Unsung Villains: Highlighting Logical Fallacies in the Indian Landscape with Respect to Credit Rating Agencies 

[By Soham Niyogi]

The author is a student of Rajiv Gandhi National University of Law, Punjab.



A calamity may be overkill, but when giant conglomerates drop like flies and wither away, it would certainly raise some eyebrows about how this disaster occurred, or how it could have been avoided. Some of these behemoths find themselves in the guise of the SREI Infrastructure Finance Ltd. (hereinafter, “SREI”) or Infrastructure Leasing and Financial Services (hereinafter “ILFS”), these two major companies are buried in the annals of India’s financial history as they threatened disaster for the thousands of people who had put faith in these companies’ instruments. Public opinion lay restricted to blaming these companies for falsely inflating their bonds’ value and then disappointing investors with a liquidity crisis of upwards of 90,000 crores (in the case of ILFS). The overlooked villains of the story are the Credit Rating Agencies (hereinafter, “CRA”) which hyped up the bonds of SREI and ILFS to be of AAA-grade quality, a complete lie brought about by cronyism, bribes, and favour politics.    

CRAs are bodies regulated by the Securities and Exchange Board of India (hereinafter, “SEBI”), to determine the ability of an issuer company to make good on its debt instruments, and timely disburse the principal and the interest. In the IL&FS crisis, recklessly CRAs had tagged IL&FS’ bonds to be of the highest grade rating, proportionate to being least likely to default. This illusion was broken by the crisis that struck, ending the market prospects of thousands of investors. SEBI had noted CRAs to be ‘financial gatekeepers’ and petty bribes along with promises of gifts shaken up the corporate debt market. The Grant Thornton Forensic Audit Report which scoped out the financial transactions of the subsidiaries of IL&FS confirmed that there were inconsistencies regarding IL&FS’ strategy of short-term borrowings against its long-term lending. Aside from dealings between IL&FS and its subsidiaries through third parties, the report also observed that loans were sanctioned at a negative spread which would be a cause for concern to any CRA. 

Primarily, the Indian version of the ‘issuer-pays’ model is the culprit behind this situation, as it is a focal point that creates the camaraderie between CRAs and the instrument issuers in a quasi-closed market where it is tough for outside players to infiltrate. What the model entails is that an issuer such as IL&FS would pay a CRA to rate their instrument, one can see how there might be a conflict of interest persisting in this relation. The income of a CRA is dependent on the revenue that it extracts from the ratings it does for a body corporate. This conflict of interest wherein the sustainability of an issuer is dependent on the CRA’s ratings showcases a symbiotic relationship. There would never be an instance where a company pays the fees to a critical CRA which could rate their instruments lowly (the CRA would lose business). Simply put, it is a legally mandated bribe.  

This conflicting relationship brings forth a situation known as ‘rating shopping’, wherein the issuer subscribes to ratings from the top CRAs, and only publishes the most favourable one. Fear of being discharged is a motive for the CRAs to give the best ratings possible. Even after observing the fall of SREI and ILFS, such has not been looked into by the SEBI per the SEBI (Credit Rating Agencies) Regulations 1999 (hereinafter, “CRA Regulations”) except for a lacklustre standing committee, mentioned in the following text. The amendments up until 2023 do not address this logical fallacy as under regulation 14 of the CRA Regulations, and the vicious cycle is perpetuated till now, as could be seen in the case of SREI’s default in 2021.  

Regulation 16 (2) of the CRA Regulations permits a CRA to issue a credit rating even if a client company refuses to cooperate, based on incomplete public information only. If we could refer to the Report, IL&FS had also sent incomplete information to the CRAs. Unfortunately, this is a great disservice to the ordinary investor who would suffer due to their reliance on uncredible credit ratings by globally acclaimed CRAs with or without disclosure as per 16(2).  

Cross-Jurisdictional Analysis of the Issuer-Pays Model  

India’s efforts to mitigate the chances of a like crisis are realised in the form of an advisory report by the Standing Committee on Finance, wherein they criticise the issuer-based model while recommending measures such as the disclosure of confidential information such as the liquidity position of the issuer. None of the recommendations made by the committee were ever implemented, but we can find a similar solution to this problem in other jurisdictions aside from India, where a successful version of the issuer-paid model is in work, from which India can be inspired.  

A comprehensive solution may be sought from separate jurisdictions, starting with the Basel Committee on Banking Supervision which has in its leagues, 45 member banks and central regulators with authorities hailing from 28 jurisdictions. The committee’s stringent laws to encourage issuer-investor relationships are admirable since they also comply with the issuer-based model with the investor’s interests in mind. The supervisory committee concurs with a system of the disclosure of liquidity ratio. Liquidity ratio is the measure of a company’s capability to pay off its short-term obligations, at the moment, no such system of disclosure exists in India.  

From 2015 onwards, the Basel Committee made it mandatory for its members to reveal its liquidity coverage ratio, guided by two base objectives, to improve a bank’s short-term resilience by warranting that it has high liquidity assets at all times to show for, and to reduce funding risk over a long time, to ensure that the company is only allowed to invest in projects when they have sufficiently stable sources of income, and high reserves of liquidity. The Basel Committee directs its members to have a common public disclosure framework for the ease of the market participants. This scheme is still in practice and could very well be a point of reference for Indian authorities to introduce changes to the flaws in its Indian counterpart. 

Additionally, even the U.S. Securities and Exchange Commission (hereinafter, “SEC”) adopted a final rule in the Investment Company Act of 1940 that requires investment companies to disclose information about their liquidity risk management program in their reports to shareholders. To accommodate the final rule, the SEC amended Form N-PORT to enhance the liquidity information reported to the Commission.  

The SEC also mandated the maintenance of non-public monthly reports on Form N-PORT to include classified liquidity information, which should be attested to by the Commission by filing all three monthly reports after the end of each fiscal quarter. This would provide the SEC with the ability to see through illegitimate credit ratings given to unstable instruments with severe liquidity risk.  

This could also be implemented in India, wherein the SEBI could implement a similar system of liquidity ratio disclosure to the SEBI itself by the issuers, and executives could verify the ratings with the paperwork submitted by the companies, through a form like that of N-PORT in the U.S.  


SEBI’s reliance on post-facto remedies like fines, or sanctions must be done away with as the economic damage that such a financial crisis does to the economy of the country, mere fines would never suffice. Only a thorough makeover of the existing laws, and setting up preventive measures may do justice to the Indian investor. The policies of the SEC and the Basel Bank are trailblazers in the development of investor-issuer relations, and such can be implemented in India with proper prudence. An environment of mutual cooperation, and healthy business must be created if we wish to see India thrive, only possible if we learn to identify flaws and be bold enough to replace old traditions if they are no longer sustainable.

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