A new Reserve Bank of India (RBI) rule linking banks' assessment of borrower risk to the past track record of local rating firms has created a significant divide within the credit rating industry. According to reports from Mint, the guideline issued in April and applicable from April 2027 effectively penalizes rating agencies whose default rates breach prescribed thresholds for various categories of ratings. This means that if a rating agency's default rates exceed RBI thresholds, lenders will have to treat borrowers rated by it as riskier than their assigned ratings suggest, leading to higher borrowing costs. The RBI has already circulated a draft proposal among rating agencies but is yet to make it public, with the regulator currently engaging with credit rating agencies on the methodology for computing observed default rates.
The RBI has set specific acceptable default rates across different rating categories. As reported by Mint, for instance, the RBI has set an acceptable default rate of 0.2% to 0.4% for 'BBB'-rated borrowers. If a rating agency's default rate exceeds 0.4%, banks will treat its 'BBB' ratings as 'BB'—one bucket lower. This means banks would need to assign a risk weight of 100% for such a borrower ('BBB' becoming 'BB'), for which it would have otherwise assigned 75%, leading to higher capital consumption. Industry executives confirmed this will be applicable to existing ratings as well as fresh ones. Under the draft norms, the RBI is in favour of using one-year default rates, averaged over the past four years, which means banks will have to set aside more capital to cover potential losses, making them either reluctant to lend or more likely to charge higher interest rates.
According to data reported by Mint, industry executives said that to check default rates, one needs to look at the one-year transition rates of ratings, averaged for the past five years. These show how many ratings from a particular category have been downgraded, with the number of ratings moving to the default category acting as a proxy for the levels specified by the RBI. Based on these calculations, all seven rating agencies' 'AAA' and 'AA' ratings meet the RBI benchmarks, meaning borrowers in these categories show default rates within acceptable limits. However, Acuite, Infomerics, and Brickwork fail to meet A rating of the RBI-prescribed default thresholds, with these three along with India Ratings failing the 'BBB' category, and all failing the 'BB' category. A spokesperson for CareEdge Ratings said that the performance for the investment-grade category is fully compliant with RBI's benchmark ranges, reinforcing the robustness of its rating framework.
Smaller rating agencies are expressing significant concerns about the new guidelines. As reported by Mint, a rating agency executive who spoke on condition of anonymity said, "This will badly hit our business as companies will not be willing to come to us anymore." The credit rating industry via its association AIRA (Association of Indian Rating Agencies) has made a submission to RBI seeking clarification on several points, including what can be included in probability of default calculations and the cohort duration. Manu Sehgal, chief executive officer of Brickwork Ratings, confirmed that based on internal reviews and calculations, Brickwork's default rates are within RBI-prescribed ranges across all borrower cohorts. "Once we get the final clarity from RBI, that updated data of default rates will be published on the website," Sehgal said. Emails sent to Infomerics and Acuite remained unanswered, while a spokesperson for India Ratings declined to comment.
Despite concerns from smaller agencies, older agencies view the RBI rule as a clear differentiator. According to Mint, K. Ravichandran, executive vice-president and chief ratings officer at Icra Ltd, said the RBI is currently engaging with credit rating agencies on the methodology for computing observed default rates. "As these discussions are confidential, Icra is not in a position to comment on the specifics," said Ravichandran. Icra views the proposed framework as a constructive step towards strengthening analytical standards and enhancing differentiation across credit rating agencies. A spokesperson for Crisil directed Mint to a note on its website that said steps that differentiate credit rating agencies by quality are welcome. The industry is divided between those that see the RBI rule as a constructive step towards strengthening analytical standards, and those concerned about potential business impact. Prakash Agarwal, a partner at debt market advisory firm Gefion Capital Advisors, noted that the RBI circular is likely to discourage rating shopping by borrowers, as the historical performance of the rating agency could directly influence the capital treatment of exposures and credit availability.
