Kathmandu. Regulators have begun to monitor the credit ratings being used in the global private debt market.
According to Bloomberg, the Financial Stability Board (FSB), the US Securities and Exchange Commission (USAC) and the Bank of England, which monitors global financial risks, have been investigating the role of privately promoted credit rating companies.
The main concerns of regulators are ‘rating shopping’ and ‘rating arbitrage’. In this business, there is a tendency for borrowers to choose the rating institution that gives them the most favorable rating out of many rating agencies. Regulators have warned that such practices could lead to increased credit flow without properly assessing risks and ultimately affect financial stability.
International concerns, local references
Given this international backdrop, similar structural risks are seen in Nepal as well. Currently, three credit rating agencies licensed by SEBON, ICRA Nepal, Care Ratings Nepal and Infomerics Nepal are active in Nepal. These agencies are operating on an issuer page model. That is, the company paying the service charge is the one that pays the appraisal. Which is considered to be a potential source of conflict of interest worldwide.
Financial market insiders say that in recent years, some corporate houses have chosen a new or lesser-known rating agency rather than a long-known and rigorous rating agency. In this context, there have been instances in the market where the same company has received a weak credit rating of ‘B’ or ‘B Plus’ from one agency, while another agency has received a high rating of ‘A’ or ‘A Plus’.
Business groups are conditional on the condition that they are responsible for all credit rating work in the case of the company they invest in, whether they have a good issuer or credit rating.
Nepal Rastra Bank (NRB) The government has made credit rating mandatory for bank loans above Rs 50 crore. In addition, the Securities Board of Nepal (SEBON) has made the issue rating mandatory for the public offering (IPO).
Credit Rating
Care Ratings Nepal, which has its own group investment in conflict of interest, has been rating its companies by a large group. After widespread criticism for fraud in the valuation of Ghorahi Cement, Vishal Group is now rating all its companies in Infomerics Nepal.
Infomerics Nepal has been using the rating of all the companies under the Shankar Group, which has been enjoying the highest bank loan facilities. A news report was published in Infomerics Nepal claiming that Shankar Group had invested its capital in the name of employees close to the group, their family members and relatives of the directors.
Companies that have received a ‘B’ rating in one rating agency on the basis of the same financial statements are deceiving the general investors and banks by taking an ‘A’ or ‘A’ plus’ rating in another agency.
According to experts, such a situation is theoretically possible. Different rating methodologies and risk measurement approaches, different time periods of use of financial statements, group support, different interpretations of liquidity management or management capacity, and the most sensitive aspect, a softer approach to valuation due to business competition.
If a company’s rating has risen significantly without a substantial improvement in its underlying financial position, cash flow, debt load or business risks, it raises questions about the credibility of the rating.
What are the risks?
If such a trend increases in Nepal’s small but growing credit market, banks and investors may be able to lend more than the actual risk. Mispricing of risk can lead to increased credit losses in the future. The credibility of the overall capital market may be undermined by the loss of confidence in the rating system.
This is why global regulators are pushing for greater transparency, multi-rating and conflict of interest management in private credit ratings.
Role of the regulator
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In the context of Nepal too, there are voices that SEBON and Nepal Rastra Bank should closely monitor the methodology of rating agencies, the basis for rating changes and the process adopted by companies when changing agencies. Analysts indicate that in the case of large loans or public bonds, a provision of more than one independent rating may be necessary in the future.
Today’s rating gap could become tomorrow’s ‘financial risk’ if Nepal does not understand the signs of the crisis in the global market in time and strengthen its regulatory framework.
