The Parliamentary standing committee on finance has recommended a systemic review by the Reserve Bank of India (RBI) to pre-empt a crisis of the sort that the Infrastructure Leasing & Financial Services (IL&FS) group underwent in 2018. In its report dated March 10, the committee headed by Jayant Sinha has also suggested a system of rotation of credit rating agencies (CRAs), which the government has shot down.
The committee said that the resolution of IL&FS remains sub judice before the National Company Law Appellate Tribunal and delays in the resolution process not only cause a steep value erosion for bankers and other creditors, but also makes an understanding of the lacunae in the system elusive.
“It is necessary to plug these loopholes as the defaults jeopardised hundreds of investors, banks and mutual funds associated with IL&FS and several NBFCs (non-banking financial companies) also faced default scare, until the government’s timely intervention in the matter. While taking note of the various investigations being undertaken and subsequent penalties being imposed for the failure in exercising due diligence, the Committee desires that a thorough systemic review should be conducted by RBI so that such episodes involving ‘systemically important entities’ are pre-empted,” the report said.
Earlier, the RBI has said on multiple occasions that it is continuously monitoring the top 50 NBFCs for signs of contagion.
The panel observed that more entities, particularly start-ups with the requisite capability and expertise to become part of the credit rating industry, should be encouraged to participate in the system. This might aid in fostering healthy competition by ensuring a level playing field and eliminating complacency in the credit rating industry. It further recommended that watchdogs be more alert and prudent in their enforcement of regulations instead of curbing the growth of credible start-ups in the industry.
The report suggested that the ministry and regulator should explore the mandatory rotation of rating agencies along the lines of statutory auditors to avoid the pitfalls of long association between the issuer and the credit rating agency (CRA), in light of the recent instances of failure of CRAs in sensing simmering ‘trouble’ in their client-entities.
“In the same vein, the Ministry may also evaluate the suggestion to have rating compulsorily carried out by more than one agency (dual or multiple), particularly in respect of debt instruments/bank credit involving large amounts say, more than `100 crore. This will help the investors to access different positions/viewpoints for an informed decision,” the panel recommended.
The finance ministry responded by saying that mandatory requirement of dual rating for debt securities would increase the cost of debt issuance and, therefore, adversely impact the interests of corporate bond issuers and hamper the growth of the corporate bond market. In practice, many issuers obtain ratings from two or more CRAs upon the insistence of investors.
“As regards mandatory rotation … the rating assessment of a CRA has to be forward looking unlike auditing. Further, mandatory rotation would be a disincentive to good and quality CRAs. It will also ensure business for less effective CRAs,” the ministry said.