Rating Divergence across Rating Agencies Could Soon Be a Thing of the Past Says SBI
With market regulator Securities & Exchange Board of India (SEBI) asking all rating agencies to do probability of default (PD) benchmarking for their AAA, AA and A ratings, the divergence across rating agencies could soon be a thing of the past, says a research note.
With rising instances of defaults and investors’ concerns around the role of rating agencies in timely evaluation of the possible risks, sudden transition of rating and deteriorating credit profiles of firms, in June this year, the market regulator had come out with a set of wider disclosure norms for external credit rating agencies (ECRA).
In the report, State Bank of India (SBI) says, "On the positive side, the SEBI approach would certainly bring in tighter credit assessment, comparability of ratings across issuers, to an extent, even across countries and, of course, more scrutiny and accountability in light of disclosure requirements put in place. However, as a logical corollary, rating agencies may go conservative to comply with the directions, in assigning rating which may lead to higher risk weights and so as the capital requirements for the banks. One view is that the new guidelines would moderate ratings and our country would have lesser number of AAAs and AAs. Additionally, it should also raise the requirement of bank capital requirements."
Subject to any unexpected legal event impacting such with certain permitted tolerance levels, SEBI has asked all rating agencies to do PD benchmarking for AAA, AA and A the rating categories.
For example, AAA rated companies is expected to deliver a benchmark default rate of zero over a two-year horizon with a tolerance of 1% is permissible when default is measured over a three-year period.
"Though SEBI has directed zero tolerance level for one year default for AAA, AA without tolerance and for A with 3% tolerance level, we observe divergence in PD itself across rating agencies. For example, in AAA category though the PD is zero in CRISIL and ICRA, it is 0.51% and 0.80% in CARE and India Rating, respectively. Similarly, stability rate indicates the proportion of rating that remain unchanged over a period. It is observed that CRISIL has stability rate of 98.84% in AAA whereas CARE and India Rating have 97.07% and 95% respectively. For, AA rated borrower also while CRISIL's stability rate is 95.68% for CARE and India Rating the same is 93.70% and 93.20%, respectively," SBI says.
According to the research note, there is divergence in stability rates across rating agencies. stability rate indicates the proportion of rating that remain unchanged over a period. SBI says, "It is observed that CRISIL has stability rate of 98.84% in AAA whereas CARE and India Rating have 97.07% and 95% respectively.
For, AA rated borrower also while CRISIL’s stability rate is 95.68% for CARE and India Rating the same is 93.70% and 93.20%, respectively. Higher stability rate indicates lower volatility. ECRA should aspire for a better stability rate across investment grade and which could also be a parameter to rate the performance of rating agency."
SBI says the new directives from SEBI will help achieve three things. Firstly, it says, the SEBI approach would certainly bring in tighter credit assessment, comparability of ratings across issuers and of course, combined with detailed appraisal and assessments to look at credit quality of each and every loan proposal.
"Secondly, new guidelines would moderate ratings and our country would have lesser number of AAAs and AAs. Additionally, it should also raise the requirement of bank capital requirements. Thirdly, one consequence of such lesser number of AAA rated borrowers is that it will result in diversification of ratings across categories. For example, most of the corporate issuance in India is currently of top credit quality, with AAA till AA- papers accounting for about 80% of all issuance while BBB or worse accounted for only 14%. This shows that the corporate bond market is largely accessible to the top rated borrowers. Thus MSME have no recourse to corporate bond markets in India and have to rely on banks for credit. Hopefully, a better diversification of ratings could help MSMEs to tap markets."
"Such a diversification could result in better trading in corporate bond market. As we see now, corporate bond market annual bond (trade) market is only around Rs15 to Rs18 lakh crore, meaning thereby on an average only Rs1.5 lakh crore worth of bonds are being traded monthly, with the outstanding corporate bonds of more than Rs30 lakh crore, as on March 2019, SBI says in the report.
The bond market in India currently lacks depth mainly because of structural impediments in the markets, including dominance of issuances by financial sector entities, prevalence of private placements, very limited market liquidity, and restrictions on institutional-investor allocations to non-investment-grade bonds, it also lacks confidence on the rating front too, especially from the retail investors.
SBI says, "With revised SEBI norms and better stability ratio coupled with transparent and structured disclosures, investor confidence will increase which leads to a better and robust secondary market with increased participation from the retail investors too."
In addition, over a longer time horizon, banks should experience lower impairments and better stress test outcomes, with beneficial impact on baseline stress test related capital requirements. Investor confidence will also increase with SEBI's move, which leads to a better and robust secondary market with increased participation from the retail investors too, the report concluded.