How many rating agencies do we need?
Saturday, 19 September 2009
Muzaffar Ahmed FCMA, FCS
It is recognised all over the world that the services of rating agencies are basically required for bond market and structured products to protect the interest of the small investors. Because of this, no international rating agency was interested to operate in Bangladesh even at the request of SEC in the mid-nineties when the Credit Rating Information & Services Ltd. (CRISL) was seeking licence and SEC desired to tag any international rating agency with it as a joint venture partner. The IFC of the World Bank, at the initiative of SEC, conducted a survey by an international rating agency. The survey report suggested that Bangladesh does not have rating market in view of the absence of bond market. During the last 12 years no significant development took place in the bond market and the survival even of a single rating agency is not supported by the economic features of Bangladesh.
The Bangladesh Bank made bank rating mandatory in 2006 which created 39 rating jobs annually for two rating agencies. While implementing Basel-II, with effect from the beginning of this year, the Bangladesh Bank adopted "Standardised Approach" initially for a period of five years before it goes for "Internal Rating Based Approach, IRB" under which banks will be determining their own credit risk internally. Since IRB system needs a customer data base for a minimum period of five years, the banks are suggested to utilise the services of the rating agencies approved by BB as External Credit Assessment Institution (ECAI) temporarily. The requirements for ECAI, as prescribed by the Bangladesh Bank are stringent and in line with Basel-II documentation. The Bank for International Settlement (BIS) warranted that in order to work with the banking sector as ECAI, a rating agency must have minimum three years of experience and its default rate must not be more than 0.003% at AA category, to be read with its transition matrices. (Default rate means a ratio calculated by number of default against outstanding ratings and transition matrices mean the number of ratings moved up or down over a period of time in all categories).
Under the above rules prescribed by the Bangladesh Bank, no new rating agency will be eligible to work as an ECAI. The ECAI service is required only for a few years, that is, during the transition period from standardised approach to IRB approach, covering a period of only 3 to 5 years. The BIS categorically wanted that not all the rating agencies but only the few having less default ratio should work for the banking sector during the transition period under standardised approach in order to save the banking sector from any additional setback. Against this backdrop, it would not be possible on the part of a new rating agency to fulfil all these conditionalities in true sense, such as having rating experience of a minimum three to five years with sufficient number of ratings to calculate effective default and transition matrices. Therefore, a rating agency cannot be considered to be promoted to do the client rating emanating from the requirement of banks for client rating for a period of three to five years. Besides, what additional new rating agencies would do after the above period is to be decided before considering additional licensing. This is the point that SECB would definitely look into before considering allowing additional rating agencies in the market.
It may be mentioned here that client rating is not mandatory for banks under BASEL-II capital adequacy framework. The Bangladesh Bank also did not make client ratings mandatory for the commercial banks. The Bangladesh Bank clearly stated that banks do not need the services of rating agencies for financing a client. However, while reporting the capital adequacy quarterly, banks may recognise the rating of a client if it is rated by an ECAI and the capital need will be dependent on rating of the ECAI. For example, if the client has AA rating, risk weight would be 50%, if it has A rating, it may carry 100% risk weight and if not rated, 125%. In addition, a large number of clients would fall under fixed rate and retail investment category which do not require rating for capital adequacy of banks. It is important to mention here that about 150 to 250 business groups may fall under corporate categories, which account for more than 50% of the investment of all the banking institutions. Therefore, credit rating of these clients is not in any way a big market for rating.
Although the Bangladesh Bank issued this circular regarding rating at the beginning of 2009, no significant number of banks has so far taken any effective step to bring their clients under rating. Hence, none of the two rating agencies has received any mentionable number of rating request from the clients. Rather the banks are afraid that if the clients are asked for rating they may change the bank and may switch over to other banks having no significant capital problem. The banks, particularly the foreign banks having less capital problem, may take the advantage of this scenario. In order to handle the capital adequacy issue, the banks are looking for other alternatives such as issuance of subordinated bonds, right offer etc. Besides, the banks will not like to rate bad clients because of the fact that it may require additional capital, if the rating is poor. Therefore, the suggestion that the banking sector requires more credit rating agencies is not based on fact. In addition, the rating requirement by client is dominated by the fact that most of the clients initially believe that rating is like auditing. Since the country has a large number of auditors, why not so many rating agencies?
India, Pakistan and Sri Lanka have adopted the same approach as Bangladesh in implementing BASEL-II, but the regulators of none of these countries have thought of new rating agencies due to the fact that new rating agencies will not qualify to be an ECAI under the regulations and to meet this temporary need of client exposure rating (for 3 to 5 years). In fact, in Pakistan, an application of a third rating agency has been rejected by the coountry's Securities and Exchange Commission. In India, though there are four rating agencies, only one rating agency occupies 75% of the market share.
Looking internationally, Securities and Exchange Commission of Bangladesh is a member of IOSCO while SEC is obligated to look into the quality of credit rating and rating agencies. The SECB asked two present rating agencies to strictly comply with IOSCO code of conduct. In addition, SECB has also finalised its regulatory framework for the ethical code of rating agencies and its professionals. In order to maintain the standard of this highly acclaimed profession in the country, the SEC should look into the market very seriously. In the absence of rating market, specially bond market, any new entry would bring down the quality of rating and may create unethical competition for survival.
Both the rating agencies of the country are the members of the Association of Credit Rating agencies in Asia (ACRAA), sponsored by the Asian Development Bank. Most of the rating agencies of Asia are members of this body. None of the countries, except India and China, have more than two rating agencies in ACRAA. It is, therefore, unreasonable that Bangladesh should have more than two rating agencies at this stage of development.
