RBI pushes credit rating quality to the centre-stage in alignment with Viksit Bharat mission

Viksit Bharat mission would require the availability of low-cost capital in the economy and stable financial markets. The Reserve Bank of India’s (RBI) draft directions on capital charge for credit risk released in October 2025 will go a long way in fulfilling this dual requirement.

The proposals seek to not only align risk weights with those prescribed by the Basel Committee but also link them to the performance metrics of credit rating agencies (CRAs).

The alignment lowers risk weights from 30% to 20% for the ‘AA’ rating category; from 100% to 75% for ‘BBB’; and from 150% to 100% for ‘BB’ — contingent upon CRAs' performance compared to the regulator-determined thresholds. 

There is a catch, though.

The reduced risk weights can be availed of by banks only if the ratings on the loans they offer are from an external CRA that meets the thresholds prescribed by the RBI. Our calculation shows the capital requirement for banks will reduce by ~Rs 1.1 lakh crore from the current base estimated at  ~Rs 6.4 lakh crore, considering the ratings outstanding on bank loan facilities as on September 30, 2025. This assumes all ratings assigned qualify for the lower risk weights.

Such freeing-up of capital creates room for incremental lending by banks;  loans could also be offered at reduced interest rates, making lower-cost debt more accessible.
The RBI has proposed linking risk weights to the external CRA’s rating quality. For each rating category, it has prescribed thresholds for default rates.  If a CRA is unable to meet the prescribed thresholds, then the bank will need to assign the risk weight applicable to the next higher bucket. For instance, if a CRA’s probability of default (PD) for an ‘AA’ rating meets the prescribed range (proposed at 0 - 0.10%, in the draft circular), the exposures it rates ‘AA’  will bear a risk weight of 20%; However, if threshold is not met the risk weight increases by a whooping 30% to 50%, equivalent to that for an ‘A’ rating. 

This move will also incentivise borrowers to work with high-quality CRAs that meet the prescribed thresholds. That should help borrowers avail better interest rates with lenders.  Our assessment shows the interest rate impact can be as high as 50 basis points (assumes 15% return on equity times 12% capital adequacy times 30% lower risk weight) in interest rate per annum if a borrower in the AA category works with CRA that meets the prescribed thresholds. Today, too, a ‘AA’ rating of two CRAs is not comparable; there is a wide variation in default rates published by the CRAs. The disparity stems from differences in analytical rigour, process standards and research quality. 

Prudent investors and lenders that use these ratings are already aware of this fact. Steps that differentiate CRAs by quality are very welcome and salutary because it creates the right impetus among stakeholders to improve. This is also timely in the current backdrop with seven rating agencies operating in the country, and another on the anvil.  Clearly, Mint Road is sending a strong message: CRAs will be held accountable for their ratings, and they will be incentivised to meet prescribed standards. 

The RBI’s move is also in line with the international Basel standards which propose regulators to appropriately monitor the quality of credit ratings. These ask for the performance of CRAs to be observed closely and call for remedial action if they breach prescribed thresholds. If performance continues to be below par, appropriate penal actions and steps can follow.

To be sure, the RBI has used similar approaches for other regulated entities.  For instance, it placed 13 banks (11 public sector and 2 private sector) under the Prompt Correction Action plan for a brief period during the past 10-years using an objective framework based on several parameters, including capital thresholds, asset quality and profitability. 

The corrective steps ranged from restrictions on growth of advances to restriction on dividends.  Additionally, preventive and supervisory frameworks are used by other regulators in India to control quality and penalise sub-standard performance of entities or market participants. For example, the Insurance Regulatory and Development Authority of India (IRDAI) uses solvency ratio to monitor the financial health of insurance companies, ensuring they can meet their long-term obligations to policyholders.
IRDAI reserves the right to take corrective action when insurers fail to maintain the necessary solvency ratio, including banning them from selling new policies. 

Better quality and objectivity of credit ratings will improve the long-term health and robustness of the domestic financial ecosystem.  This can be understood from the performance of CRAs in the past. Remember the painful cycle of high NPAs between 2013 and 2020 borne by banks and other financial institutions? Those 8 years were a drag on growth because of reduced capitalisation levels.

It is pertinent to see if all CRAs were alert enough to forewarn the banking system of the rising credit stress through their rating actions. We looked at the exposures of CRAs to 40 non-performing assets (NPA) accounts referred by the RBI  for insolvency proceedings between 2016 and 2020. Wide variation in the share—or the quantum of loans rated in investment grade a year prior to default, which later became non-performing assets—was noticed among CRAs.

Such variations justify the RBI’s move and the premise that working with a better-quality CRA is helpful for the country’s long-term financial stability. CRAs play a vital fiduciary role in the credit markets, providing independent and objective assessments of issuers and their debt securities. The quality of their ratings, as reflected in their default statistics, is crucial in managing systemic credit risks and maintaining financial market stability. For banks, insurers and brokers, capital is a fundamental requirement. 
For CRAs, capital is their reputation and track record, as reflected by default statistics. Therefore, differentiating CRAs by default statistics is eminently logical.

Subjecting those that come up short to a corrective action framework will establish prudent deterrence, elicit a higher order of accountability and transparency and go a long way in further strengthening the financial system. In doing so, the RBI is serving the cause of India’s financial stability well, just as we march towards the goal of a Viksit Bharat.