if we had more time. Rating reviews can occur over the course of a year when many loans would be In addition, borrowers and rating agencies can determine whether, in the absence of, say, a letter of comfort, a downgrade can be avoided with more assurance. About a month ago, IBA ( Indian Banks’ Association) had filed an application on behalf of the (banking industry),” a senior banker told ET.
“We haven’t heard anything from RBI. But usually RBI doesn’t respond. If they make a decision, they can announce it closer to the deadline,” another banker said.
While RBI has given rating agencies six months – from July 26, 2022, the date of its CEO statement to rating agencies – to downgrade or withdraw the ratings, the banks believe such a measure should only be introduced. over the next fiscal year. Especially since due to the divergence of views of the two financial market regulators – RBI and the Securities & Exchange Board of India – and the anomaly it could cause: Sebi not insisting on stopping In some “credit enhancement” support structures, a bank loan (covered by RBI regulations) would have a lower rating than a debenture or bond (issued under Sebi rules) by the same borrower.
WHY NOT HIGHER RISK WEIGHTINGS FOR CHALLENGING COMPANIES?
“While this is a significant issue, the rating agencies have a bigger issue to deal with, and it is uncooperative borrowers. This is an issue they have discussed with IBA as it would require the backing of banks,” an official at the ratings firm said.
Rating agencies believe that the risk weighting on bank loans to these provocative borrowers should be increased or even doubled.
The refusal of many companies to share data leads to a situation where agencies score them on the basis of inadequate information – which would not fully capture a borrower’s financial health and ability to repay a loan – or stop rating them altogether. write them down.
But, in many cases, companies and banks have little deterrence when ratings are withdrawn. Indeed, the risk weighting of an “unrated” borrower (at 100%) is lower than the rating (150%) of a “sub-investment grade” borrower (with a “double B” rating).
With a capital adequacy regulation of 9%, a bank lending, for example, ₹100 crore to a company with a risk weight of 100%, will need a minimum capital of ₹9 crore; however, the minimum capital requirement increases to ₹13.5 crore for the same loan amount when the risk weight on the business reaches 150%; and, at ₹18 crore when the risk weight is higher at 200%.
“In several cases, companies that are reluctant to cooperate with rating agencies are in the sub-investment grade category with borrowings of ₹100 crore or less. For them as well as the banks that lend them, an unrated loan is better than one There are good reasons for the RBI to increase the risk weight on unrated loans to 150% or even 200% This would also push banks to incentivize borrowers to get a rating and share data with rating companies,” another industry official said.