ROLE OF CREDIT RATING AGENCIES IN BANKING REGULATION:

ABSTRACT:

By offering impartial evaluations of credit risk, Credit Rating Agencies (CRAs) significantly contribute to the improvement of financial regulation. Their ratings assist banks evaluate the financial health of borrowers, establish capital adequacy requirements, and comply with regulatory frameworks such as Basel regulations. CRAs help banks manage portfolio risks and make wise lending decisions by providing clear and consistent risk information. Credit ratings are also used by regulators to keep an eye on systemic stability and make sure institutions have enough safeguards against possible defaults. Concerns about rating accuracy and conflicts of interest underscore the need for more stringent regulation, even though CRAs help maintain market discipline. All things considered, CRAs continue to be a crucial part of contemporary financial regulation.

Introduction:

Credit Rating Agencies (CRAs) play an important role in modern banking regulation by providing objective assessments of credit risk. In an increasingly complicated financial climate, banks rely on accurate data to assess the safety of lending and investment decisions. CRAs address this need by examining the financial health, repayment capacity, and long-term stability of borrowers, which include corporations, governments, and financial institutions. Their ratings are important indications that assist banks assess potential default risks and maintain cautious credit exposure. Regulators also use CRA ratings to determine capital adequacy requirements, monitor systemic risks, and ensure that banks follow solid risk-management methods. By fostering transparency, CRAs help to reduce information asymmetry between lenders and borrowers. Despite some criticism, credit rating agencies continue to play an important role in the banking regulatory framework, helping to maintain financial discipline, investor trust, and general market stability.

Review of literature:

1. 1. According to Robert and Gary (1994), a rise in non-performing loans rather than inefficient operations is the most obvious sign of failing banks. Non-performing loans in failed banks have generally been associated with local macroeconomic problems.

2. According to DeYoung and Whalen (1994), the US Office of the Comptroller of the Currency discovered that the quality of management was what separated failing banks from those that were sound or had recovered from issues. Superior mangers not only run their banks in a cost efficient method, and hence make significant profits relative to their rivals, but also apply better loan underwriting and monitoring criteria than their peers which result to superior credit quality.

3. According to Patricia Langohr and Herwig (2010) By guiding institutional investors' asset allocation, credit rating agencies play a critical role in capital markets as private capital moves freely around the globe in quest of the optimum risk-return trade-off. They have, however, also come under heavy fire for their inability to recognize the Asian crisis in the early 1990s.

4. According to Owojori et al. (2011) emphasized the data that was available from the dissolved banks. The incapacity to recoup loans and advances made to customers, directors, or businesses connected to directors and management was a major contributor to the suffering of the banks that were liquidated.

Origin of credit rating agencies:

Credit rating organizations emerged in the early twentieth century as investors sought accurate information about bond issuers. Moody's, the first modern agency, was founded in the United States in 1909 by John Moody, who issued studies of railroad firms' financial health. This concept emerged as financial markets expanded, particularly during the Great Depression, when openness and risk assessment became increasingly vital. Other significant agencies, such as Standard & Poor's and Fitch Ratings, emerged over time. Initially centered on corporate bonds, they gradually expanded to include government debt and structured finance, becoming critical institutions in global financial markets.

Later, they started appearing as a huge spectrum of knowledge about diverse businesses. In 1909, John Moody published only on railway bonds which became the first to be published worldwide in approachable format and his company was the first company which charged subscription fees to investors.

What are credit rating agencies:

Credit rating agencies (CRAs) are independent institutions that assess borrowers' creditworthiness. These borrowers could be businesses, financial organisations, governments, or any other body that issues debt instruments like bonds or debentures. A CRA's principal job is to determine the likelihood that the borrower will return the loaned amount on schedule. CRAs consider a variety of variables, including the entity's Economic well-being, previous repayment history, business performance, economic environment, management quality, and market conditions. After assessing these factors, they issue a credit rating, which is usually in the form of alphabetical grades (such as AAA, AA, BBB, and so on), indicating the level of risk involved with lending to that organisation.

International credit rating agencies:

· Standard & poor’s (S & P).

· Moody’s investors service.

