Credit ratings now look without credibility

Some banks, whose fragility was exposed only recently, continued to enjoy top-tier credit ratings for years by agencies that helped those lenders create an impression of strong financial health to rope in depositors and investors.

After the 5 August regime change, tightened scrutiny by regulators exposed their real health, leading to board restructuring and limiting depositors' access to money.

For instance, Islami Bank Bangladesh PLC (IBBL) has consistently received an AAA rating—the highest possible, signalling minimal risk to stakeholders. Of late, depositors would learn that of the bank's more than Tk1.74 lakh crore loans distributed till June, roughly half or over Tk80,000 crore went to a single business group.

Now, depositors are struggling to access their funds, raising questions about the real risks hidden behind the AAA rating given by Emerging Credit Rating Ltd (ECRL).

A similar case can be found at National Bank Limited (NBL), one of Bangladesh's first-generation banks, or Padma Bank, a troubled lender since its beginning.

Worldwide, creating a false impression of corporate health and hiding financial flaws is an offence involving penalties in the millions.  

In 2015, Standard & Poor's was fined $1.5 billion by the US regulator for inflating mortgage-backed securities ratings before the 2008 financial crisis, with Moody's fined $864 million for similar issues. In 2019, India's regulator penalised two rating agencies for negligence. Recently, the US fined six rating agencies $49 million for failing to keep proper records.

Yet, in Bangladesh, no credit rating firm has been punished in 22 years, despite accusations of inflated ratings that mask the real health of the corporate world and financial sector.

Generous ratings

Even after the IBBL's financial health began to deteriorate following its controversial takeover in early 2017, the rating agencies continued to assign it the same top-tier rating until 2023. This gave depositors and investors the false impression that their money was safe with IBBL.

However, a startling revelation came to light on 5 September when the bank's new chairman, Obayed Ullah Al Masud, publicly disclosed that the S Alam Group, under various names, had taken over half of the total loans disbursed by IBBL.

Once a reputable institution, NBL saw its fortunes decline after a family took control in 2009. Large, irregular loans caused its non-performing loans (NPL) to balloon to over one-fourth of its total loans as of the audited report for 2022. The bank's other indicators, such as profits, price-earnings, and net asset value all were declining. Yet, NBL was rated AA- for 2022-23 and A- for 2023-24, still considered an investment-grade rating.

Other struggling banks, such as Padma Bank, which has faced difficulties since its inception in 2013, also received strong ratings. Padma was rated BBB+ for both 2022-23 and 2023-24 despite its precarious position. Similarly, Global Islami Bank and Union Bank, both grappling with financial challenges, were assigned A+ ratings.

Beyond the banks, the situation is even worse for non-bank financial institutions (NBFIs). Out of 35 NBFIs in Bangladesh, many are in deep trouble unable to repay depositors. The situation in the insurance sector is not better than NBFIs. Yet, these institutions were given positive ratings by agencies painting a misleading picture of their financial health.

 Why rating agencies far from reality

So why are these credit ratings so out of step with reality? What is preventing the rating agencies from providing unbiased, professional assessments? These questions have sparked growing concerns about the transparency and accountability of Bangladesh's credit rating system as depositors and investors continue to suffer losses from these misleading evaluations.

Muzaffar Ahmed, executive president of CRISL, Bangladesh's first credit rating agency, expressed surprise at Islami Bank Bangladesh being awarded a AAA rating despite its deteriorating health and the Islamic Development Bank's offloading of shares.

He said that the bank was also given an ST-1 short-term rating for 2023-24, signifying a high certainty of timely payments, strong liquidity, and robust access to alternative funding sources—almost akin to the safety of government short-term obligations. "This rating was given at a time when Bangladesh Bank was supporting the bank by printing money," Ahmed told The Business Standard.

Dr Jamaluddin Ahmed, chairman of ECRL, which has rated Islami Bank in the last three years, said ratings are based on audit reports. "If the audit report isn't accurate, the credit rating won't be accurate either," said Jamaluddin, a former president of the Institute of Chartered Accountants of Bangladesh (ICAB). ICAB members and their firms audit most companies in Bangladesh, including banks and non-bank financial institutions.

