How IL&FS colluded with rating agencies

With rating agency ICRA sending its CEO Naresh Thakkar on leave citing regulatory concerns, the role played by the rating agencies -- highlighted innumerable times in the past -- has once again come under the spotlight. An anonymous complaint alleged that there were lapses when ICRA assigned a high rating of 'AAA' to IL&FS.

The complainant alleged that ICRA's top brass had meddled in assigning high ratings to IL&FS and its subsidiaries. This is the first time that exemplary action has been taken unilaterally by an organisation in the gargantuan IL&FS scam. India Ratings and Research Pvt. Ltd, ICRA and Credit Analysis and Research Ltd (CARE) had assigned IL&FS the highest rating of 'AAA', even when its subsidiary, IL&FS Transportation Networks Ltd, defaulted in June last year.

The Serious Fraud Investigation Office (SFIO) report points out gaping holes in the style of functioning of rating agencies which were complicit with the rogue management.

Here is the modus operandi: Credit rating agencies (CRAs) used to have a meeting with the management of IFIN, wherein managing director Ramesh Bawa used to lead the IFIN team wherein the management's response on loan portfolio, asset quality, capital infusion plans and group exposure was taken by the CRAs. On the basis of the factual details as provided by IFIN and on the basis of the interaction with the managing director and or the other individuals of the coterie like Arun Saha, compromised rating agencies used to provide a rating to the instrument of IFIN.

This collusion between the Bawa/Saha-led management and rating agency led to the ruination of the shadow banks which continued to function due to the 'triple A' rating given by these agencies.

The RBI in its directions contained in Master Circular - Prudential Guidelines on Capital Adequacy and Market Discipline - New Capital Adequacy Framework (NCAF) to All Scheduled Commercial Banks vide Circular No. DBOD. No. BP. BC. 73 /21.06.001/209-10 dated 08.02.2010 has laid down that the borrowings shall be risk weighted as per the ratings assigned by the ratings assigned by the ratings agencies registered with SEBI and accredited by the Reserve Bank of India.

Therefore, the borrowers from banks are required to obtain a credit rating of the borrowing instrument from an accredited Credit Rating Agency (in short CRA) to enable the banks to invest the funds in IFIBN.

The private placement of debentures by NBFCs are guided by Companies Act. 2013 and Rules framed there under, SEBI regulations and RBI guidelines/instructions/directives on the subject. As per SEBI (issue and listing of debt securities) regulations, 2008, the issuer of a debt instrument which is proposed to be listed, has to obtain an external credit rating from credit rating agency registered with SEBI.

Similarly, issue of commercial papers are guided by RBI guidelines/instructions/directives on the subject. As per the guidelines issued at various points of time "Eligible participants/issuers shall obtain credit rating for issuance of CP from any one of the SEBI registered CRAs. The minimum credit rating shall be 'A3' as per rating symbol and definition prescribed by SEBI."

The SFIO investigation report says that IL&FS Financial Services or IFIN had obtained credit rating of its instruments from external credit rating agencies. The Credit Rating Agencies had examined various parameters of IFIN viz. its capital adequacy, asset quality/quality of earnings, parentage and management linkages etc. while giving the ratings to the instruments of IFIN. For carrying out their analysis. CRAs had relied upon the audited financial statements of IFIN and had based all their rating decisions upon the same.

The CRAs follow hierarchies where in the evaluation of the issuer i.e. IFIN and its instrument is carried out by its analysts, who prepare the rating memos/rating notes after obtaining and evaluating all the material aspects, rating agencies takes up the mandate on the basis of the Agreement between the Client and the rating agency.

As per the agreement entered between the rating agency and IFIN, it is seen that IFIN was required to provide the details which inter alia include outstanding debt, details of delay/default (if any) in meeting debt service obligations, latest financial results, operational details, financial projections and details of ongoing/planned capital expenditure along with its costs and means of finance etc.

It is seen from the Credit Rating Committee Memorandums/notes, that IFIN used to provide to the CRAs its Financial results, Asset Classification, Analysis of the Assets, Investment Profile, Credit History, Restructured Accounts, Details of Top Borrowers category wise, liquidity, Risk Profile and Resource Profile.