NIBL Credit Rating

Nepalese financial sector has seen exponential growth during last two decades. From 1990 to 2009, the number of commercial banks increased from 5 to 26, the number of development banks increased from 2 to 63 while the number of finance companies increased from 0 to 77. Even during the conflict years of 1996 to 2006, financial sector did remarkably well and managed to flourish (See figure 1 for details). With the rapid growth in the financial sector, growth has trickled down to real sectors in the form of wider access to finance, innovative products catering to wider customer base and faster service delivery on the part of financial institutions.

 

However with the rapid growth in financial sector and the number of financial institutions, it’s becoming hard to distinguish between a good financial institution and an average or a bad one. Beside, Nepal Rastra Bank (NRB), which is as a regulatory body of all financial institutions, we don’t have an independent entity that ascertains the risk profile of a financial institution. As a regulator and a central bank of the country, NRB role is to monitor and supervise financial institutions and take corrective action if it finds anything wrong with a particular institution. NRB, as a central bank, doesn’t go around informing people about which financial institutions is relatively good or bad. Hence, for an average depositor or a layman investor, there is no credible information out in Nepal which objectively distinguishes a good financial institution from a bad one. In these contexts, there is a strong need for a globally recognized Credit Rating Agency in Nepal.

 

A Credit Rating Agency (CRA) evaluates the creditworthiness of an individual, a corporation or a country. Based on the rating models that look into asset quality, interest sensitivities, diversification of loan portfolio, capital base, and board structure, among others, a CRA assigns credit score to a particular financial institution. The ratings/score enables an investor to gauge the risk involved in investing with that particular entity. CRA rates not only a particular corporation but also various debt instruments of corporations and a same bond issuer may have different credit ratings for different bonds. Globally, credit ratings are used by investors, investment bankers, brokers and government as a risk metric when allocating funds.

 

Figure 1: Growth of Banking and financial sector

 

 

As mentioned above, ratings from CRA enables investor to ascertain the creditworthiness of a particular institution. Internationally various investors rely on ratings when allocating funds among different asset classes. For example a fixed income investor relies on bond ratings, a pension fund who is interested on investing on debt issue of a particular country relies on sovereign ratings and an investment bank to cross check their portfolio’s risk.  Ratings are useful not only for investor but corporation also as a lower rating helps them to raise funds at a lower cost.

 

In Nepalese context, CRA could be beneficial from various ways. The exponential growth of the financial sector has underscored the need for a CRA that distinguishes a good financial institution, through their ratings, from a bad one. The recent debacle of Nepal Development Bank (NDB) and corporate governance issues in some commercial banks has underscored the need for an independent credit rating agency that rates financial institutions.

 

Moreover, a credit rating agency creates a win-win situation for regulators, investors and rated institutions.  For an investor, credit rating will serve as an important risk metric during investment decisions. Investors, from depositors who deposit their money in financial institution to those who buy stocks in secondary market, can rely on ratings when depositing their money or buying stocks. For a good financial institution, it’s in their interest to have a credit rating as a good rating will enable to distinguish itself from the rest. It will bring about a culture of self discipline and rigorous risk management among domestic financial institutions to avoid bad ratings. Moreover, internationally accepted credit ratings will enable domestic banks to improve trade finance operations as good rating will enhance the trust of domestic banks. Furthermore, under the Basel 2 agreement, banks can use certain approved CRAs (called "External Credit Assessment Institutions") when calculating their capital requirements.

 

From a regulator perspective, the recent growth of financial sector has increased the supervisory burden of the NRB which is going to increase further in days ahead as financial sector further expands. Though it’s imperative for the NRB to step up its supervisory practice, going forward, establishment of globally recognized CRA in Nepal can be useful for the NRB in filtering good financial institutions from a bad one. The internal assessment and self discipline that the culture of credit ratings bring forward will also be beneficial from a regulator’s viewpoint.

 

Apart from financial institutions, there are various other sectors where credit ratings will be necessary as the domestic economy expands and funding needs of corporation increases. Under existing regulations, local corporations cannot raise capital from international capital markets. However in the future, in order to mobilize large scale of funds necessary for infrastructure and development projects, it’s necessary to liberalize the capital restrictions in Nepal. Hence, moving forward, a universally accepted credit rating is imperative when Nepalese corporation enter into international market to raise capital.

 

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