NKA Mobin FCA, president of the Association of Credit Rating Agencies of Bangladesh, explained that their ratings rely primarily on an organisation's audited financial accounts. He said that they follow a methodology based on international best practices, which is approved by both the Bangladesh Bank and the Bangladesh Securities and Exchange Commission (BSEC).

Mobin noted that around 60% of a company's credit rating score is derived from financial data in its audit report, while the remaining 40% is based on non-financial factors, such as compliance.

"When the audit report shows that all financial indicators of Islami Bank are in order—no issues with bad loans, provisions, or cash flow problems—a credit rating agency has no choice but to award the full 60% for financials," said Mobin, who is also the managing director of ECRL.

"We don't have the authority to conduct audits ourselves. Perhaps we could have been more cautious," he told The Business Standard.

A F Nesaruddin, senior partner of Hoda Vasi Chowdhury & Co., a leading audit firm, pointed out that governance issues are the primary reason behind poor auditing and credit ratings.

"Company owners often exert undue influence, and regulators remain silent despite finding irregularities. If wrongdoers aren't held accountable, what can you expect?" he questioned.

Nesaruddin also highlighted another issue: The trivial fees paid to the audit firms. He noted that companies are often unwilling to pay reasonable amounts for auditing and credit rating services.

Why has credit rating become a 'shopping culture' in Bangladesh?

In Bangladesh, the credit rating industry has grown rapidly, with eight licenced agencies operating under the oversight of the Bangladesh Securities and Exchange Commission (BSEC). These include names like Credit Rating Information and Services Ltd (CRISL), Credit Rating Agency of Bangladesh Ltd (CRAB), Emerging Credit Rating Ltd, and others. While CRISL and CRAB were established in 2002 and 2004, respectively, the remaining six agencies were licensed between 2010 and 2012, allegedly due to political influence.

This proliferation of agencies has led to questions about the quality of credit ratings in the country. By comparison, India, the world's fifth-largest economy with a $3.6 trillion GDP, has only five credit rating agencies. Pakistan has two, while Thailand and the Philippines each have one. Globally, just three firms—Standard & Poor's, Moody's, and Fitch—dominate the industry.

Has the increase in rating agencies in Bangladesh led to a decline in rating quality? Both insiders and industry observers believe so.

Dr Toufic Ahmad Choudhury, former director general of the Bangladesh Institute of Bank Management (BIBM), said the issue lies in the unhealthy competition among too many agencies. "With a borrower being rated for Tk 5,000 to Tk 10,000, what level of quality can you expect?" he asked, pointing to how the low fees undermine the credibility of the ratings.

Jamaluddin, chairman of ECRL and former president of ICAB, acknowledged that the industry is struggling with price competition, blaming older and financially stronger companies for driving down fees. Despite this, Muzaffar Ahmed, head of CRISL, denied that his company has ever compromised on quality to lower prices.

NKA Mobin, president of the Association of Credit Rating Agencies of Bangladesh, shed light on just how low the pricing has become. "Sometimes we are forced to conduct credit ratings for as little as Tk 2,500," he said. This, he added, is mainly because banks, which are the primary users of these ratings, require them for their clients, but are unwilling to pay higher fees.

"The result is a 'shopping culture,' where companies seeking a favourable rating may simply choose the agency offering the lowest price—potentially at the expense of accuracy and reliability," said Tajul Islam, former chief rating officer at CRAB.

Rezaul Karim, executive director and spokesperson of the Bangladesh Securities and Exchange Commission (BSEC), the regulator of rating agencies, said they have recently met with credit rating agencies, urging them to adhere to BSEC regulations.

"There is unhealthy competition among the rating agencies due to the small size of the market. Improving the quality of audit reports is essential," Karim told The Business Standard.

He added that a taskforce is addressing the issue, and BSEC will act according to its recommendations.

Responding to a query about whether any credit rating agencies have been penalised for wrongdoing, he stated that since joining the BSEC in 2003, he has never heard of any financial penalties imposed on raters.