· Fitch ratings

Indian credit ratings agencies:

· India ratings and research (Ind-Ra)

· CARE Ratings, (Credit Analysis and Research Ltd)

· CRISIL, (Credit Rating Information Services of India Limited)

· ICRA, (Investment Information and Credit Rating Agency)

What is CIBIL score:

A CIBIL score is a three-digit number that assesses a person's creditworthiness based on previous borrowing and repayment history. It normally runs between 300 and 900. A higher score implies responsible credit conduct, which makes it simpler to obtain loans, credit cards, and lower interest rates. The score is based on characteristics such as payback history, credit utilization, categories of credit, and length of credit history. Banks and lenders use this score to determine the risk of providing money to an individual. Maintaining regular payments, moderate credit usage, and a balanced credit mix will help you develop and maintain a decent CIBIL score.

Relationship between cibil score and credit rating agencies:

1. Diverse Focus Areas

· Credit rating agencies (CRAs), such as CRISIL, ICRA, CARE, and India Ratings, assess the creditworthiness of businesses, financial institutions, and government instruments.

· TransUnion's CIBIL Score assesses the creditworthiness of individual consumers (retail borrowers). Thus, CRAs deal with institutional/large-scale ratings, whereas CIBIL works with individual credit scores.

2. Common objective:

· CRAs and CIBIL share the goal of assessing credit risk. CRAs evaluate a company's likelihood of repaying debt, whereas CIBIL evaluates an individual's likelihood of repaying loans or credit card dues.

3. Data dependency:

· CRAs employ financial statements, project reports, cash-flow data, market situations, etc. CIBIL gathers information about loan repayment history, credit utilization, account count, and other factors from banks and NBFCs. Both rely substantially on accurate and timely information from lenders.

Role of credit rating agencies:

Credit rating agencies assess the creditworthiness of governments and their assets, as well as the relative credit risk of specific debt securities, structured finance instruments, and borrowing institutions.

· Credit rating establishes a relation between risk and reward. They have become a benchmark in measuring the risk for any instrument.

· In the absence of a credit rating system, a common investor’s impression of risk is heavily influenced by his acquaintance with the names of the partners or promoters.

· Investors use ratings to analyse risk levels and optimise their risk-return trade-off. They compare the provided rate of return to the expected rate of return for the specific level of risk. -Return trade-off

· Offering each potential investor the chance to complete a thorough risk assessment is not feasible for the corporate issuer of a debt instrument.

CRA’S important role in financial services:

Credit Rating Agencies (CRAs) are specialist organizations that assess financial instruments, governments, and businesses for creditworthiness. Their ratings aid investors in comprehending the degree of risk associated with making loans or purchasing securities.

Risk Assessment:

· To ascertain the issuer's capacity to repay loans, CRAs examine financial statements, corporate performance, market conditions, and governance structure. This aids investors in evaluating various investment possibilities according to risk tolerance.

Investor trust:

· Ratings serve as an impartial assessment of credit risk. More investors are drawn to higher-rated assets, which boosts market confidence.

Market Self-Control:

· Issuers are compelled by low ratings to enhance corporate governance, financial discipline, and transparency in order to preserve investor confidence.

Encouraging the Mobilization of Capital:

· Governments and businesses with high ratings are able to raise money at reduced interest rates. This promotes economic development, company growth, and infrastructure expansion.

Use of Regulation:

· Ratings are frequently used by financial authorities to establish standards for capital adequacy, investment eligibility, and risk management for banks and other financial organizations.

Advantages of credit rating agencies:

· Helps Investors Make Informed Decisions: Credit ratings provide a clear understanding about the safety and risk level of bonds, debentures, and other financial instruments. This aids investors in selecting appropriate assets according to their ability to take on risk.

· Reduces information asymmetry: Diminishes Information Inequality Rating agencies collect, verify, and evaluate financial data of companies. This lowers the gap in information between the issuer and investors, improving openness in the financial mark.

· Lower Cost of Borrowing for Good Issuers: Companies having a good credit rating are considered low-risk. As a result, individuals can raise funds at a reduced interest rate because lenders trust their payback capabilities.

· Improves Market Discipline: Regular ratings urge organisations to maintain good financial practices, robust governance, and timely disclosure to keep or improve their rating.

· Assists Regulators and Banks: Credit ratings are used by banks and regulators to evaluate compliance, capital needs, and risk exposure. By doing this, instability is avoided and the financial system is strengthened.

Disadvantages of credit rating agencies:

· Conflict of Interest: Most CRAs use a "issuer pays" model, which means that the firm seeking the rating pays the agency. Agencies may feel pressured to offer high ratings in order to retain clients, creating a conflict of interest.

