Credit Rating Agencies (CRA) become the focal point of criticism after every financial crisis. Discuss the issues with respect to CRA’s functioning and suggest measures to regulate them. (200 words)
Refer – The Hindu
Enrich the answer from other sources, if the question demands.
IAS Parliament 7 years
KEY POINTS
· Despite their vital role in the global financial world, rating agencies often failed to inspire confidence in markets and among nations.
· Rating agencies are accused of having failed to predict the 1997 Asian financial crisis and then for overly under-rating them when the event unfolded.
· Such agencies have been subject to a range of lawsuits, especially after Enron’s collapse and during the recent subprime mortgage crisis in the U.S.
· Recently, the relegation of Greece, Portugal and Ireland to “junk” status is said to have lead to a sovereign-debt crisis in these countries.
Issues with CRA’s functioning
· Inconsistencies – In India, ratings have had a mixed record and SEBI had to intervene in some cases, investigate and tighten rules and disclosure norms for agencies.
· For example, there is a lack of due recognition for India’s economic achievements in most reports of foreign based ratings.
· Notably, such inconsistencies have led to moves by Russia and China to set up their own ratings agencies to provide better information to investors.
· Conflict of Interests – Most rating agencies generate a significant portion of revenues through non-rating activities, which makes them structurally flawed.
· Despite maintaining an iron curtain between their rating and non-rating businesses, common management gives ample scope for conflict of interests.
· Numerous studies have showcased that rating agencies seek to provide issuers, with non-rating services, along with potentially influencing a higher rating.
Solutions
· The services offered by rating agencies are indeed crucial in the market and hence we too need to nurture strong indigenous rating agencies.
· But we also need to place multiple safeguards to minimise market distortions, by ensuring greater supervision over anomalous upgrades or downgrades.
· Corporates can be mandated to change rating agencies on a regular basis and “issuer-pays” model needs to change to an “investor-pays” model.
· Also, SEBI can explore options to bar credit rating agencies from providing non-rating advisory services.
· Above all, government fiscal decisions should not be skewed towards chasing ratings and rather be focused on employment generation and innovation.
