A Credit Ratings Perspective

MADAN SABNAVIS offers means of modeling businesses for the future rather than the present.

The credit rating business is unique as it is dependent almost entirely on the external environment. If the economy does not grow and companies do not borrow money, there will no requirement of a credit rating. On the other hand, the business has a touch of continuity in the form of annuity where regulation demands that until the debt is repaid, a surveillance exercise has to be done. Also, a credit rating is required for bank loans as per the RBI regulations for the purpose of determination of risk weights by banks when reckoning capital adequacy. As working capital is perpetual, a rating would also tend to be continuous. This ensures that there is income in the business even if there is no fresh business.

The Indian economy has gotten into a low equilibrium trap where there is subdued investment activity, which gets reflected in lower borrowings in the debt market and from banks. Therefore, FY2020 will be a slow year for the ratings industry just as it is for other sectors as demand for a rating is derived from what happens at the macro level.

It is, however, universally accepted that the low equilibrium will not last for long and that the economy has the potential to grow at 8 per cent per annum on a sustained basis to reach the mark of $5 trillion in five to seven years. This will be associated with increased growth in investment as these levels climb back to the 35 per cent mark from the existing levels of 28 to 29 per cent. This will then result in a higher growth of bank credit to manufacturing and services, which have to be the prime drivers of the economy as well as enhanced issuances in the corporate bond market. There is already a regulatory push given to the latter by both SEBI and RBI. Therefore, it will be just a matter of time before the credit rating business will move up after the cyclical downturn witnessed along the U-shaped path in the last three years or so. Keeping this in mind, the business models have to be carved for the future rather than the present, which may not offer too many opportunities. To navigate and be better prepared for the future, the 5R approach has to be pursued.

The product being delivered has to be accurate with a negligible margin of error. This means ensuring that the models used and the analysis that goes into such prognosis is accurate. While this has always been so with CARE Ratings, given the recent volatility in some sections of the market, the need to be on track is even more compelling. The business involves a large ‘reputation risk’ as the brand often is the distinguishing factor when it comes to which rating agency to choose. Therefore, honing analytical skills is always a work in progress that can be built on to 

be fully prepared when the business takes off.

As credit rating has become a standard tool used by investors when taking decisions, the regulatory processes have been streamlined and strengthened, which is in turn good for the industry. There have been a series of new regulations that have been put in place, like norms on the default curve, defining the probability of 

default, separation of various businesses to avoid conflict of interest, setting up of review committees, more transparency in disclosing unaccepted ratings and so on. While most of these norms have been pursued by CARE Ratings, some would require fresh actions like separating non-ratings businesses, which can be done in this period of transition as the norms come into effect next year. This helps in streamlining activity.

Ratings are based on a company’s debt where the unit is studied in detail and a prognosis is made. However, the micro picture cannot be distanced from the macro conditions and hence the overall industry and economy come into play. Therefore, research has to be multi-layered and the knowledge that emanates from here becomes an integral part of the rating process as it provides the background against which a decision is taken. Keeping the research architecture in place across all sectors is required with continuous monitoring so that this platform becomes solid.

This is probably the main raw material that goes into a rating. Here both human resources and technology matter. The analysis is done by a human being while technology can facilitate the flow of information. Technology needs to be scalable to meet any size of business while the former needs to be equipped with the right tools to do a perfect analysis where skill sets are continuously upgraded. The focus of CARE Ratings is to continue to build a strong team of rating analysts at different levels with sector specialisation, who can read between numbers and take cues from the market on the company. Technological upgradation is a continuous process that is always ahead of the curve where business demands have to be anticipated all the time. 

Ratings are all about building relationships with companies and the main strategy is to cover the entire set of corporates. While the large borrowers provide volumes, the smaller ones today could be the bigger ones tomorrow. Therefore, the business teams keep nurturing these relationships, which are not just during the time of ratings but also through regular knowledge sessions where feedback of sectors is provided. This not only helps in building relationships but also assures the client of the value brought by CARE Ratings.

Hence, in a period of slow business growth due to extraneous factors, this paradigm based on the‘5R’ is being pursued diligently so that when the economy turns the corner and there is a pick-up in business, the company is prepared fully and would not feel any of these attributes lacking.

Madan Sabnavis, Chief Economist, CARE Ratings, has been a corporate economist for 32 years with varied experience in development banking (ICICI), commercial banking (ICICI Bank), engineering and construction (L &T) and commodity derivatives (NCDEX).