International credit rating agencies have been committed to delivering sensible credit ratings to every corporate, financial institution and sovereign they are asked to assess. However, since the occurrence of the 2008 global financial crisis, they have been under scrutiny.
In fact, credit rating agencies – in the crosshairs of reformers and regulators since the crisis – are entering a phase of even closer inspection and ultimately tighter regulatory enforcement and institutional due diligence.
The level of increased scrutiny is not any different for domestic credit rating agencies, with the latest being South Korean credit appraisers that are now under attack for inflating the rating of local companies to secure profits.
The Korea Center for International Finance (KCIF), an organisation which helps assist the government in evading financial crises, said on May 13 that Korea Ratings, Nice Investor Service and Korea Investors Service have rated domestic corporates on average six grades higher than comparable assessments by the three global agencies – Moody’s Investor Service, S&P and Fitch Ratings.
While international and local credit rating agencies have different metrics when it comes to deciphering the creditworthiness of a corporate, the large discrepancy shows that the credit rating system in Korea is flawed.
In fact, it could potentially turn into a bigger problem if not addressed early. There are growing signs that the nation’s financial system is battling with an overdose of non-performing loans (NPLs), stemming from both the retail and corporate sector.
For example, major South Korean banks saw their bad debt rise by about KRW1.5 trillion (US$1.38 billion) this year due to some larger companies’ financial troubles and households’ failure to repay debt, according to the Financial Supervisory Services (FSS) on May 8.
Also, top lender Kookmin Bank and its five other rivals had a combined bad debt worth KRW13.1 trillion as of end-March, up 13% from the end of last year.
While banks themselves deserve to bear the brunt of the blame for failing to detect the creditworthiness of these corporates and households on their own accord, local credit rating agencies are also liable. After all isn’t the duty rating agencies to provide the financial industry with clear and accurate benchmarks – by discovering the red flags in these businesses before the market does?
To make matters worse, the fact that Korea’s local credit rating agencies have been overstating the creditworthiness of domestic corporates in the economy could mean that they could have also overlooked potential corporate failure.
And this is not ideal at a time when the nation’s financial sector witnessed a flurry of bankruptcy cases in the last few months. For example, shipbuilding conglomerate STX Group’s liquidity crunch has increased local banks’ concerns towards highly risky and cyclical sectors. The banking sector’s exposure to the group reached KRW13.19 trillion as of end-March.
Also, last September, another mid-sized Korean conglomerate Woongjin Group, declared bankruptcy for its construction arm and its holding company, pledging all-out efforts to salvage the reputation of the group, but the company failed to repay promissory notes worth KRW15 billion.
Local media reported that rating agencies failed or neglected to catch the looming collapse.
As a result, Korea’s rating agencies must investigate these suspicions thoroughly to prevent any more cases of corporate demise for their own economy’s sake.
In fact, these examples should serve as an occasion for financial policymakers and regulators to check their crisis-monitoring system from the ground up, and perhaps impose stricter guidelines on rating agencies.
Investors should also learn that ratings, like investment bank research, can never be a substitute for independent analysis and due diligence.
This is no time for complacency given the dire economic situations. A small hole can destroy a dam if Korea is not careful.