Disadvantages of Credit Rating Agencies

1. Evaluation Is Highly Subjective There are no standard formulas to establish an institution’s credit rating; instead, credit rating agencies use their best judgement. Unfortunately, they often end up making inconsistent judgments, and the ratings between different credit rating agencies may vary as well.

2. There Can Be Conflict of Interest The credit rating agencies usually provide ratings at the request of the institutions themselves. Although they sometimes conduct unsolicited evaluations on companies and sell the ratings to investors, they usually are paid by the very same companies they are rating.

3. Ratings Aren’t Always Accurate Although credit rating agencies offer a consistent rating scale, that does not mean that companies are going to be rated accurately. For many years, the credit ratings of these agencies were rarely questioned. However, after rating agencies provided AAA ratings for the worthless mortgage-backed securities that contributed to the recession, investors don’t have nearly as much faith in them. Their ratings are still referenced by almost everyone, but their credibility has taken a serious hit.

What is mean by Good Credit Scores ?

Whether a score is good or not would depend on the bank’s internal policy, its customer profile and its risk appetite. Some banks may perceive 700 as a decent score and another may not. Therefore, in India, different banks will rank different scores as good. Still, any score over 700 may be considered good by banks. However, a credit score is only an indicative tool for managing risks, and its effectiveness depends on the internal control mechanism of the bank in question. An objective thing such as credit score will not only help a bank to reduce defaults but also make loan disbursing much faster, improve operational efficiency and brings costs down.

A good credit score will indicate the character of the borrower concerning financial matters. The following are some indicators of a good score.

1. Evidence of financial discipline.
2. If the borrower has defaulted payments once or twice due to reasons beyond their control, those will show up as clear aberrations in overall consistent payment history.
3. The longer the credit history, the better. The lender’s assessment presumable improves as he gets more significant spans of repayment. One should be cautious about closing old accounts and opening new ones.

• It helps in analysing one’s right financial standing and make plans for future finances.
• One can be on top of their borrowing and avoid debt traps.
• With a Credit Information Report in hand, he or she will be in an excellent position to make decisions concerning availing new forms of credit, while also being able to extract the best possible rates from banks or lenders.
• It helps in cultivating financial discipline.

• On time loan EMI payments.
• Regular payments of credit card bills.
• Completely paying off credit card bills rather than paying a minimum due amount always.
• Avoiding over-leveraging.
• Managing strong financial records.
• Multiple forms of credit (such as unsecured personal loans) among family member.
• Proper utilisation of approved credit limit.
• Ensuring banks and other financial institutions with a record and submit positive information to CIC’s.
• Requesting to maintain a copy personally rather than through financial institutions.

• Multiple credit report enquiries by banks and institutions.
• Bouncing of Cheques/ dishonours.
• Irregular repayment of loans.
• Defaulting on credit card bills/ late payments or consistent part payments.
• Too many unsecured credits such as multiple personal loans.
• Multiple applications for unsecured loan getting rejected.
• Defaulting as a guarantor.
• High utilisation of approved credit limit or overshooting the limit.
• Error in records by banks and other financial institutions.

• Even after all these guidelines, there are series of high-profile disasters in stock markets including AAA-rated instruments. It means there is serious credibility issue of credit rating agencies and the questionable methods adopted by them. Such manipulation can happen only under two conditions either rating agencies are not competent, or they have a defective methodology for the rating of the debt instruments.
• If rating agencies have credible and time-tested methodology, in that case, there is a deliberate attempt to suppress  facts due to some motivation or some understanding between the credit rating agencies and the promoters of the instrument which is to be rated. In both the cases, there must be a proper investigation and suitable action should be taken to send a message to concerned agencies to stop manipulating behaviour.
• Is this the way rating agencies want to earn the confidence of regulators and want to protect public trust? That is why EU wants to reduce the dependency on a few Rating Agency and want full disclosure by fundraising entities. The issue is why the status of various litigations are missing from IIFL prospectus? Media and regulators must scrutinize all the rating certificates of all IPOs, new offers. Promoters and rating agencies must be made accountable for hiding the facts which are already in the public domain.

• Concerned Authorities must study this case in detail and identify the reasons for hiding the facts from the investors. If required, modify the Guidelines for Credit Rating Agencies Reporting formats to avoid stale and misleading rating certificates for raising money from the market. After NPAs due to bad project evaluations by top bankers, now this is time to ensure tight regulations for credit rating agencies. Please note no one is saint in this business.
• Top Management and largest shareholder of Credit Rating agencies must be made accountable for their acts and omissions. Their act is shaking the confidence about governance in India and bringing a bad name to the country. No should be allowed to play with the national interest and interest of minority shareholders.