Firms paying rating agencies is conflict of interest, RBI has a planhttps://indianexpress.com/article/business/banking-and-finance/firms-paying-rating-agencies-is-conflict-of-interest-rbi-has-a-plan-4672609/

Firms paying rating agencies is conflict of interest, RBI has a plan

This is aimed at gradually replacing the existing practice wherein the borrower or the issuer company pays the agency rating its credit worthiness, leading to a clear conflict-of-interest.

RBI, Resrve Bank of India, RBI on firm rating agencies, NPA accounts, indian express news
RBI plans to create a fund from which payments will be made to agencies for rating of corporate borrowers. (File)

In a move that could drastically overhaul the operating framework of credit rating agencies in India, the Reserve Bank of India (RBI) plans to create a fund from which payments will be made to agencies for rating of corporate borrowers. This is aimed at gradually replacing the existing practice wherein the borrower or the issuer company pays the agency rating its credit worthiness, leading to a clear conflict-of-interest.

The proposed fund from which payments will be made to credit rating agencies will be created out of contributions from the banks and the RBI, a senior government official said. The new model will first be implemented for “large borrower” accounts and later it is expected to be expanded to cover other accounts too. “The scope of the new framework for credit rating agencies will evolve in due course. It is expected to be implemented for large borrower accounts in the first place,” the official said.

Rating agencies, however, say that it will not impact their overall issuer-pays model as RBI is only looking at a specific area. “They (RBI) are talking about some specific mandate (NPA accounts) and not for the overall rating business,” Naresh Takkar, MD and Group CEO, ICRA Ltd, said. These changes are being planned in order to resolve the large stressed assets in the economy. For stressed accounts, the RBI also plans to assign rating agencies to bank to rate specific accounts.

“Over 95 per cent of the fee for obtaining credit ratings is currently paid for by the borrowers to the rating agencies. There is an argument that when the (debt) issuer company or the borrower pays the agency, it is able to influence ratings in its favour. But in practice that is not always the case,” said DR Dogra,

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Conflict of interest: RBI plans fund pool to stop practice of firms paying rating agencies former MD of Care Ratings. Dogra said the central bank’s intention is start the new system for stressed accounts in order to resolve the non-performing assets in the economy. Only in less than 5 per cent of the cases, agencies unrelated to the company being rated pay fee to credit rating agencies. For instance, an asset reconstruction company pays for the accounts it wants to get rated or sometimes stock exchanges depute agencies to conduct research on companies for which the exchanges make payments.

The central bank on Tuesday said it will expand the enlarge the number of members on Oversight Committee dealing with stressed assets. The RBI also announced plans to set in order the business model of rating agencies. “The Reserve Bank envisages an important role for the credit rating agencies in the scheme of things and, with a view to preventing rating-shopping or any conflict of interest, is exploring the feasibility of rating assignments being determined by the Reserve Bank itself and paid for from a fund to be created out of contribution from the banks and the Reserve Bank,” the central bank said.

The issuer-pays-model was widely criticised after the US subprime crisis, which led to a global financial contagion in 2008. An estimated $3.4 trillion of losses were incurred globally on largely AAA rated structured products, leading allegations of inflated ratings being given by the agencies overlooking the repayment risks.