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This article is written by Tejasvi Jat.


The Credit Rating Agencies have become an indispensable part of the Indian Financial System. However, their legitimacy is being questioned given the various recent scams: IL & FS, DHFL, ZEE, etc. Such incidents bring out the inadequacy of the regulatory regime in India and pose a serious question before us: how credible are our Credit Rating Agencies?”

Credit Rating Agencies are the gatekeepers of the financial market, and essentially provide an informed opinion to the investors about the timely payment of the interest and principal on a debt instrument and it would be impossible to predict the early signs of stress from the borrowers in their absence. Since they stand at a cross between the government and private rating providers, it is very much possible that conflicts of interest are bound to happen and therefore all the more need to address this to ensure that the economy of the country does not face any repercussions from defaulters who are given high ratings. 

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This article examines the role and legitimacy of the CRAs in the Indian Financial System along with the current regulatory regime. Thereafter, it analyses the probable impact of the guidelines issued by SEBI on the market and makes certain recommendations to improve upon the same.

The legitimacy of CRAs as an institution

Credit rating agencies evaluate the ability of different businesses to repay their financial commitments by considering various factors such as assets, liabilities, cash flows, etc.

It is both short-term and long-term but in recent times, investors prefer short-term credit rating over the long term. Since the inception of reforms in 1991, there has been an increase in the value and volume of total investments because of a general increase in the per capita spending capacity and as such has remained a major factor in the growth of CRAs in India. It is worth mentioning here that the country witnessed an average national income growth of 5.8% from 1981-90 and the industrial growth of 10.5% from 1989-90.

But the financial crisis of 2008 bought these credit rating agencies into the spotlight for bad reasons as they failed to act as an early warning system. This was further exacerbated by the failure on the part of the CRAs to keep adequately updated ratings. Thus, lagging behind market indicators. As credit rating agencies are meant to assure the issuer’s ability to repay debt, it is by and large playing a silent role in the bad loan crisis of India, with loans worth Rs 15 lakh crore ($200 billion) being distressed. In the aftermath of the financial crisis, SEBI set up a committee to review the regulatory regime in the country, however, due to lack of evidence regarding any systematic misconduct on the part of these agencies, the committee did not suggest large-scale reforms. 

Another major concern is the “issuer- pays” model which leads to a conflict of interest and thereby creditworthiness of the borrower. The recent example being the IL & FS scam wherein delay in identifying the stress in the IL&FS Group, which defaulted on its loans from banks, mutual funds, and provident funds led to jeopardization of hundreds of investors, banks, and mutual funds associated with IL&FS group. 

Conflict of interest

The practice of CRAs in India – to rate the securities, provide security valuation opinion, and advisory services to its clients is quite arguable. Typically, issuers remunerate these agencies for their ratings. It shows a conflict of interest and raises serious allegations on the legitimacy of the CRAs. In a bid to maximize their earnings, there is an obvious negative impact on the output- investors who rely on such ratings do not have a window into the issuer’s business.

The same CRA providing rating, valuation opinions as well as advisory services portray a situation wherein the Legislative, Executive, and Judicial functions of a Democracy are being performed by a single institution. If the CRA market hadn’t been an oligopolistic one then, the amount of influence on the market and investors’ choices wouldn’t have been much due to ratings given based on prevalent practices and hence there could have been a more effective rating practice based on true/legitimate factors.

As per the current practices, CRAs aren’t allowed to publish critical details of an issuer and CRAs in India, while trying to be cognizant of future business opportunities with the issuer, refrain to publish the ratings without the issuer’s consent as an issuer always has the option of going to other CRA who might publish a better rating. To address this conflict of interest, The IIIrd Schedule of the Regulations requires CRAs to not rate securities in which there exists a conflict of interest among the issuer of the securities and the CRA. Now even though there is a reduction of “Information Asymmetry” to an extent, but there is a significant lack of independent, objective and adequate assessment.

