Rating agencies, facing regulator's wrath for IL&FS tragedy, are left with a hard choice now

After ICRA, CARE Ratings has sent its CEO Rajesh Mokashi too on leave pending investigation on an anonymous complaint received by the market regulator, Securities and Exchange Board of India (SEBI). Recently, ICRA had sent its managing director and chief executive officer (CEO) Naresh Takkar on leave on similar grounds.

Though the exact details aren’t known yet, it is understood that the investigation pertains to wrong rating calls given to the collapsed non-banking financial company (NBFC), IL&FS and thereby misguiding the investors relying on such ratings.

Rating agencies are paying the price for sheer inefficiency in their jobs. Globally, questions were first raised on the efficacy of the rating process in the aftermath of the 2008 global financial crisis. Raters were equally clueless as common investors about the build-up of substantial risks that would shake the world economy until all hell broke loose on the day when Lehman Brothers filed for bankruptcy. Post-this, the world over, rating agencies were subjected to criticism. These entities were urged to revamp their rating practices and keep a high vigil on the state of the companies they rate.

File image of Rajesh Mokashi. Pic: CARE Ratings website.

But, even in the subsequent period, raters often failed to identify risks in some of the major cases of financial failure, acting only after the crisis happened and claimed the damage.

In the Indian context, there are several examples where rating agencies failed to sense the imminent danger and continued awarding top ratings to firms in trouble only to witness payment defaults a few months later. The latest such example was IL&FS.

As this Mint report states, India Ratings & Research, ICRA, and CARE, had given IL&FS the highest rating of AAA, even when its subsidiary, IL&FS Transport Networks, defaulted in June. After the default came to light, top ratings were revised to junk in a span of 45-50 days, leaving the investors shocked and inviting the wrath of regulators.

In an interview given to this writer for Mint newspaper in August 2011, ICRA had alleged that its rivals were diluting professional standards to garner business. “Some of the issues relating to an excessive competition are possibly resulting in some rating agencies taking a liberal interpretation of the principles, which are well-established internationally," Naresh Takkar had alleged then.

Raters’ credibility is already at stake. Episodes like IL&FS didn’t happen overnight but the result of constant rolling over of liabilities using fresh loans to cover up defaults. It was the job of the rater to identify these unhealthy practices early and take appropriate rating actions. In cases like IL&FS, they failed to do that.

In the context of serious questions raised on the efficiency and rating practices of such agencies, these firms are left with only two choices—either self-regulate and do their job properly or lose relevance and surrender to stricter regulations.