Credit rating – Finance Sector Leaders Step Forward

I had the privilege of moderating the second Africa Credit Rating Summit this week.

On hand was a panel of senior finance sector professionals and leaders.  Vivienne Yeda, Director General of the East Africa Development Bank, Philip Mulaki from Africa Trade and Investment Development Insurance (ATIDI), Simon Rutega, Mahesh Kotecha in New York, and John Ngumi.  Dozens of other professionals joined the stimulating and robust conversation.

As an aside, the covid lockdown had at least one positive impact.  It accelerated video conferencing.  What was a novelty just a few years ago is now commonplace. Fifteen years ago, the government had installed a video conferencing facility at the Kenya School of Government. You had to book weeks in advance to host one.  Today you can host a global meeting, workshop or conference from the comfort of your office, only it is now called a webinar.  Some conferencing platforms like Zoom have achieved market dominance, while others have disappeared. Whatever happened to Skype, which was all the rage ten years ago?

Back to the webinar. It discussed the use of credit rating in capital raising and pricing.  As the discussions got underway, it was soon clear that current crisis around sovereign credit ratings in Africa may have started off on the wrong foot. Many government leaders on the continent and further afield have in recent past complained against credit ratings, and the agencies that undertake them.  They have voiced their disappointments quite loudly, the latest being the US Secretary of the Treasury.

But if you are happy with your credit rating, then there is something wrong with you, one expert observed. You should be aspiring for better.  You ought to figure out what rating agencies are looking for, before you get rated. One way to do that is to get yourself a ratings advisor.  Criticizing rating agencies is quite counterproductive. You will not obtain a better rating by calling the rating agencies names. Credit Rating Agencies (CRAs) have to maintain independence, have very professional approach to rating, and exercise high-quality control of the assessment methodology. Otherwise, the market would not trust the ratings.

Ratings are critical in accessing capital internationally. They provide a common yardstick to assess investment propositions.  And a poor rating is better than no rating at all. It gives you somewhere to work from.  It provides a roadmap on how to improve.

Everyone aspires to have a better rating. Many believe our organizations are AAA. But we should be putting our best foot forward. While in some areas of financial sector there is a common understanding and practice, credit rating is yet to achieve that status. For example, in financial reporting, there is widespread acceptance to adhere to international financial reporting standards. Yet, even though central banks require risk-based pricing, credit rating is not widespread.

As ratings become more common, the rating models and technology are expected and need to converge. And there is reason for this expectation.  Rating agencies are licensed by capital market authorities based on the rating models they run and there is already a fair amount of uniformity in the rating methodology.  However, regulators should tighten regulation while expanding the scope and use of ratings.  There are several licensed credit rating agencies in the region including Metropol Credit Rating Agency which was our host.

The experts drew parallels between the current nascent state of credit ratings with the growth of credit information bureaus.  Twenty years ago, there were hardly any credit bureaus on the market. But sustained efforts by institutions such as IFC, got central banks to adopt this important mechanism.  Today, lending to individuals and small businesses would be inconceivable without the bureaus. A similar effort is necessary for credit rating to take hold. EADB and ATIDI are well placed to provide leadership of such an effort.

Getting convergence and widespread acceptance is a long-term prospect. We should use what is available today.  There are several rated entities, including banks and insurance companies.  There is an opportunity to rate the many institutions including banks, that are yet to be rated.  At the moment though, there is hardly any price differentiation in the domestic market, unlike in overseas markets. The regulators, particularly Central Banks and Capital Market Authorities should create incentives.

Regulators need to make ratings attractive for investors, by creating positive incentives.  For instance, if you invest in a rated product you should be allowed to get a bigger slice.  Similarly, regulators could also lower the level of capital requirements for banks when they invest in rated instruments.

Mandated ratings are taking place in some countries, including Colombia and Turkey.  African regulators could encourage things by requiring one or two ratings from the institutions they regulate.

We need to localize ratings.  The stepping up of African-owned or located credit rating agencies is a welcome development. Methodologies used, local knowledge and their presence on the continent should also result in lower prices, encouraging broader use.

Finance sector leaders must be at the forefront of promoting the adoption of credit ratings. It is within themselves, in their areas of practice to not only agree but use ratings for their investment decisions and appraisal.  In addition, regional regulators should act in concert.  To encourage such action, a gathering of East African regulators is planned for the first quarter of 2024.

African countries have been calling for a new global financial architecture.  But they must be at the forefront of creating such an architecture.  Sadly, capital markets remain relatively underdeveloped on the continent in part because of a reluctance to use tools and innovations that could make them vibrant.  For instance, ratings could make investment decision-making more cost-effective, and faster.  They also provide investors with protection, and in any case, are an important tool for pricing risk.

A credit-rated company is more attractive for investment and development banks. Appraisal is faster and benefits from an additional professional view. Regular review offers a measure of investor protection.

@NdirituMuriithi is an economist

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