INSTITUTIONAL EYE Credit rating agencies | Wrong Analyses 02 May, 2023

Every time a rating agency fails, its issuer-pays business model is called into question. “It is an accepted fact that there exists an inherent conflict of interest in the ‘Issuer pays’ model specifically with the reliance of the rating agency on earnings arising from the fees paid by its clients. In turn, an issuer armed with this leverage, would be in a position to get inflated ratings in his favor.” SEBI too recognizes that the investor-pays model will have equal challenges, and is not an obvious alternative to the issuer-pays model. When investors pay, there is no obligation from the issuer to provide the rating agency with the necessary information. This will compromise the rating agencies’ analytical depth. Keeping the rating under surveillance will also have its challenges as the debt gets sold from one investor to another. Most importantly, the investor-pay model will keep the bond market at shallow levels – most debt funds don’t invest below AA category rated paper.

Rating failures are not a question of rating agencies’ business model - but of the strength of its operations, the tone that is set at the top, and its corporate culture. If one considers ratings like any other product, then it is merely the pressures of revenues that drive poor decision making, independent of where the revenues are sourced from. In effect, it is no better or worse than car manufacturers trying to cheat emission norms and project better fuel efficiency just to sell more cars; or indiscriminate lending by some banks just to show growth. Ratings quality could be equally compromised for an investor that regularly pays high fees for an ‘acceptable’ rating.

Ratings are not infallible and rating agencies will fail. That is the nature of the business. How often a rating agency fails, the size and extent of its failures, and the changes it makes from the lessons learnt is important. That is the role of leadership and not a function of the ratings agencies’ business model.

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  • Credit Rating
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