Saturday, June 11, 2011

Credit Rating Agencies and SME sector in India

B. Yerram Raju*

Credit rating agencies (CRA) are organizations that rate the creditworthiness of a company or a financial product, such as a debt security or money market instrument. CRAs attracted the ire of the investors in the context of the global financial crisis and the Securities Exchange Commission of US also reformed them after long debates in the Senate. Alive to such ongoing debates, SEBI’s disclosure norms relating to rating agencies in 2010 received wide appreciation. These would apply to corporate credit ratings. When we have integrated with the financial system globally, we need to see what reforms are round the corner in making assembly line credit flows to the corporates and SMEs, more effective.

Lakhs of crores involved in scams notwithstanding, the economy is on the growth trajectory clocking 8.25 percent growth with a seesaw growth in manufacturing sector. Micro, Small and Medium Enterprises have a special dispensation at the hands of the regulators and there is a Ministry at the Centre dedicated to this sector to ensure its development mainly because of its potential to contribute to the job growth and growth of the economy. Growth of this sector always outstripped the growth in manufacturing sector. After redefining the sector in the MSME Development Act 2006, there is enough evidence to show that Banks moved to medium enterprises swiftly. SIDBI, the Bank dedicated for micro, small and medium enterprise credit also moved to medium enterprise credit and totally ignored the micro and small enterprise credit. Equating micro finance with finance to micro and small enterprises is a fallacy. RBI’s published statistics for 2009-10 show that the variance in credit outstanding to the MSE is 22.1% and medium enterprises is 8.6%. The Banks seemed to have hurriedly corrected their portfolio in this area in 2010-11: MSE credit has fallen to 11% and medium enterprise credit increased from earlier 8.6% to 39.2%. This could mean two things: there is migration of the small sector to medium sector – and if it happens, it is the best thing to happen for the economy. The other, Banks started distancing from the micro and small, because lending to them involves higher transaction costs and greater supervision. This is not good for the economy, as these are the seedbeds of entrepreneurship and employment. Medium enterprise credit is rating driven, thanks to the Basel norms.

The Chartered Financial Analysts did a global survey in 2009 to confirm that the ratings are not useful instruments to take investment decisions, irrespective of who delivers Fisch, Moodys, Standard & Poor etc. Although debt rating started late in India, and these rating agencies with their compatriots, CRISIL, ICRA etc., were only rating investments in the past, they are the most respected rating agencies recognized by the regulator, RBI even in India.
Most Banks, which are wont to go by the advisory of the RBI, have now come to swear by them. Most Indian Banks also moved to template lending or Assembly line approach to lending through the Centralized Processing Platforms redefining their approaches to do due diligence of the enterprises they finance. Speed has become the essence of the game of competition among banks. Now that the futures markets and derivative markets have become more active than before, and their late entry into debt rating is more by patronage of the Banks and FIs, it is important that the other regulator – RBI- also looks at the Report Card on rating agencies and resolve certain inherent conflicts. The Credit Information Services are at a nascent stage, CIBIL being the first to start such service with collaboration from Dun & Bradstreet and many commercial banks. Transparency in client information is a long way to go, as unshared data is more than the shared data both about individuals and institutions. In this scenario, the RBI also should consider issuing detailed instructions on rating agencies, their ways of assessment, forms and reports in the public domain. In any case, it is desirable that until the credit information repositories scale up in size and efficiency in providing the required data to reduce the information asymmetry, the rating instrumentality application to the SME sector has to be put on a low key.
In India, the track record of the Rating Agencies may not have much to show up in favour or against them. There is no evidence of any of the rating agencies reducing the ratings to any large industrial enterprise on the ground that they owe monies to their vendor SMEs for more than the contracted period for all payments of more than Rs.2lakhs as required under the Companies Act, 2000. The RBI should actually insist on different rating agencies for rating the Corporates and their related SME vendors. It is also desirable that the payment for rating agencies should come from the institutions that seek rating. It is a different matter if such amount is later recovered from the liability firm.
In essence, there should be a mechanism to evaluate the performance of Rating agencies. Further, the method of payment also needs to be linked to the extent possible to evaluation. Their services have value but to what extent one should depend on their rating also needs to be quantified. There should be a recompense clause and the rating agencies should be made to compensate may be, not to the full extent, but by way of penalty for wrong ratings or variance in rating on a large scale. Their rating performance over a period has to be made transparent for the benefit of investors and for every one connected to evaluate.
It is time that the Banks go back to basics and do due diligence and seek support from the CRA just as yet another support for their credit decision until full scale reforms in credit information and credit rating take off in the financial sector.
------------------------------------------------------------------------------------------------------------*Dr.B. Yerram Raju is an economist and Regional Director, Professional Risk Managers’ International Association (PRMIA), Hyderabad Chapter. Can be reached at