There’s no option

N. S. Vageesh | Updated on October 19, 2012

Rating agencies are once again in the news in India because of the threat of a sovereign downgrade. Over the past few weeks the flurry of ‘reform’ announcements and the unusual urgency in the government’s tone probably had their origins in this threat.

In that sense, we probably owe a vote of thanks to this otherwise besieged industry — often pilloried for getting its decisions wrong.

Rating agencies have had their credibility questioned for some time now — especially for their failure to spot the global credit crisis of 2008. Very often their rating actions come a bit too late in the day for investors and lenders to take protective action. It is a measure of their low credibility that stock and bond markets often tend to shrug off the effects of a ratings downgrade shortly after the deed.


Sometimes, the actions of rating agencies are inexplicable and defy logic — as, for instance, when they put a couple of beleaguered European nations a few notches higher than India on the ratings scale.

Sometimes, the rationale they cite for a particular action is contestable — when they downgraded the State Bank of India last year because of its inability to raise capital at will. As the Bank’s management pointed out, this was a factor that had not changed since 1955. Why should this suddenly become an important factor while re-considering a rating? Those questions remain unanswered.

As the bank management conceded, ratings are sometimes a matter of perception and mood as much as fact. Borrowers, whether they are companies or countries, may not agree with the decisions of rating agencies. But if they want to raise funds in the market, they need to part with information and be transparent with the lenders and rating agencies.

Rating agencies have their flaws. Importantly, the inherent conflict of interest in having the issuer of instruments pay for the ratings rather than the user has remained unresolved.

There is much to quarrel with them and their opinions. Yet, their raison d’etre is this: lenders and investors need an independent assessment of borrowers — when human nature and corporate culture tends more towards cover-ups rather than openness.

In the final analysis, what was said about democracy — that it is the worst form of government except all the others that have been tried — applies to the rating industry too. It is not perfect. It could be better. But you need it. What is the alternative?

Also read: >Inherently flawed

Published on October 19, 2012

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