Due to this practice, CRAs try to provide a good rating to the issuer based on their collaterals irrespective of their financial position, confidence in the internal management, the impact of promoter selling, etc. This system leads to the concept of Issuer Pays; which indicates that the issuer pays a CRA for rating its securities, debt instruments, etc. Even if a CRA doesn’t agree to window dress the ratings as per the issuer, the practice of Rating Shopping defeats the whole purpose of independence of CRAs. Rating Shopping refers to the practice of an issuer/company managing to get a better rating after a short period, i.e., 3 months from another CRA. This whole system of provisional rating and prevalence of short-term rating rather than long-term rating along with Rating Shopping is quite indicative of serious concerns regarding the conflicting interests and the legitimacy of the CRAs.

A comparative perspective

European Union and the United Kingdom

The European brought in the concept of “civil liability” through Article 35a in the EU Regulation in 2013. Under this, the investor is under the burden of proof to show that the CRA has infringed. However, it is pertinent to note that the investor should have been unaware of the information that lies solely within the sphere of the CRA. In ascertaining the liability of the CRAs, the courts will have to see if the losses could have been “reasonably anticipated”. Thus, the two principles of “foreseeability” and “proximity” of the tort law have been essentially incorporated. 

United States of America

Traditionally, CRAs have been exempted from liabilities in the United States. in the aftermath of the global financial crisis of 2008, the USA was amongst the first countries to impose civil liability on the CRAs and after the introduction of the Dodd-Frank Act, the United States has subjected CRAs to expert liability. However, this had a negative impact on the activities of the CRAs as it also contained the stringent provision of imposition of strict liability on statements of CRAs in registration statements, as long as the rating was not entirely true, or omitted something. 

India’s Position

In the Indian context, it may not be possible to import the models followed by other nation-states as is as it is difficult to make these CRAs legally responsible to the investors who are most vulnerable to rely on wrong ratings. To do away with the practice of rating shopping is combatted by placing restrictions on withdrawing ratings, requiring disclosures, and imposing obligations preventing unfair competition. Even with such regulatory actions, rarely there have been instances of taking actions against defaulting CRAs in the past. This is partly because of the fact that there is little awareness regarding such measures in the market. 

The way forward: how effective are SEBI’s guidelines?

CRAs are information- intermediaries that step in to assess the quality of the product when the sellers of the product cannot testify the credibility of their products on their own. CRAs will function effectively when they will have reputational capital at stake and will suffer loss in the event of their ratings being biased, negligent, or false. 

SEBI’s effort to align the rating practices with the global best practices is yet to address the conflict-of-interest problem that continues to plague the rating industry. The foremost of these regulatory guidelines remains the explicit statement of “probability of default” of the instruments these CRAs rate. However, the guidelines regarding analyzing the deteriorating liquidity conditions of the issuer, not granting even provisional rating in matters of strategic decisions such as debt restructuring, scenario-analysis in loan refinancing can be seen as a welcome respite. But stringent actions such as setting up of surveillance group by the government is yet to be brought in. Affixing some monetary or business implications on such agencies can be another practical solution to bring accountability towards the investors. 

These guidelines have the potential to bring in dynamic changes because now the rating will be based less on historical data and more on the current or future risk trends and thus may align to short-term changes in the market. Under such circumstances, recognizing stresses within the companies would not come at the later stage such as what happened in the case of the IL & FS group. 

Arguably, the most crucial and the most complex aspect of the regulatory regime is the: lack of regulation with activities that stand apart from the securities market. With a wide array of instruments and entities being rated by the CRAs, the differences in instruments, therefore, need to be accounted for while making regulations for CRAs. 

A separate concern that arises is the mandatory reliance on these ratings by the RBI clearly when there is a lack of independent assessment by these agencies. Mechanistic reliance on these ratings has to be reduced especially when these are mere opinions and not “recommendations” in practice. 


Investors need to understand the negative consequences of relying solely on ratings of CRAs especially after the incidents of IL& FS and ZEE as these are mere opinions and not “recommendations” in practice. In addition, CRAs could take some steps to gain confidence regarding their effectiveness and legitimacy like- disclosing underlying assumptions, potential influential factors regarding a company, relying on much wider information to give ratings, improving their surveillance models, and bringing more transparency in their functioning. Conclusively, uniformity in the rating system rather than competition amongst the CRAs could help stabilize the rating practices. 

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