Mar 2, 2010

Mr Finance Minister, you need to know how Credit Rating agencies take the entire banking system for an easy ride

I have often asked analysts and economists from the credit rating agencies and banks, who I occasionally meet on TV shows relating to commodity markets and trading, as to how do they manipulate the data so cleverly that whatever they present is taken up by the ignorant media (and the Finance Ministry) as gospel truth. Not everyone has been forthcoming. Some have merely smiled, and others have given me a little indication and insight. Piecing it together, here is how the data is manipulated. 

Everyone agrees that the analysts and so called "experts" first set a target forecast that they wish to come up with and then play with numbers till the desired outcome is reached....these projections are then covered and celebrated by the media.

Simple. Isn't it?

Well, talking about manipulations, it isn't that simple. I can give you an example from the recent monetary policy review in October 2009 when the Reserve Bank of India (RBI) increased the provisioning coverage for banks on their non-performing assets (NPAs).

First of all, the 'experts' realised that they had only bits and pieces of information but since their objective was to come out with a release and so they tried to gather the 'provisioning coverage' data, NPAs and slippage figures for their clients (instead of the entire banking system).

Since they had statistics for many banks till September and all of them till June, latest figures were collected. Now see where the mischief is done. Although it was apparent that the figures clearly indicated that the NPAs and slippages were on the rise in the banking system and thus the impact on profitability would be much larger, but since this was not what the credit rating agencies wanted to predict, so they conveniently chose to:

1.Use March 31st numbers for all projections.

2. Use a completely arbitrarily chosen level of NPA's for March 2010 which helped them make less dire projections when it came to the impact on the banking sector profitability. (You wouldn't doubt this since it comes from people who claim to be the torchbearers of analytical excellence !)

3. These 'brilliant' analysts (obviously they are brilliant if they can deceive the RBI) actually (a) did not take into account the obvious inflation of commodities which caused the obsene hikes in commodity prices; (b) also chose to ignore the impact of withdrawal (even if it is partially as in Budget 2010) of the government stimulus as and when it occurs (it was expected soon considering the soaring inflation); (c) the impact of a theoretically inevitable decline of the US dollar and it's impact on export units and related NPAs , and so on.

4. Curiously, they then put words in the mouth of "who's who" of top companies wihout even telling them in advance.... (only to be subsequently explained)

5.Interestingly, let us not forget that these experts had completely ignored the high levels of restructured assets in the banking system, a chunk which will soon turn into NPAs, which in turn will again impact the reported profits.

6. In many cases, clever graphing and statistical techniques are used to prove points which hardly represent the truth.

Ha ! What a great swindle.

As a matter of fact, most 'experts' are concerned with just getting the job done and keeping the money flowing in. Not that everyone is deaf to these computations, there are a few exceptions (even at the top) but their voice is marginalised and for obvious reasons.

This example is not related strictly to the ratings but as is evident the entire concept is not reliable. I am told that the sovereign ratings for India are far below those of the USA despite protests from even the Indian government (to which the agencies respond with standard one line answers).

Besides, I am not bringing in the issue of conflict of interest with the issuers of securities (as they pay these rating agencies to get rated). It is always there and is clearly visible, but who cares as long as money flows. It makes the heads of departments put a lot of pressure on analysts to issue "good" ratings to the clients. I am told in some cases, there have even been upgrades when the analysts started off with the opinion that a downgrade was on the cards.

Before I end, one more thing. I learn that the asset reconstruction agency ARCIL has actually been buying bad loans from banks and is helping them make their balance sheets look pretty. But the ownership of ARCIL still remains largely within the banking system, banks like the ICICI which earlier lent blindly during the boom are now transferring their problems to the system. This could in time create issues with the entire banking system. All we need is a real-estate crash which brings prices to realistic levels.

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