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MUMBAI : A regulatory intervention by the Reserve Bank of India (RBI) that barred rating agencies from using certain forms of diluted guarantees for credit enhancement ratings for bank loans will lead to debt worth 35,000 crore being downgraded by a couple of notches, according to estimates by Icra.

The downward movement in ratings would force banks to assign higher risk weights to these loans, leading to an additional capital requirement of about 400 crore. The potential spate of downgrades is likely to raise the cost of bank loans for these companies. Credit enhancement involves providing assurance of repayment of a debt by another entity, thus improving the borrower’s credit profile.

According to Icra, the new guideline would potentially lead to ratings of about 100 entities rated by it being lowered. Companies from sectors like power, healthcare, engineering, construction, and roads, account for 60% of the total entities whose ratings would be affected.

On 22 April, RBI wrote to credit rating agencies, saying that a review of rating agencies’ policies on issuing bank loan credit enhancement ratings shows wide variation regarding evaluation mechanisms. Therefore, to streamline such practices, RBI issued certain broad principles.

The regulator said that while assessing support for evaluation of credit enhancement ratings, agencies will have to rely only on explicit guarantees by rated external entities, including parents, group companies, or by financial institutions like banks and non-bank financiers. It prohibited them from taking into account support structures like letters of comfort, and letters of support, among others, since these are not legally enforceable. These changes, RBI later said on 26 July, will need to come into force within six months.

However, letters of comfort issued by central and state governments and “shortfall undertakings", which are legally enforceable, irrevocable and unconditional, could be treated as valid supporting structures, RBI said in April.

“Our assessment suggests that if the credit profile of these entities does not undergo any change when the review happens in the next few days, the earlier assessment or the existing rating that is outstanding stands, then based on this scenario, there could be an average impact of around two notches to the existing ratings," said Jitin Makkar, senior vice-president and head of credit policy at Icra.

Crisil Ratings said it is in the process of determining the impact of the new rules. “Crisil is evaluating the impact of the RBI’s guidance note on bank loans with CE ratings in its portfolio," said Somasekhar Vemuri, senior director, ratings centre of excellence, Crisil.

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