A few days ago, an international agency, Moody’s, lowered the outlook for Indian banks from stable to negative. It says that the asset quality of Indian banks is deteriorating due to the loss caused by the coronavirus and that this plague is expected to occur in all sectors, including corporate, medium and small industry and retail. This will affect both capital and liquidity of banks. Moody’s also said that while public bank funding and liquidity may remain stable, smaller lenders may face the liquidity crunch due to the recent mess of a private sector bank (Yes Bank). After this announcement, there was a sharp decline in Indian bank stocks.
This is not the first time that Moody’s or any other rating agency has downgraded its ratings. Rating agencies often do this and sometimes it happens for no reason. It should be noted that the advice given by the Securities Exchange Board of India (SEBI), the regulator of the Indian stock market, was also ignored by Moody’s. SEBI said a three-month moratorium on principal and interest payments should not be considered loan default, and is only a short-term deal.
It should be understood that the downgrading of Indian banks’ ratings has not only caused upheavals in the stock market, but may also create more hurdles for banks recovering from the current NPA problem. It remains to be seen how the downgrading of the four banks – ICICI Bank, Indus Bank, IDBI Bank and Axis Bank – will impact the financial system.
Three major rating agencies—Standard and Poors’, Moody’s and Fitch—have a significant presence around the world. Standard and Poors’ and Moody’s are headquartered in the United States, while Fitch is headquartered in New York and London. They rate countries and financial institutions around the world. Based on their ratings, the interest rates on the debts contracted by these countries are determined. People’s trust in various financial institutions also depends on these ratings. Although these agencies assess the credibility of institutions and countries around the world, they themselves are not above suspicion.
Shortly before the 2008 financial crisis, these agencies were giving high marks to the financial institutions involved, and the world had no idea of their poor financial health. In such a situation, the credibility of these agencies was called into question. There have been several instances of their criminal errors in India as well. The role of audit firms is no less suspect. For example, a multinational auditing firm was hiding the frauds of the software company “Satyam” in India. The company has also been highly rated by rating agencies. This caused a huge loss to the country and the shareholders of the company.
Although the agencies lowered their ratings for financial institutions around the world due to the economic impact of the virus, critics believe these agencies had already overstated their corporate clients. That’s because they don’t usually do suo-moto reviews; companies pay them for ratings. Therefore, these rating agencies do not lower the ratings even after the deterioration of the financial situation of their customers for fear of losing customers.
The Financial Times wrote that in 2015, Standard and Poor’s acknowledged that it rated its clients high in order to win business. The agency paid $1.4 billion in compensation to the US government. In 2017, Moody’s paid $864 million in damages for a similar charge. These incidents expose the reality of these rating agencies.
Experts believe that despite the financial crisis of 2008, there has been no improvement in the functioning of these agencies. The fault is not primarily theirs; the fault lies with the system where companies are allowed to directly or indirectly pay the agencies, thanks to which they obtain high ratings. This issue is a conflict of interest.
It is also believed that investors make their investment decisions based on the ratings of these agencies. Now the situation is changing, and investors have also begun to study other parameters. But rating agencies still play a major role.
What is needed today is to limit the monopolistic powers of these rating agencies, so that the credibility of companies can be assessed accurately, avoiding conflicts of interest. Today, investors around the world are losing out on fake credit ratings, but the penalty imposed on these companies is far less than that. It is true that in many cases it is not possible for rating agencies to have complete information. But hiding the information received cannot be justified.
These rating agencies enjoy a monopoly worldwide, although they are mostly based in the United States. For this reason, the United States and its companies have also been found to score higher. Moreover, since all of the rating activity is in the hands of only three companies, the opportunities for abuse of monopoly powers increase. It is therefore important that these rating companies face competition.
More and more rating agencies need to be recognised. There is no shortage of talent in various countries. Why can’t India have its own rating agency? Similarly, different countries may have their own rating agencies. In such a situation, the monopoly of a few agencies will come to an end. At the same time, these rating agencies should have a system to earn money from the investors themselves. Companies should not be allowed to pay fees to these rating agencies.
Associate Professor, Department of Economics, PGDAV College (University of Delhi)
(Email: [email protected])