A few days ago an international agency, Moody’s, downgraded the outlook of Indian banks from stable to negative. It says the quality of assets of Indian banks is deteriorating due to the loss caused by the coronavirus and this blight is expected to happen in all sectors including corporate, medium and small industries, and retail. This will affect both the capital and liquidity of banks. Moody’s has also stated that though funding and liquidity in state-owned banks may remain stable, small lenders may face the crisis of liquidity due to the recent mess in a private sector bank (Yes Bank). After this announcement, there was a sharp decline in shares of Indian banks.
This is not the first time that Moody’s or any other rating agency has dropped ratings. Rating agencies often do this and sometimes it happens without a reason. It has to be noted that the advice given by the Securities Exchange Board of India (SEBI), India’s stock market regulator, has also been ignored by Moody’s. SEBI said a three-month moratorium in principal and interest payments should not be considered as default in loan repayment, and it is only a short-term arrangement.
It has to be understood that the downgrading of the rating of Indian banks has not only led to upheaval in the stock market,but may also create more hurdles for banks recovering from the ongoing NPA problem. It remains to be seen how the downgrade 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 significant presence in the world. Standard and Poors’, and Moody’s have headquarters in the US, whereas Fitch is headquartered in both New York and London. They rate countries and financial institutions around the world. Based on their ratings, the interest rates on the debts taken by these countries is determined. People’s trust in various financial institutions also depends on these ratings. While these agencies rate the credibility of institutions and countries around the world, they themselves are not above suspicion.
Shortly before the financial crisis of 2008, these agencies were giving high ratings to the financial institutions involved, and the world had no idea about their poor financial health. In such a situation, the credibility of these agencies was questioned. There have been several instances of their criminal errors in India as well. The role of audit firms is no less suspicious. For instance, a multinational audit firm was hiding the frauds of the software company ‘Satyam’ in India. The company was also highly rated by rating agencies. This caused a huge loss to the country and the company’s shareholders.
Although agencies have lowered their ratings for financial institutions around the world due to the economic impact of the virus, critics believe these agencies had already overrated their client companies. This is because they generally do not make suo-moto ratings; companies pay them for ratings. Therefore, these rating agencies do not drop ratings even after the deterioration of the financial condition of their clients due to fear of losing customers.
Financial Times wrote that in 2015, the Standard and Poor’s conceded that they had been rating their clients high in order to win business. The agency paid a compensation of $1.4 billion to the US government. In 2017, Moody’s paid damages of $864 million 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 pay the agencies directly or indirectly, due to which they get high ratings. This issue is of a conflict of interest.
It is also believed that investors make their investment decisions based on the ratings of such agencies. Now the situation is changing and investors have started investigating other parameters as well. But rating agencies still play a major role.
What is needed today is to curb the monopolistic powers of these rating agencies, so that the credibility of companies can be accurately assessed, preventing conflict of interest. Today, investors around the world are losing out due to false credit ratings, but the penalty on these companies is much less than that. It is true that in many cases it is not possible for rating agencies to have complete information. But hiding information received cannot be justified.
These rating agencies enjoy a monopoly all over the world, though they are mostly US-based. For this reason, it has also been seen that the US and its companies get better ratings.Not only this, since the entire rating business is in the hands of only three companies, the possibilities of misuse of monopoly powers increase. Therefore it is important that these rating companies face competition.
More and more rating agencies must get recognition. There is no dearth of talent in various countries. Why can’t India have its own rating agency? In the same way, different countries can have their own rating agencies. In such a situation the monopoly of a few agencies will end. At the same time, these rating agencies should have a system of earning money from investors themselves. Companies should be disallowed to pay fees to these rating agencies.
Ashwani Mahajan
Associate Professor, Dept of Economics, PGDAV College (University of Delhi)
(Email: ashwanimahajan@rediffmail.com)