Credit rating : An impact in banks Of Nepal
KAROBAR CORRESPONDENT
Wednesday, May 13, 2020
672

Credit rating, in general is a quantified assessment of the credit worthiness of any entity such as corporations, conglomerates, autonomous governments or even a country. It is the symbolic indicator of the opinion of Credit Rating Agency with reference to the capability of the issuer to repay the debt as per its terms. The rating is assigned by an independent credit rating agency based on substantial evaluation of key parameters of the entity. Standard and Poor’s (S &P), Moody’s and Fitch Ratings are some of the prominent examples of international rating agencies which has captured more than 95% of the credit rating business in an international market. 
Credit rating is a relatively new concept in Nepal and it is emerging after the monetary policy of 2018/19 made it mandatory as a basis of loan appraisal for NPR 500 million. Followed bythe monetary policy of FY 2019/20 mandatory requirement for commercial banksto issue debentures equivalent to 25% of its paid up capital by mid-July 2020 many commercial banks have been assigned a credit rating. ICRA Nepal Limited and CARE Nepal Limited are two credit rating agencies in Nepal. They have done more than 250 ratings, mostly of banks and also include Steel Industries, Cement Industries, Hydropower Companies, Insurance Companies and Hotel Industries.
Credit Rating can be important for various stakeholders including a country itself. A country with its credit rating can get access to international financial markets to borrow funds as well as attract foreign investors. Whereas, investors can get criticalinformationregarding the entity and enable comparison of risks and return of various entities prior to investing.Borrowers on the other hand can reduce costs of borrowing through issuing bonds and can increase the flexibility of funding resources. Credit rating is also beneficial for regulators in development and stability of financial markets. 

CREDIT RATING IN NEPAL. HOW IT IS DONE? 
The concept of Credit Rating started in Nepal with incorporation of   ICRA Nepal Limited (a subsidiary of ICRA Limited of India) in 2011 as the first rating agency in Nepal. It commenced rating services from October, 2012 after getting license from Securities Board of Nepal (SEBON). The second rating agency, CARE Ratings Nepal Limited (a subsidiary of CARE Ratings Limited, India) got license from SEBON in November, 2017 to carry out credit rating business in Nepal.  They have been offering credit ratings for IPOs, FPOs, right shares and debentures, including Bank Loans/Line of Credit Ratingfor corporate houses. 
In general, the Credit ratingsare carried out on the basis of evaluation of three major parameters; management quality, business risk and financial risk including analyzing competitive position of the entity. Derived results are compared with their peers and final rating is assigned based on thorough analysis of each component of the parameters. For Banks there are additional parameters such as operating and regulatory environment, ownership structure, management strategy and risk positioning, governance structure, asset quality,diversification of portfolios,profitability, and capital adequacy. Based on the evaluation a rating is assigned by the agencies. Following table provides the rating scale and definition as described by ICRA Nepal Limited.Table 1: Rating scale and DefinitionAAA Issuers with this rating are considered to have the highest degree of safety regarding timely servicing of financial obligations. It carries lowest credit risk.  AA Issuers with this rating are considered to have high degree of safety regarding timely servicing of financial obligations. It carries very low credit risk. A Issuers with this rating are considered to have adequate degree of safety regarding timely servicing of financial obligations. It carries low credit risk. BBB Issuers with this rating are considered to have moderate degree of safety regarding timely servicing of financial obligations. Such issuers carry moderate credit risk.  BB Issuers with this Rating are considered to have moderate risk of default regarding timely servicing of financial obligations.  B Issuers with this Rating are considered to have high risk of default regarding timely servicing of financial obligations.  C Issuers with this Rating are considered to have very high risk of default regarding timely servicing of financial obligations. D Issuers with this Rating are in default or are expected to be in defSource:  ICRA NEPAL
With the above rating scale, various stakeholders such as investors, customers and regulators can get the picture about the entity’s strength and its appetite for credit and operational risk. However, one must be clear that credit rating is only an opinion of the independent agency and it does not constitute any recommendations to buy/sell or hold any shares or withdraw deposits in bank and to sanction or renew the line of credit facilities of any corporate houses. 
Recently, the government of Nepal has awarded Fitch Ratings (Among renowned international credit rating agencies) to evaluate and confirm sovereign credit rating. This shall not only assess the creditworthiness of the country but also shall give an opportunity to review the progress and shortcomings in various parameters of the economy. This will help Nepal on global financial market allowing it to gain the attention of capital market investors and foreign direct investors. These capitals can then be efficiently channeled to national wealth creating mega-projects leading to economic growth.

