The story so far: Ratings agency S&P on Friday upgraded Kotak Mahindra Bank (KMB)’s ratings to ‘BBB’ from ‘BBB-’ after the Reserve Bank of India (RBI) lifted restrictions that barred the private lender from onboarding new customers and issuing fresh credit cards. Elaborating on the rationale, it held that the private lender was “well positioned” for growth in the next two years and “likely” to maintain “strong capitalisation”. “This, together with the banks’ good risk management and strengthened technology infrastructure, will support growth, particularly in new credit card issuances and digital onboarding,” it held.
What exactly had happened?
In April last year, the apex banking regulator placed restrictions on KMB after having observed “serious deficiencies and non-compliances” about its IT inventory and user access management, data leak and leak prevention strategy, business continuity and disaster recovery rigour and drill, among other things. This was based on the regulator’s examination of the private bank’s systems for two years, that is, 2022 and 2023. The bank was also deemed non-compliant with RBI’s subsequent recommendations or ‘Corrective Action Plans’ (CAPs).
Back then, S&P had held apprehensions about the restriction to be a potential setback to their credit growth and profitability. It had observed that credit cards were KMB’s “higher-yielding target growth segment”. For perspective, the portfolio grew 52% YoY as on December 31, 2023, compared with a total loan growth of 19%.
However, it refrained from altering their ‘BBB-’ rating. According to the agency, credit cards made up only a “small” 4% of their total loans as of December-end 2023.
What are ratings agencies and why are they important?
Rating agencies assess the credit worthiness and financial health of corporations, sovereigns, equities and bonds. Their reports are used by potential investors and lenders in making an informed decision about the assessed entity’s ability to meet payment obligations. In other words, they rank a corporation, equity or debt’s financial stability and/or its potential for high or low risk of default. Rating agencies periodically re-evaluate a rating in tandem with larger socio-economic and/or company-specific developments. These could entail a slowing lending economy, higher interest rate regime or in KMB’s case a regulatory action.
According to the United Nations’ Conference on Trade and Development (UNCTAD), the underlying logic of credit rating agencies is to avert the information asymmetry between borrowers and lenders about the latter’s creditworthiness. It further explains that issuers with lower credit ratings pay higher interest rates – reflective of the greater associated risk with lending to them, than the higher rated issuers.
What grading pattern do they follow?
The three prominent ratings agencies, viz., Standard & Poor’s, Moody’s and Fitch subscribe to largely similar grading patterns.
Standard & Poor’s accord their highest grade, that is, AAA, to countries, companies or bonds with the exceedingly high capacity to meet their financial commitments. Its lowest grade is ‘D’, accorded to entities with high probability of payment default or breach of an imputed promise. This is particularly accorded in case the concerned entity has filed for bankruptcy. Its grading slab includes letters A, B and C with an additional single or double letter denoting a higher grade.
Moody’s separates ratings into short and long-term definitions. The former involves obligations maturing in thirteen months or less whereas the latter involves obligations maturing in eleven months or more. Its longer-term grading ranges from ‘Aaa’ to ‘C’, with ‘Aaa’ being the highest. The succession pattern is similar to S&P. The short-term ratings scale ranges from P-1 to NP, with P-1 being the highest.
Fitch, too, rates from AAA to D, with D being the lowest. It follows the same succession pattern as Moody’s and Fitch.
Are their examples of how rating agencies have impacted banks and NBFCs in India?
Rating agencies draw their observations based on publicly available data, disclosures to exchanges and knowledge about a corporation or a sovereign. Downgrades could potentially invite further closed regulatory monitoring to ensure companies are closer to minimum operating requirements and avert a collapse.
In October 2011, Moody’s downgraded the State Bank of India (SBI) citing modest capital and declining asset quality, putting pressure on the government to inject money into the bank, Reuters reported. The downgrade led to the state lender’s scrip declining to a two-year low on BSE. The grim impact reverberated on the markets particularly on financial stocks. Thereafter, in March a year later, the state lender received a ₹7,900 crore capital infusion by the government.
Conversely, on downgrades from regulatory actions, non-banking financial company Mannapuram Finance’s shares slumped 16%, an over four-year low, following downgrades apprehending a potential hit to earnings, Reutersreported. This was after RBI had barred Asirvad Micro Finance (the microfinance arm of Manappuram Finance) alongside Arohan Financial Services, Mitsubishi UFG-backed DMI Finance Private, and Navi Finserv from disbursing and sanctioning of loans.
Were rating agencies accused of a role in the 2008 global financial crisis?
U.S.’ Financial Crisis Inquiry Commission (FCIC) in a 2011 report held rating agencies Moody’s, S&P and Fitch as “key enablers of the financial meltdown”. It held that the mortgage-related securities – which were at the centre of the crisis, “could not have been marketed and sold without their approval”. According to the report, “Thier ratings helped the market soar and their downgrades through 2007 and 2008 wreaked havoc across markets and firms”. In other words, the initially favourable ratings were crucial to facilitate the sale of the bonds, in turn, the housing boom in the U.S. between 1998 and 2006. When the price ceased to rise and instead began to fall later, the mortgage borrowers began to default.
The FCIC further observed that Moody’s rated nearly 45,000 mortgage-related securities as AAA between 2000 and 2007. In contrast, only 6 private sector companies carried this rating in early 2010.
Published – February 23, 2025 12:07 pm IST