· 2. Potential for Inaccurate or Biased Ratings: Rating are based on the opinions, presumptions, and information that analysts have access to. If these are faulty or incomplete, the rating can be misleading, causing investors to take poor conclusions.

· Investors' Over-Reliance: Ratings are viewed by many investors as the sole measure of safety. If the rating turns out to be incorrect, this over-reliance diminishes their own analysis and could result in bad investing choices.

· Rating Lag / Slow Updates: CRAs are often tardy in revising ratings when a company’s financial status changes. Delays in downgrading might result in significant losses for investors during financial crises.

· No Guarantee of Accuracy: A high credit rating does not mean that default will not occur. Companies with strong ratings have failed in the past, proving that ratings are not failsafe.

Recent case studies:

During a recent parliamentary session, Congress MP Karti Chidambaram expressed serious concerns about the CIBIL credit score system's lack of openness, data veracity, and dispute resolution methods. He said that in the lack of an effective redressal process, the financial hardships encountered by a major percentage of the people are worsened.

What Karti Chidambaram inquired about?

· He described CIBIL as "a private company" that scores everyone's credit history, but "we do not know whether they are updating our credit history properly." He told the Lok Sabha that CIBIL's credit-scoring system "lacks transparency."

· He expressed worry that borrowers, including farmers and others, frequently discover that repayments including subsidies or settled loans are not accurately reported in their credit records, unfairly lowering their "score."

· He noted that there is “no way for us to appeal,” i.e. no effective redressal mechanism for persons who believe their credit history is erroneous.

What information is available since the parliamentary inquiry?

· According to reports, CIBIL received over 22.95 lakh complaints in 2024–2025, of which approximately 5.8 lakh were the result of mistakes made by CIBIL. Chidambaram's fears are supported by the numerous complaints, many of which are concerning CIBIL's own "errors." The Reserve Bank of India (RBI) advises banks not to deny loan applications based only on a borrower's lack of credit history. At the same time, the government (via the finance ministry) stressed that a credit score is not required for first-time borrowers.

What Chidambaram wants and what might change?

· greater openness about the collection, reporting, and scoring of credit history, particularly with regard to how updates (repayments, settlements, and subsidies) are reflected. A strong redressal mechanism is a straightforward, user-friendly procedure that allows anyone to challenge or rectify inaccurate data. Stronger inspection or regulation of private credit bureaus like TransUnion CIBIL might be necessary to prevent such systemic problems from continuing unchecked.

Suggestion:

· Improve Transparency in Rating Methodology CRAs should clearly explain how ratings are generated, including risk models, assumptions, and data sources.

· Steer clear of conflicts of interest Ratings may be impacted by the popular "issuer-pays" concept. Independence can be guaranteed via an investor-pays hybrid model or a regulated fee system.

· Frequent Observation and Prompt Updates Instead of delaying downgrades during times of crisis, ratings must be regularly reassessed to reflect changes in the market.

· Increased Penalties and Accountability Regulatory agencies should impose liability for significantly erroneous ratings originating from negligence.

· Enhance Rating History Disclosure Investors can assess accuracy and long-term dependability by looking at previous rating revisions. Adopt Data Analytics and Technology Improve default prediction and risk assessment by utilizing AI, machine learning, and big-data platforms.

Conclusion:

The conclusion for "Role of Credit Rating Agencies in Banking Regulation" is as follows: --- Conclusion By offering an unbiased evaluation of credit risk, credit rating agencies are essential to bolstering financial regulation. Their ratings assist banks in managing overall financial stability, maintaining sufficient capital under regulatory frameworks such as Basel requirements, and making well-informed lending decisions. By acting as a bridge between regulators, investors, and financial institutions, CRAs promote openness and reduce information asymmetry in the financial system. However, their influence also necessitates thorough control to prevent conflicts of interest and ensure accuracy. As a result, even while CRAs greatly aid in banking supervision, their efficacy depends on ongoing oversight, accountability, and advancements in rating techniques.

Author’s Guide:

1.    Mr.C.Ajay, Assistant Professor, School of Law, Dhanalakshmi Srinivasan University,

2.    M.Abinesh, School of Law, Dhanalakshmi Srinivasan University,

3.    V.Abimanyu, School of Law, Dhanalakshmi Srinivasan University.