When the necessity of credit ratings jumps:

Though Bangladesh first got a credit rating agency in 2002, the Bangladesh Bank made it mandatory for banks in 2012 to get their clients rated by External Credit Assessment Institutions (ECAIs), which are basically rating agencies.

Apart from entity credit ratings, all scheduled banks are required to nominate ECAIs for their own as well as their counterparty credit rating. Bangladesh Bank recognised these eight credit rating agencies to provide rating services in Bangladesh. The BB's decision fuelled the demand for credit rating as banks became the main users of this rating. Now even an SME client with a Tk10 lakh loan has to be rated by agencies.

"Before that, credit rating was mandatory for companies that wanted to be publicly listed or a company that wanted to issue bonds or raise money through commercial papers. Then BSEC made credit rating mandatory for all listed companies," said Mobin of ECRL.

How rating manipulations benefit banks

Under Basel III guidelines, a bank's Risk-Weighted Assets (RWA) are calculated by considering the credit risk associated with loans. A better credit rating for a client indicates lower risk, which allows the bank to assign a lower risk weight to that client's loan, reducing the RWA. This, in turn, improves the bank's Capital Adequacy Ratio (CAR), which measures its financial strength.

For example, if a bank lends Tk1,000 crore to a client with a AAA credit rating, the risk weight assigned might be 50%. This means the loan adds Tk500 crore to the bank's RWA. However, if the client had a weaker credit rating, the risk weight could be 100%, adding the full Tk1,000 crore to the RWA.

Thus, a better credit rating improves the bank's CAR by reducing the RWA. CAR is calculated by Tier I plus Tier II capital divided by RWA. If the bank's capital is Tk100 crore, the CAR for this loan, assuming a 50% risk weight, would be 20%. If the client's credit rating were lower and the risk weight was 100%, the RWA would be Tk1,000 crore, and the CAR would drop to 10%.

Credit raters said with a lower RWA, the bank can maintain a higher CAR without needing to raise additional capital. For example, if a bank's large corporate client is rated highly, it reduces the bank's need to hold excessive capital against those loans, enabling the bank to lend more or pursue other growth opportunities without breaching the minimum capital thresholds.

What about the audit reports:

Credit rating agencies say their assessments of companies are primarily based on audited financial statements. This raises the question: What's wrong with the quality of these audit reports?

AF Nesaruddin, senior partner at Hoda Vasi Chowdhury & Co., and former president of ICAB shared an example to illustrate the problem. A few years ago, a prominent businessman approached him to audit the finances of his insurance company.

"It typically takes 4 to 6 weeks to audit an insurer, but he offered me just Tk75,000 when the minimum fee is between Tk3-5 lakh," Nesaruddin explained. "When a team, including senior managers, works for a month or more, how can they be paid so little?"

He noted that lower-quality audit firms may accept such low fees, but the quality of their work reflects that. "The credit rating will simply reflect the quality of the audit report," he added.

In another instance, Nesaruddin mentioned a company with an annual turnover of Tk1,000 crore that refused to pay Tk2 lakh for its audit, citing concerns over increased business costs.

According to him, the situation is even worse for credit rating agencies which face even greater pressure when it comes to fees and charges. 

To enhance the quality of audit reports, the Institute of Chartered Accountants of Bangladesh (ICAB) in January 2016 introduced a structured audit fee schedule. This was aimed at ensuring that audits are conducted with the highest level of professional care in line with ICAB by-laws and international financial reporting standards.

The ICAB established the fee schedule based on various client categories, taking into account factors such as gross turnover, gross assets, number of branches, loans and advances (for banks and NBFIs), and gross premiums (for insurance companies).

For example, ICAB set a minimum audit fee of Tk3.5 lakh for publicly listed manufacturing companies with gross assets or turnover not exceeding Tk50 crore. The audit fee increases proportionately as the company's assets or turnover rise.

For banks, ICAB set the audit fee at Tk10 lakh for those with up to 50 branches. For banks with more than 150 branches, the fee is Tk15 lakh, with an additional 4% of Tk15 lakh charged for every 12 branches beyond that.

ICAB president Mohammed Forkan Uddin, however, declined to comment on the issue.