A credit rating is an expression of an opinion in a standardised form. And the rating assigned to a given debt shows the agency’s level of confidence that the borrower will honour the debt obligations.
Credit rating agencies are right to seek the intervention of the Securities and Exchange Board of India (Sebi) to resolve the confusion following the Reserve Bank of India‘s (RBI) new, stringent directive on ratings given on corporate loans. The directive says ratings on such loans can’t be notched up based on ‘guarantees’ and ‘letters of comfort’ to help group companies raise money and bargain a lower interest rate on the back of such support from parent companies. However, Sebi’s existing directive allows all these supports to lift the rating for non-convertible debentures. So, situations of the same issuer having a higher rating for non-convertible debentures and a lower one on a loan cannot be ruled out. Sebi and RBI must find a way to resolve this contradiction. Else, the Financial Stability and Development Council (FSDC) should resolve the turf tussle.
Almost 90% of the 50,000 debt ratings are reportedly on bank loans. Banks prefer rated loans due to a lower regulatory risk weightage on such assets that helps them save capital. A credit rating is an expression of an opinion in a standardised form. And the rating assigned to a given debt shows the agency’s level of confidence that the borrower will honour the debt obligations.
Legal due diligence is all very fine. However, RBI’s guidance also restrains rating agencies from deriving comfort from ‘obligor-co-obligor’ structures – common arrangements by infrastructure companies where multiple special purpose vehicles (SPVs) pool their cash flow to create a mechanism where funds of one SPV can be used to service the debt of another facing a cash crunch. RBI’s concern that such structures are still untested for delinquency is understandable. But stringent rules may indirectly kill the structured products market. That is wholly avoidable.