Basel II and credit rating of Bangladesh

Express (July 9, 2010)

Both public and private sector banks have large non-performing loans (NPL). The major part of these NPL is with the public sector enterprises. This means, the government is major defaulter of bank loan. There is allegation that the businesses take loan through political patronisation and don't pay back to banks.

Meanwhile, Bangladesh got credit rating from Moody's and Standard and Poor's (S&P). These country credit ratings are really good news for Bangladesh, which will give a positive signal to all stakeholders around world. Moody's Investors Service has assigned Bangladesh Ba3 rating meaning macroeconomic fundamentals of the country is better and it has less chance to face severe stress on creditworthiness. Another global agency Standard & Poor's after analysing the macro and micro economic conditions of the country has issued it the rating 'BB-' for long term and 'B' for short term. Bangladesh's rank is above Pakistan but lower than India in the sub-continent.

The rating broadly incorporated assessment of Bangladesh's reasonable degree of financial and balance-of-payments robustness which, coupled with prospects for continued macroeconomic stability, reduces the likelihood of severe stress on the country's creditworthiness, Moody's said in a statement. This is good news for the nation.

Credit risk is the primary financial risk in the banking system and exists in virtually all income-producing activities. How a bank selects and manages its credit risk is critically important to its performance over time; indeed, capital depletion through loan losses has been the proximate cause of most institution failures. Identifying and rating credit risk is the essential first step in managing it effectively.

On the other hand Bangladesh agreed to implement Basel ll. The major objective of Basel II is to revise the rules of the Basel Capital Accord to link the capital closely with their risks, taking account of progress in the measurement and management of these risks and the opportunities, which provide for strengthened supervision. But policy makers pay less attention to the credit risk as well as control over the credit risk measurement and regulatory capital control. A mare provisioning of profits of nationalised banks to help the banks under policy framework of national budget seems like a support to banks, which fail to perform despite all policy support. These extra provision from profit is a national loss. We recognise the problem in the policy paper like budget but don't take any positive steps to reduce NPL. We are more engaged in blame game and shifting responsibility over to some others shoulders like borrowers and politicians.

There is a procedure of assessment of projects by bank officials who have no expertise to do the job. This job is a very specialized job and done by Credit rating agencies (CRAs). Their assessment is done as per the guidelines of Investment policy of Bangladesh Bank. Banks should use credit rating by CRA before investment.

CRAs are specialised in analysing and evaluating the creditworthiness of corporate and sovereign issuers of debt securities. In the new financial architecture, CRAs are expected to become more important in the management of both corporate and sovereign credit risk. Their role has recently received a boost from the revision by the Basel Committee on Banking Supervision (BCBS) of capital standards for banks culminating in Basel II. The logic underlying the existence of CRAs is to solve the problem of the informative asymmetry between lenders and borrowers regarding the creditworthiness of the latter. Issuers with lower credit ratings pay higher interest rates embodying larger risk premiums than higher rated issuers. Moreover, ratings determine the eligibility of debt and other financial instruments for the portfolios of certain institutional investors due to national regulations that restrict investment in speculative-grade bonds. Banks have now flexibility to fix the interest rate on the basis of credit rating as well.

CRAs play a key role in financial markets by helping reduce the informative asymmetry between lenders and investors, on one side, and issuers on the other side, about the creditworthiness of companies or countries. CRAs' role has expanded with financial globalisation and has received an additional boost from Basel II, which incorporates the ratings of CRAs into the rules for setting weights for credit risk. Ratings tend to be sticky, lagging markets, and overreact when they do change.

In the United States, policy action has included the 2006 Credit Rating Agency Reform Act, which has overhauled the regulatory framework by prescribing procedural requirements for Nationally Recognized Statistical Rating Organization ("NRSRO") registration and certification and by strengthening the powers of the Security Exchange Commission.

At international level, the main initiative has been the publication by International Organization of Securities Commissions (IOSCO) of its Code of Conduct. This Code aims at developing governance rules for CRAs to ensure the quality and integrity of the rating process, the independence of the process and the avoidance of conflict of interest and greater transparency. In its 2005 Technical Advice to the European

Commission on possible Measures Concerning Credit Rating Agencies, the Committee of European Securities Regulators (CESR) recommended the implementation of the IOSCO Code in Europe.

There is only one Credit Rating Agency in Bangladesh, which was incorporated as a public limited company under the Registrar of Joint Stock Companies in August 2003 and received its certificate for commencement of business in November 2003. It has been granted license by the Securities & Exchange Commission (SEC) of Bangladesh for operating as a credit rating company from February 2004.

Bangladesh needs more credit worthy Credit Rating agencies to address the weakness of bank in assessing worthiness of borrower. The country needs law and rule for regulating Credit Rating Agency through the regulating authority of Security Exchange Commission.