IL&FS fiasco: Sending ICRA executive on leave isn't enough; time regulator kicked off sweeping reforms for raters

The international rating agency Moody’s Indian arm ICRA has done well to tick off its executive Naresh Takkar by sending him on leave pending an inquiry on the anonymous charge received by SEBI. The charge relates to top credit ratings given to IL&FS by a slew of credit rating agencies in India including ICRA. IL&FS went bust last year thus putting the rating agencies squarely in the dock. It was a throwback to the US mortgage crisis of 2008 when top-notch agencies blithely gave top ratings to sliced and diced mortgage portfolios (loan accounts picked up at random without anyone having a clue as to the creditworthiness of individual accounts) that were pitched as security for the fresh issue of mortgage bonds. The cookie crumbled when the exaggerated prices of real estate crashed and mortgagers blithely thumbed their nose at the home loan companies as in the US there is no personal liability of borrowers beyond the mortgage. There has been a raging debate ever since on the evils plaguing the rating industry. ‘Rating shopping’ is a serious menace. SEBI has addressed it nicely and squarely by mandating the publication of all the ratings, favorable as well as unfavorable when multiple ratings are resorted to. This has put paid to the convenient practice of cherry-picking. But SEBI is yet to address the problem of raters’ remuneration. The most popular model is the bond-issuing company pays raters’ their fees. The obvious demerit of this model is it fosters mutual back-scratching tendencies—I pay you high fees and you wink at the skeletons in my cupboard. Bond subscribers paying for ratings has not been seriously considered in anticipation of their apathy. Regulator-pays-model should be seriously considered. SEBI, after all, is a cash-rich organisation as it collects hefty registration and renewal fees from all market players. [caption id=“attachment_5251861” align=“alignleft” width=“380”]  Representational image. Reuters.[/caption] Coming back to the IL&FS fiasco, there are many who have sprung up in defense of the credit rating agencies. Why not first catch hold of the independent directors of IL&FS and its auditors is their chorus? This is a specious argument. Action against one does not preclude action against others. To be sure, the auditor is cast in the role of the most potentially powerful whistleblower. Independent directors are not roped in for their supine role in just attending board meetings. They are supposed to watch over executive over-exuberance and high-handedness. But none of these mean raters can pass the buck. They must bear the cross for things souring for want of diligent rating and its timely revision given the fact that subscribers to bonds are swept off their feet by the exceptional ratings which raters invariably give without batting an eyelid. In other words, subscribers to bonds are led up the garden path by the rating agencies. Rating, especially its symbols, is meant for the financially illiterate. In the case of IL&FS, for instance, it was amazing that the rating firms which gave it a good rating for its Rs 75 crore issue as late as August 2018 failed to catch the fact that while the holding company’s profits were Rs 584 crore in FY18, the IL&FS Group’s losses were Rs 1,887 crore. The liabilities of IL&FS on a standalone basis were Rs 17,757 crore while those of the group were Rs 116,447 crore. SEBI must carry out comprehensive roots and branches rating reforms. It is not enough for Takkar’s head to roll. ICRA’s top brass must also be swiftly brought to account as the anonymous whistleblower seems to suggest that Takkar only went along with the top management’s indulgence of IL&FS. While this would be IL&FS specific, industry-wide reforms should include SEBI volunteering to bear the rating agencies fees among others. (The author is a senior columnist and tweets @smurlidharan)