Explain the significance of credit rating agencies in India and highlight the issues in their working.
Credit rating Agencies are corporate bodies registered under SEBI Act 1992. They work to provide ratings to corporate bonds, debentures, shares, etc. Credit rating is an assessment of the credit worthiness of a borrower, who can be an individual, corporation, etc.
- It provides credit ratings for bonds which enhances their uptake.
- Increases public confidence in debt investments like bonds.
- Provide extra-bank credit for the corporate sector through bonds.
- Helps in bond-market development. Reduces pressure on banks for long-term loans for infrastructure, etc, which creates NPAs.
- In India 7 credit rating agencies are approved by SEBI, like CRISIL, ICRA, CARE, FITCH, etc.
Their role, however, came under criticism due to their failure in giving liquidity forecasts for some firms.
Issues associated with their working:
- The bond issuer can choose the CRA for the bonds, which promotes rating-shopping.
- Conflict of interest, with other functions such as providing Consultancy Services to the firms, etc.
- Less competition in the rating market due to strict norms.
- The issuer of bonds can refuse to give certain information to CRA, which increases the dependence of CRA on market information and it leads to poor reports.
- CRAs are not rotated, hence a company can have long-term relations with the CRA.
Due to the significance of CRAs, it is necessary to regulate them properly. Increasing competition, providing for regulator-pay/customer-pay model, etc can be important steps.