Home ›› 09 Apr 2023 ›› Editorial
Credit rating by an independent body is an effective device for assessing the strength of any financial institution in the redemption of future liabilities of investors.
Thus, credit ratings from reliable and impartial Credit Rating Agencies [CRA] manifest financial robustness with reference to specific criteria applicable to the institution. Excellent credit ratings of a manufacturing plant, bank, or financial institution enhance investor confidence. Both domestic and international agencies periodically provide credit rating standing —currently, eight CRA are entrusted with performing the task in Bangladesh. Three international agencies such as S&P Global Ratings, Moody's, and Fitch Ratings, work as valuable guidance from a global perspective, and their neutral rating is often considered an article of faith for other countries.
The current ranking of the banking sector of Bangladesh by Moody's from a rosy outlook in March 2022 to negative status is a blow to the overall favorable ranking. However, few predicted that 2022 would be as grim for Bangladesh. “But now, in a staggering reversal of fortune, it has downgraded the rating for the whole banking system." The negative outlook could signal a reckoning for the Bangladeshi banking sector, plagued by scams, corruption allegations, and nonperforming loans that accounted for 8.16 per cent of the total loans disbursed as of December 2022. Non-performing loans with the feature of impunity are a scar on the banking system. The responses to the problems have ranged from outright denial to downplaying their importance. The regulatory reticence and inaction against malpractice in state-owned banks and, of late, several large private banks caused the already "eroding confidence to reach a tipping point towards downgrading." Moody's lowered the rating of Social Islami Bank in December 2022 after the institution lost around $1.6 billion in loan scams. The agency also put the ratings of seven other Bangladeshi banks under review for downgrades.
The moody alert manifests the few symptoms of a sick economy; a weakened currency, edging double digits inflation, and declining reserves. The economy feels the pinch of the Ukraine war, and the uncertainty hidden in the world geopolitical arena could bring chaos to even a disciplined economy. The cross-border financial transactions may face a ceiling as a few overseas institutions, such as Dubai-based Mashreq Bank and Standard Chartered's Hong Kong office, declined letters of credit openings for at least two Bangladeshi banks. The number of new letters of credit slumped from 14 percent of the year in July to December last year.
Discordant parallelism may be observed in the rankings of the financial institutions by the domestic CRA with a foreign counterpart that could further impair the banking sector's NPL status, culminating in the overall bizarre confidence in the banking sector with ostensible bank runs. The CRA in Bangladesh is being forced by certain tricks by the banking sector for a better standing on the financial status that the measuring criteria could not justify—the ranking in a superior grade despite outstanding shortfalls and deviations. A few listed financial firms have recently received the highest credit rating despite poor performance.
In contrast, many advanced economies, including the US, still maintain AA or AAA credit ratings. Therefore, on a relative scale with a foreign counterpart, how do we equate in reference to fundamental criteria? Unfortunately, the superior ranking preludes to more investment and bulging NPL. This applies to an entity’s stock inflated share price and the chaos in the stock market. It is very uncertain to chart the movement of the share market in Bangladesh.
The demand for a better standing by the banking institution despite poor performance is under the purview of Bangladesh Bank. The Governor of the Bangladesh Bank expressed his concern in a meeting on April 2, 2023, with the representatives of the Association of Credit Rating Agencies in Bangladesh.
It is the discretion of the individual bank to select the CRA, so there could be a temptation to assign a fair grade for retention of jobs despite deficiencies and loopholes in the performance of the financial institution. The capital market regulatory agency, Bangladesh Security and Exchange Commission [BSEC] issue the CRA licensees, which are enlisted to Bangladesh Bank. The individual bank can provide a panel with a list of two or three agencies to Bangladesh Bank who may select a rating for an appropriate time with rotation. Indeed, some CRA with a low profile may be tempted to assign a superior grade as per the bank's demand even with poor performance or maintain a consistent rating exposing the bank to risk.
The dubious role of credit rating agencies in fueling the global financial crisis of 2008 is now an accepted fact. Indeed, the ratings of complex financial products such as Collateralized Mortgage Obligations [ CMO], Credit Default Swaps [ CDS], or Special Investment Vehicles [SIV] in the securitization ordeal were the culprit in the whole episode. Securitization is the process in which certain assets are pooled to be repackaged into interest-bearing securities- an attempt to diffuse the risk of the assets originating from the balance sheet to those other financial institutions such as banks, insurance companies, and hedge funds.
The role of independent credit rating agencies could have been more explicit who rated those mortgage-backed securities as AAA. Surprisingly, one unit of the firm provided consultancy on how to design these products to fetch a higher return, and another team rated these products using the format as was prescribed by the design unit. So, there was collusion on structured products. Indeed, independent credit assessment from the credit rating agencies was a significant drawback that deceived the investors who primarily rely on rating agencies to fix their portfolio of investment.
The state of the capital market is in its infancy in Bangladesh, and unfortunately, banks and non-banking financial institutions predominate the financial market structure. The concept of a subprime mortgage in developed economies, akin to lending to unworthy clientele with a poor credit record, is rampant in Bangladesh. It will be catastrophic if the trend of inflated ratings continues.
The writer teaches at BRAC University and BIDS as an adjunct Faculty in the Master's Programme in Economics. He can be contacted at [email protected]
