Banks Should Enhance their Due Diligence Mechanism to Evaluate Ratings by CRAs: Assocham-PwC

A holistic regulatory framework encompassing participation from all stakeholders in the credit rating ecosystem is imperative to improve the efficacy of credit rating agencies (CRAs) and effective credit risk assessment and monitoring in India, suggested an ASSOCHAM-PwC joint study.

“Improving efficacy of CRAs needs to be looked from a holistic perspective where all participants in the ecosystem, the regulators, CRAs, corporate, investors (banks), borrowers and others need to work jointly towards a better system of credit risk assessment and monitoring,” noted the study titled ‘Growing NPAs in banks: Efficacy of credit rating agencies,’ jointly conducted by The Associated Chambers of Commerce and Industry of India (ASSOCHAM) and Pricewaterhouse Coopers (PwC).

Banks’ credit risk assessment, administration and monitoring have increasingly come into focus owing to considerable increase in levels of non-performing assets (NPAs) and stressed assets (SAs) in past couple of years, the study added.

“The banks, apart from putting up a strong regulatory framework, should also upgrade their skills for greater due diligence to effectively evaluate the ratings given by the CRAs,” it said.

“Besides, banks need to move towards risk based pricing whereby they can use rating as more than just a mandatory exercise by identifying greater incentives for them to adopt ratings,” suggested the study.

“Banks and CRAs should be able to contribute to developing an ecosystem where credit assessments become more effective,” it added.

Banks should treat the credit rating only as an ‘opinion’ and not as the gospel truth and the information generated by their ratings should be used in conjunction of banks’ credit risk framework to decide on suitability of loan exposure, further noted the ASSOCHAM-PwC study.

Banks should also be encouraged to develop their internal rating models and validate these ratings by comparing them with publicly available ratings and also seek more information from the rating agencies, if necessary to be doubly sure of their credit assessment process, it said.

A forward-looking and market based credit rating mechanism as part of a move towards risk based pricing can also help the system to take proactive corrective steps to reduce the burden of stressed assets and potentially reduce NPAs systemically and avoid panic and kneejerk reactions, recommended the ASSOCHAM-PwC study.

Besides, early warning systems along with dynamic rating mechanism measuring all the risks of the market can help the banks and other lending institutions to effectively predict the credit risk associated with the borrower and take necessary actions to mitigate such risks.

Considering that financial education in India is still at a nascent stage, the ratings should be displayed on a common website for comparison, the study recommended.