Inflated credit ratings cause bank lending mismatch

Posted by BankInfo on Sat, May 20 2017 05:59 am
Crowding credit-rating firms blamed for wrong rating of SMEs for creditworthiness
Jasim Uddin Haroon

Country's credit-rating firms are allegedly giving higher ratings to SMEs mainly in a rat race for their own survival as the number of raters has far outstripped the requirement.

Commercial banks that rely on such ratings for the clients' creditworthiness were inevitably lulled into a comfort zone in lending to the small and medium enterprises (SMEs).

People both in the rating companies and the banks admitted that such practice is on and that it would impact on the banking sector. Many believe it is a "serious concern for the banking industry".   

Credit rating for the SMEs began just a couple of years back in the country under the guidelines of the central bank. The country's eight rating firms, believed to be quasi-regulatory bodies, are authorised to do the rating of the units in the booming SME sector.

A website-based analysis conducted by this scribe shows that a number of rating companies gave SME-3 rating, equivalent to "A", to around 60 per cent SME clients.

This was done during the period between April -2016 and March 2017. They need to publish ratings on their respective websites.

Some agencies gave more than 70 per cent category "A" to the SMEs, which is believed highest investment grade. Under this category, banks need 6.0 per cent capital requirement.

Capital requirement, also known as regulatory capital or capital adequacy, is the amount of capital a bank has to hold, as required by its financial regulator.

This is usually defined as a capital-adequacy ratio of equity that must be held as a percentage of risk-weighted assets.

These requirements are put into place to ensure that these institutions do not take on excess leverage and become insolvent.

However, a number of rating companies rated 10-plus-category SME-2, equivalent to "AA", for the SMEs.

Under this category, as per the regulator guidelines, banks need to hold 2.0 per cent capital requirement.

The analysis shows that trading house, rice mills, agro-firms, furniture makers, cement and rod traders, and jute-product producers are among the SMEs who take rating services from the agencies.

On the other hand, SME-4 that stands for "BBB" was also given to the SMEs, which is not preferable to the banks as it needs 8.0 per cent capital requirement.

One rating firm gave only 3.0 per cent to this category in the year under review.

However, none of the rating firms did give the highest rate, that is, SME-1 or risk-free category during the year under review.

And none of the raters did give SME-5 which believed to be risky investment by the banks.

Some rating firms' top executives said major rating agencies are in competition among themselves and some have a "shortfall" in terms of understanding the risks of the SMEs.

The rating agencies used to rate only corporate bodies earlier but now extended their arms up to SMEs in view of their roles in the economy.

These rating agencies also did not undertake sufficient branch-level investigation and interaction with clients while assigning their worth, they said.

While talking to the FE, Prof Muzaffor Ahmed, CEO and President at the country's oldest rating firm-CRISL--said many have been giving higher ratings to the SMEs for their survival. But, he claimed, his firm does not compromise on quality.

He, however, said: "Banks are gaining benefits by this high rating as they need less capital requirement for good-rated SMEs."

The rating-agency CEO said banks should not allow selective rating firms as it is 'clear conflict of interest'.

He said regulators should monitor as to whether the agencies are following the guidelines of the central bans properly.

Md Momin Ullah Patwary, managing director of NCR (National Credit Ratings Bangladesh), told the FE that they were hearing about such higher ratings on the SMEs.

This practice, he believes, will ultimately impact upon the banking industry.

Muhammed Asadullah, managing director of Alpha Ratings, told the FE that sometimes banks try to influence the rating companies for good ratings as it helps them keep lower requirement.

Up to SME -3 the banks could invest in the SMEs. The rating firms which work as 'external credit-assessment institutions according to the central bank are authorised to do the rating of the SMEs.

Mr. Asadullah, who served many UN agencies-UNDP, UNHCR, UNDCP and UNOPS--across the world, told the FE that the recovery of SME credits is not so high.

"Banks want high ratings as a means of requirement but we give proper assessment," he told the FE.

According to BASEL-II standards, banks are required less capital for lending to good clients as the risk involved is less.

On the other hand, people in the banking circles said banks prefer good ratings for investment. But they also believe that many ratings are not properly done.

Nurul Amin, managing director and CEO at Meghna Bank, told the FE that the practices of the rating agencies are sometimes just similar to that of the auditing firms

He said there is need for regulatory intervention if any rating agency did not rate properly as wrong rating will ultimately impact on the banking industry.

Currently, there are two organisations that monitor the activities of the rating agencies - the Bangladesh Bank and the Bangladesh Securities Exchange Commission.

Bangladesh has now eight rating agencies: CRISL, CRAB, ECRL, Alpha, NCR, BDRL, WASO and URGUS. They are treated as external credit-assessment institutions as per the Bangladesh Bank guidelines.

During the period under review, five firms rated 2605 SMEs. The average fees for assessing the SMEs are just over Tk 10,000.

news:financial express/20-may-2017
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