Should we rate the rating agencies?

22 June 2012 05:20 am - 0 - {{hitsCtrl.values.hits}}

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By Michael Soris
This writer is by no means an expert on credit ratings or even financial affairs and therefore not in any position to give an expert opinion in this area. But I think it’s time that we seriously analyzed what is being reported in newspapers, as a couple of days ago, it was said that Sri Lanka’s banking economic risks are very high, according to Standard & Poor’s (S&P).

Conflicting official opinions
This agency assigned Sri Lankan banks to its Banking Industry Country Risk Assessment (BICRA) group ‘8’, which reflects ‘very high risk. BICRA group ‘1’ represents ‘lowest risk’, while BICRA group ‘10’ signifies ‘highest risk’. The international rating agency also assigned Sri Lanka to an economic risk score of ‘8’ and an industry risk score of ‘7’.

According to S&P, the other notable countries in the BICRA group ‘8’ are Nigeria, Tunisia and Kazakhstan.

Another report in the same newspaper said that despite an increasing trend in non-performing loans (NPLs) being recorded in the first quarter, the International Monetary Fund (IMF) has expressed confidence in the stability of Sri Lanka’s banking system.
Speaking at a recent press conference, the IMF reviews mission chief, Dr. John Nelmes, who was visiting Sri Lanka had said, “There is a small issue in terms of non-performing loans in the banking system but this is really a very small issue. Overall, the banking system remains sound, solid and well capitalized with a strong liquidity position.” “To date, there has been a very small increase in the NPLs. However, these are natural movements that you can expect to see in this macroeconomic environment,” he added.

So, where does one stand from the point of view of understanding the real picture? How much do we believe in the opinion of this rating agency? And if we do believe, then what action do we take? Should we be taking precautionary measures like withdrawing our money from the banks?

Rating rating agencies
On the other hand, is this responsible reporting by the rating agency? As equating Sri Lanka to Nigeria is almost like being damned to hell. Well, if one reads further into the S&P report, there are some redeeming factors that were beyond the headline. This brings me to another point, i.e. who rates the rating agencies, especially when they have been known to be unreliable in their opinions and forecasts!

I recently read a report in the Arbitrage Magazine that the US Congress is pressing on with its investigation on credit rating agencies and whether the firms overlooked crucial information that led to MF Global Holdings’ bankruptcy. The Chairman of the House Financial Services subcommittee sent letters to the Chief Executive of Moody’s and the President of Standard and Poor’s inquiring on the decision process that determined MF Global’s credit score.

MF Global Holdings Ltd., the holding company for the broker-dealer run by ex-Goldman Sachs Group Inc. (GS) Co-Chairman Jon Corzine, filed for bankruptcy protection last November after making bets on European sovereign debt. Its broker-dealer unit, MF Global Inc., faces liquidation. The firm listed debt of $39.7 billion and assets of $41 billion in Chapter 11 papers filed in U.S. Bankruptcy Court in Manhattan.

The Arbitrage Magazine also reports that United States is not the first to question the trustworthiness of rating agencies. EU leaders expressed frustration towards these firms in 2011 at the height of the eurozone crisis. It says that the three most influential companies – S&P, Moody’s, and Fitch – grade government and corporate debt (AAA, as the top notch rating) by diving into financial documents and analyzing current events. The credit score aids investors in their decision to invest and improves transparency in the system.

Protecting market sanity
A few understand why these companies are as influential as they are, but they undoubtedly have enormous power over global investment decisions. Markets esteem credit ratings as one of the most important indicators of the quality of assets and a downgrade from any one of these agencies can trigger a massive sell-off.

“As the referees on the sideline, who watch as events unfold and blow the whistle when needed, rating agencies have become one of the players who kicks the ball and alters the game. They push investors towards decisions that otherwise may not have occurred to them.

When the EU’s member states were trying to contain the crisis last year, S&P, Moody’s and Fitch downgraded European sovereign bonds at the worst timing: A few days before critical EU summits or before bond auctions.”

The Arbitrage Magazine says that they destroyed market confidence at the most crucial moments for Europe and because of these untimely downgrades, the rescue cost for Europe went up and bond auctions yielded disappointing selling results.
This Paradigm Shift column is in no way saying that we are not in need of rating agencies to analyze us, but for the sake of sanity in our markets there has to be some authority (hopefully independent) interpreting this information before it comes into public space! We have to learn from the mistakes of the West and not leave everything to the Laissez-faire formula.

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