Ratings agencies have seen huge growth in business due to the Reserve Bank of India’s (RBI’s) order for rating of corporate clients under Basel-II norms. While thus has meant growth in volumes, margins have dropped substantially. Naresh Takkar, managing director of Icra, talks to Abhijit Lele on business environment and challenges ahead. Excerpts:
Ratings agencies have got a lot of business in the last two years after RBI made rating of corporate borrowers mandatory under Basel-II norms. How did the market benefit from it?
The expansion in the universe of rated entities is good for the growth of the debt market in India. Earlier, only about 600-700 entities were rated. Now, the number has grown to about 5,000.
Besides the increase in the number of rated entities, there is now wide diversity in size and sectors that companies represent. Rating will help companies raise funds from the market and, in the long run, increase the share of debt. At present, companies predominantly look at equity and bank loans to fund businesses.
While there has been an increase in potential business for ratings agencies due to Basel-II requirements, there is also a rise in competition. How has it impacted margins?
Margins have come down from 64 per cent in 2008-09 to 58 per cent in 2009-10 due to relatively small ticket sizes and competitive pressures. With a relatively subdued debt market and contraction in structured finance issuances, the volume of debt issues rated by Icra declined during the year.
The Securities and Exchange Board of India recently tightened regulatory norms for ratings agencies. It has asked the agencies to make more disclosures. How is it going to impact the business?
Icra, an associate of global ratings entity Moody’s, is already in compliance with the new norms, which require us to carve out a separate entity for business advisory services.
The economic and business environment is showing signs of recovery. Is there a case for RBI to relook at its decision to lower the risk weight for unrated portfolios?
RBI, in October 2008, reduced the risk weight on unrated portfolios to 100 per cent as part of steps to manage the global financial crisis.
Now, the economic environment has improved and there is merit in tightening the risk weight to 150 per cent. There are two benefits (of such decision). One, banks have the benefit of better risk management and supervision. Also, it improves systemic management capacity.
RBI has prescribed risk weight as part of prudential norms to ensure that banks maintain quality loan portfolios. Can other financial sector regulators adopt a similar approach?
At present, insurance companies can only invest in papers which are rated AA and above. There is limited supply of such papers. There could be projects with rating lower than AA, but with strong fundamentals. In such cases, there is a case for aligning exposures with risk weights.
Insurance and pension funds may be permitted to invest in papers with a lower rating. Regulators can prescribe weights to mitigate the risks associated with investments in papers which are rated lower than AA. The default history is available with agencies and so it is possible to define risks weights.
What is the outlook for 2010-11 and what will drive business?
The agency does not provide specific guidance for business performance. The economy has come out of the slowdown that marked 2008-09 and 2009-10. We expect credit growth to be better this year. Basel-II implementation is expected to provide growth opportunities in the short to medium term.
However, revenue and profitability growth is likely to be moderated by the increasing proportion of relatively smaller-ticket business.
Also, there are enhanced possibilities of risk-based pricing by banks, as loan exposures get rated under Basel-II.
With increased competition among agencies and volatility in global financial markets, there must be some risks that Icra will have to grapple with?
There is a risk from protracted slowdown and disruption in domestic debt/capital markets. Also, prolonged slowdown in economic or investment growth can impact business activity.
The squeeze on profit margins from pricing and cost pressures, and increasing proportion of relatively smaller-ticket business are some issues that will engage our attention.
Besides competitive pressures from other ratings agencies, ability to retain and attract quality manpower; increasing compensation and operating costs will impact performance.
What will propel growth in the medium to long term?
Higher corporate issuances in the local debt market, which is relatively underpenetrated, will give business in the medium to long term. Likely continuance of growth in credit demand and improvement in capital markets are expected to drive financial sector-related issuances.
While rating remains the mainstay, other segments like consulting and outsources services are expected to chip in substantially.
Large investments, including infrastructure projects, will lead to an increase in funding requirements. The concerns over management of foreign exchange inflows will give a push to steps for reviving the debt market.