The writer is President and CEO, CRISL
It is recognised all over the world that the services of rating agencies are basically required for bond market and structured products to protect the interest of the small investors. Because of this, no international rating agency was interested to operate in Bangladesh even at the request of SEC in the mid-nineties when the Credit Rating Information & Services Ltd. (CRISL) was seeking licence and SEC desired to tag any international rating agency with it as a joint venture partner. The IFC of the World Bank, at the initiative of SEC, conducted a survey by an international rating agency. The survey report suggested that Bangladesh does not have rating market in view of the absence of bond market. During the last 12 years no significant development took place in the bond market and the survival even of a single rating agency is not supported by the economic features of Bangladesh.
The Bangladesh Bank made bank rating mandatory in 2006 which created 39 rating jobs annually for two rating agencies. While implementing Basel-II, with effect from the beginning of this year, the Bangladesh Bank adopted "Standardised Approach" initially for a period of five years before it goes for "Internal Rating Based Approach, IRB" under which banks will be determining their own credit risk internally. Since IRB system needs a customer data base for a minimum period of five years, the banks are suggested to utilise the services of the rating agencies approved by BB as External Credit Assessment Institution (ECAI) temporarily. The requirements for ECAI, as prescribed by the Bangladesh Bank are stringent and in line with Basel-II documentation. The Bank for International Settlement (BIS) warranted that in order to work with the banking sector as ECAI, a rating agency must have minimum three years of experience and its default rate must not be more than 0.003% at AA category, to be read with its transition matrices. (Default rate means a ratio calculated by number of default against outstanding ratings and transition matrices mean the number of ratings moved up or down over a period of time in all categories).
Under the above rules prescribed by the Bangladesh Bank, no new rating agency will be eligible to work as an ECAI. The ECAI service is required only for a few years, that is, during the transition period from standardised approach to IRB approach, covering a period of only 3 to 5 years. The BIS categorically wanted that not all the rating agencies but only the few having less default ratio should work for the banking sector during the transition period under standardised approach in order to save the banking sector from any additional setback. Against this backdrop, it would not be possible on the part of a new rating agency to fulfil all these conditionalities in true sense, such as having rating experience of a minimum three to five years with sufficient number of ratings to calculate effective default and transition matrices. Therefore, a rating agency cannot be considered to be promoted to do the client rating emanating from the requirement of banks for client rating for a period of three to five years. Besides, what additional new rating agencies would do after the above period is to be decided before considering additional licensing. This is the point that SECB would definitely look into before considering allowing additional rating agencies in the market.
It may be mentioned here that client rating is not mandatory for banks under BASEL-II capital adequacy framework. The Bangladesh Bank also did not make client ratings mandatory for the commercial banks. The Bangladesh Bank clearly stated that banks do not need the services of rating agencies for financing a client. However, while reporting the capital adequacy quarterly, banks may recognise the rating of a client if it is rated by an ECAI and the capital need will be dependent on rating of the ECAI. For example, if the client has AA rating, risk weight would be 50%, if it has A rating, it may carry 100% risk weight and if not rated, 125%. In addition, a large number of clients would fall under fixed rate and retail investment category which do not require rating for capital adequacy of banks. It is important to mention here that about 150 to 250 business groups may fall under corporate categories, which account for more than 50% of the investment of all the banking institutions. Therefore, credit rating of these clients is not in any way a big market for rating.
Although the Bangladesh Bank issued this circular regarding rating at the beginning of 2009, no significant number of banks has so far taken any effective step to bring their clients under rating. Hence, none of the two rating agencies has received any mentionable number of rating request from the clients. Rather the banks are afraid that if the clients are asked for rating they may change the bank and may switch over to other banks having no significant capital problem. The banks, particularly the foreign banks having less capital problem, may take the advantage of this scenario. In order to handle the capital adequacy issue, the banks are looking for other alternatives such as issuance of subordinated bonds, right offer etc. Besides, the banks will not like to rate bad clients because of the fact that it may require additional capital, if the rating is poor. Therefore, the suggestion that the banking sector requires more credit rating agencies is not based on fact. In addition, the rating requirement by client is dominated by the fact that most of the clients initially believe that rating is like auditing. Since the country has a large number of auditors, why not so many rating agencies?
India, Pakistan and Sri Lanka have adopted the same approach as Bangladesh in implementing BASEL-II, but the regulators of none of these countries have thought of new rating agencies due to the fact that new rating agencies will not qualify to be an ECAI under the regulations and to meet this temporary need of client exposure rating (for 3 to 5 years). In fact, in Pakistan, an application of a third rating agency has been rejected by the coountry's Securities and Exchange Commission. In India, though there are four rating agencies, only one rating agency occupies 75% of the market share.
Looking internationally, Securities and Exchange Commission of Bangladesh is a member of IOSCO while SEC is obligated to look into the quality of credit rating and rating agencies. The SECB asked two present rating agencies to strictly comply with IOSCO code of conduct. In addition, SECB has also finalised its regulatory framework for the ethical code of rating agencies and its professionals. In order to maintain the standard of this highly acclaimed profession in the country, the SEC should look into the market very seriously. In the absence of rating market, specially bond market, any new entry would bring down the quality of rating and may create unethical competition for survival.
Both the rating agencies of the country are the members of the Association of Credit Rating agencies in Asia (ACRAA), sponsored by the Asian Development Bank. Most of the rating agencies of Asia are members of this body. None of the countries, except India and China, have more than two rating agencies in ACRAA. It is, therefore, unreasonable that Bangladesh should have more than two rating agencies at this stage of development.
The writer is President and CEO, CRISL