CREDIT RATING IN COMMERCIAL BANKS OF NEPAL. HOW BANKS CAN BENEFIT? Many commercial banks in Nepal have gone through a credit rating process mostly during the time of issuing shares and bonds. Recently a rating of [ICRANP-IR] A (pronounced as ICRA NP issuer rating A) was assigned to Nepal Bank Limited by ICRA Nepal Limited. 
Bank’s with highest rating 'AAA' and 'AA' are supported by major key drivers such as strong promoter profile (for e.g. SCB Nepal with SCB-UK and Nepal SBI with SBI INDIA), established track record in industry along with better risk management practices and digitization. Similarly bank with ‘A’ ratings are supposed to have lower cost of funds, profound management, strong capitalization, healthy deposit profile (strong current account and saving account deposits) and net interest margins. 
Banks with the range of 'A' and 'AAA' ratings are competitively well positioned in the industry and are capable of timely serving any financial obligations. They are capable to withstand shocks arising out from credit and operational risk
Credit rating can create a positive impact in banks of Nepal.First and foremost, Banks can inject the capital from the financial markets and hence increase the flexibility of funding sources while reducing cost of borrowings from directly borrowing from public through shares and debentures.Fiscal year 2018/19 had a transaction of NPR 6.6 billion of debentures while there were no debentures issued at all in past 3 years prior to 2018/19. Followed by the provision of NRB to issue debentures of 25% paid up capital of banks, year 2019/20 is expected to flow maximum number of debentures.The amount of debenture issued in the capital market is almost double the IPOs held this fiscal year. Credit rating, thereby, has played a major role in providing detailed information to the investors regarding bank's capability of repaying the debenture. On the other hand, banks have been able to generate funds through capital market and increase its capacity to float more loans. 
The rating is done by the third party and is viewed by all related stakeholders, thus, this will also help in bringing out the best in corporate governance practices.As Nepalese Banks are allowed to obtain loan from foreign banks, having a credit rating can give the idea about degree of safety and credit risk to foreign banks. 
Following the NRB’ provisioning of credit rating for loans more than NPR 500 million, bank can also enhance the loan appraisal and decision making process which in turn shall create better credit portfolio of the banks. Like other countries, Banks in Nepal can also use credit rating to structure the interest rates to the clients based on the rating.
Credit Rating can also be effective in enhancing access to SME Financing for the banks.  SME is a major contributor of the economy, comprising 22% of the GDP in Nepal.  However, a report published from NRB shows that only 50% of SME has access to finance. The share of loans to SMEs in the overall credit portfolio of BFIs in Nepal is only around 3.5 % as of 2019.  Lack of collaterals is one of the major hindrances for access to SME finance. On the other hand lack of adequate business information and credit histories makes lending a risky scheme to the bank. Credit rating can hence provide detailed information of an enterprise incorporating its strengths and risks exposed, serving as a good reference documents to the bankers reducing the time required for loan appraisal with an availability of key information reports. 

WHAT CAN BE DONE FURTHER?
 NRB including Ministry of Industry must come with the provisions thatencourage banks as well as the SME entity itself to use credit ratings to enhance lending to SME enterprises. For instance, the Central Bank (RBI) in India has a provision where banks can use credit ratings done by reputed credit rating agencies to structure the interest rate depending upon the ratings assigned which sounds a feasible approach in Nepal as well. The BASEL III in Nepal only uses Simplified Standardized Approach (SSA) to measure credit risk while computing capital adequacy. The limitation of credit rating practices makes the use of advance approaches to compute credit risk unfeasible.  With widely gaining popularity of credit rating due to the provisions in monetary policies, NRB can enhance its capital regulatory framework implementing advance approaches like Internal Rating Based Approach or Standardized Approach where commercial banks shall be able to determine the risk weights assigned to the loan provided by the bank. For instance, In India if the rating is within the top three i.e. 'AAA', 'AA' OR A, then risk weight assigned to the loan is 20%, 30% and 50% respectively. Hence the availability of a credit rating not only shortens the bank loan appraisal process, it also enables the bank to give the borrower a more favorable interest rate on the loan.
Similarly, to encourage business entities to opt for credit rating, the regulatory body can come with provisions of levying minimal charge for the rating. Aligning with NRB, a mechanism to structure interest rate based on the credit rating can be developed. For instance, the   Ministry of Medium and Small Enterprises(MSMEs), India has a provision where an enterprise could get 75% reimbursement of the rating fees charged by the credit rating agencies. A study on impact of these provisions on SMEs found that SMEs who obtained credit rating obtained loan at a lower interest rate, increased operational efficiency, enhanced business growth with improved record-keeping, and strengthened organizational system and policies. While, the commercial banks were able to enhance the loan appraisals, reduce the credit risks and also increased financing as these firms enhanced growth and required capitals. 
Credit Rating can play an important catalyst to foster growth, stability and efficiency in financial markets.  Nepal being a developing economy and in order to achieve a higher growth needs to have a mechanism capable of inducing a favorable investment climate in order to attract FDIs, generate capital from international capital markets.  In order to have an impact of credit rating, a country should start with its own sovereign credit rating first.

  -Bishal Tripathi