A robust credit rating system is key for India

A recent Sebi decision to scrap Brickwork Ratings' licence has sent a strong message. Now, courts must consider carefully the issue of investor protection as many funds rely on rating agencies to deploy the household savings of citizens

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The capital market regulator's extreme step of cancelling the licence of credit rating agency Brickwork Ratings got the financial sector to miss a heartbeat on October 6. Whole time member Ashwani Bhatia's 51-page order asked Brickwork Ratings to wind down its business in six months and barred it from taking on new clients.

It is not often that a big financial firm gets its licence cancelled in India; therefore, the messaging from the Securities and Exchange Board of India (Sebi) has sent shockwaves through the industry. While the firm will appeal the decision and probably get a stay from the court, we must look at the issue through the lens of investor protection rather than the impact on the business of the firm, its employees, the papers it rated, and its clients.

Put simply, a bond is a promise by the borrower to the lender to pay a certain rate of interest, at a certain periodicity and the return of principal in exchange for a loan. To create a market where there are unknown lenders and borrowers, the evaluation of the risk of default of both interest and principal becomes important. How will the buyers of bonds understand the risks of thousands of businesses that are borrowing by issuing bonds? This problem was solved by credit rating agencies whose job is to evaluate the business and the risk, and then give their "opinion" on the quality of the paper. This risk is denoted by a series of alphanumeric symbols - for example, a triple-A or Al rating denotes very low risk to the lender, and a D-minus or A4 rating points to very high risk.