Basel II - A reality check

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: Further, the claims on rated corporates are to be risk-weighted as per the national ratings assigned by rating agencies registered with the Securities Exchange Board of India and recognised by the RBI. The RBI's draft guidelines propose a risk-weighting of 20% to 'AAA'-rated corporates, 50% to 'AA'-rated companies, 100% to single-'A' and un-rated companies, and 150% to companies rated 'BBB' and below. The proposed risk-weightings using national ratings alone are not totally consistent with the Basel II standardised approach as far as appropriate capital allocation may be concerned. This is because national ratings are unique to a country and differ substantially (particularly in low rated sovereigns) from international ratings assigned by international rating agencies such as Fitch, Standard & Poor's or Moody's in terms of default probabilities. For example, Fitch assigns an international long-term rating of 'BB+' to National Thermal Power Corp (NTPC), an Indian corporate entity engaged in the power sector (India's sovereign rating is also 'BB+'). NTPC has also been assigned a national rating of 'AAA (ind)' by Fitch India, Fitch's wholly owned subsidiary. As is obvious from the above illustration, the risk-weighting for NTPC will only be 20% under the RBI's proposed guidelines (its national rating being 'AAA'), but 100% if NTPC's international rating ('BB+') were to be considered. Clearly, the capital requirements will be vastly different (a multiple of five times in the above example) depending on whether NTPC is treated as 'AAA' or 'BB+' risk. Also, the fact that an unrated borrower gets a more favourable treatment (100% risk-weighting) than a 'BBB'-rated borrower (which will attract 150% riskweighting) appears harsh for 'BBB'-rated borrowers, and possibly at variance with the authorities' objective of increasing disintermediation and encouraging greater disclosure and more widespread use of external ratings. However, this is similar to the provisions in the Basel II proposals under the standardised approach, which also penalises lower rated borrowers ('BB-' and below) more than unrated ones.