Credit ratings may seem complicated to ordinary depositors and investors, but they play an important role in managing risk and maintaining discipline in the financial system.
They help banks assess borrowers' ability to repay loans and provide investors with an independent assessment of the risks associated with companies and debt instruments.
Historically, lending decisions often depended heavily on the judgement of bank officials. As financial markets evolved, the need for independent assessments led to the emergence of credit rating agencies. Bangladesh now has eight agencies providing such services.
A credit rating agency evaluates a borrower's ability and willingness to repay debt, offering an independent opinion on its creditworthiness. It does not decide whether a bank should approve a loan but helps lenders make informed decisions by assessing potential risks against an established rating scale.
The importance of ratings becomes clearer when considering how banks operate. A bank's equity may account for only a small proportion of its funding, with deposits and borrowings providing most of the remainder. Banks must therefore manage these funds responsibly while meeting their obligations to depositors.
For instance, a bank collecting deposits at 8% interest and lending at 12% earns a four-percentage-point margin. If borrowers fail to repay, the bank loses expected income and may incur substantial losses, potentially putting depositors' money at risk.
Credit assessments help banks identify such risks before lending. They also influence capital planning. Under the Basel framework, banks must maintain adequate capital against lending exposures. Depending on applicable regulations and risk weights, exposures to stronger-rated borrowers may require less capital than those to riskier borrowers.
Ratings generally range from high investment grades, such as AAA and AA, to lower-rated and non-investment-grade categories. The assigned grade reflects an assessment of the borrower's financial strength and repayment capacity.
How credit rating agencies work
Credit rating agencies assess the financial strength of banks, financial institutions, business groups and debt instruments to determine their capacity to meet debt and interest payments on time.
A credit rating depends on more than a company's financial statements. Agencies examine the outlook for the sector in which it operates, government policies affecting the business, market demand for its products and its prospects for profitability
Bangladesh's recognised agencies include Credit Rating Information and Services Ltd (CRISL), Credit Rating Agency of Bangladesh Ltd (CRAB), Emerging Credit Rating Ltd (ECRL), National Credit Ratings Ltd (NCRL), ARGUS Credit Rating Services Ltd (ACRSL), Alpha Credit Rating Ltd (ACRL), WASO Credit Rating Company (BD) Ltd (WASO) and The Bangladesh Rating Agency Limited (BDRAL).
The process typically begins with collecting information on an entity's balance sheet, income, expenditure, cash flow, outstanding loans, bank liabilities, non-performing loans, business operations and management.
Agencies examine whether a borrower can service its debt from earnings, whether it faces liquidity constraints, how heavily it is indebted and what risks could affect its operations. They then assign a rating using established methodologies.
A higher rating generally indicates lower credit risk, while a lower rating signals a greater likelihood of repayment difficulties. Agencies explain the basis of their assessments and review ratings as financial conditions change. However, a rating is not a guarantee of repayment.
What determines a credit rating?
A credit rating depends on more than a company's financial statements. Agencies consider industry prospects, government policies, market demand, profitability and the borrower's ability to generate sufficient cash flow.
An entrepreneur's business background, experience and integrity may also influence the assessment. Agencies examine projected cash flows over the following one to four years to determine whether the business is likely to generate enough money to repay loans on time.
The proportion of a project financed through the entrepreneur's own investment, rather than bank borrowing, is another consideration. Agencies also assess the project's location and access to essential utilities, including gas and electricity.
Ratings require regular monitoring because economic conditions, supply disruptions and policy changes can alter a company's risk profile. A factory facing inadequate gas supplies, for example, may struggle to maintain production, reducing revenue and profitability. Such deterioration could lead to a downgrade even if the company previously held a strong rating.
Monitoring these changes helps lenders identify emerging risks and make better-informed decisions.
Competition raises concerns over rating quality
Despite their importance, credit rating agencies face challenges that may undermine the credibility of their assessments. One concern is the potential conflict of interest arising because the entity being rated pays for the service.
To mitigate this risk, agencies may avoid rating banks with which their directors are associated or companies owned by their directors' relatives.
An industry representative argued that Bangladesh had too many rating agencies relative to the available market. He cited eight agencies in Bangladesh, compared with two each in Singapore, Malaysia and Pakistan, and three to four in India.
According to him, excessive competition had driven down fees for small and medium-sized enterprise (SME) ratings. Assessments that should cost Tk15,000–20,000 were reportedly being offered for as little as Tk5,000.
Such low fees can make on-site inspections difficult to finance, potentially compromising assessment quality.
The representative also alleged that some agencies offered favourable ratings to retain clients. Another challenge was that companies did not always share confidential reports prepared by their auditors, limiting the information available to rating agencies.
Calls for reform and a private credit bureau
Industry participants have called for coordinated reforms involving the Credit Rating Agency Association of Bangladesh (CRAAB) and regulatory authorities.
One proposal is for the Bangladesh Securities and Exchange Commission (BSEC) to introduce minimum fees for rating services. Proponents also suggest reducing the number of agencies to two or three through mergers and consolidation.
They have further proposed that agencies collect fees in advance, before rating reports are placed before rating committees, in line with practices they describe as common internationally.
The proposed introduction of a National ID-based private credit bureau, announced by Bangladesh Bank, could make credit scoring more accessible to ordinary people. Appropriate oversight would also be important as the sector develops.
Credit ratings need a bigger role in investment decisions
Muzaffar Ahmed, FCMA, FCS, executive president of CRISL, said credit ratings remained poorly understood in Bangladesh's investment arena. Their use was still largely concentrated among banks and financial institutions seeking capital adequacy benefits under the Basel framework.
The broader value of ratings, he said, lies in investment analysis and decision-making, particularly in evaluating risks and supporting long-term investment. A strong regulatory framework and credible assessments are essential to ensuring that ratings serve their wider purpose.
Ahmed identified CRISL's market standing and acceptance among users as major achievements. Its ratings help banks assess credit risks and enable businesses to raise funds for working capital and expansion.
CRISL has also contributed to capital market confidence through ratings of debt instruments and companies seeking initial public offerings (IPOs). As Bangladesh's first credit rating agency, it has helped popularise ratings through its services, training initiatives and support for regulators in developing appropriate frameworks.
Drawing on nearly 30 years of industry experience, Ahmed said his priority was to ensure that the sector followed appropriate standards and that the economic importance of ratings became more widely understood.
He expects ratings to play a growing role in long-term investment, particularly following banking sector reforms. Aligning rating standards with international practices could also improve Bangladesh's standing among global investors and help attract more foreign direct investment.
Stronger oversight key to restoring confidence
Md Monowar Hossain, FCA, a forensic auditor, capital market specialist and former banker, said lasting trust in credit ratings required systemic improvements rather than piecemeal reforms.
He called for stronger regulatory oversight and greater transparency in rating assumptions and historical performance. Digital technologies and artificial intelligence could help agencies improve credit risk detection and monitoring.
Hossain also highlighted the need to strengthen creditor rights, improve insolvency procedures and incorporate environmental and social risks into rating methodologies.
Addressing conflicts of interest, data quality and governance shortcomings is essential to making ratings more reliable, he said. Independent assessments, combined with capital market development, could strengthen lenders' confidence and bring Bangladesh's credit rating system closer to international standards.