What works for bonds can aid investors elsewhere too

However, private placements also get rated as they could be offered in the market at some point. In fact, issuers of such private placements get ratings from two or three CRAs, as investors often insist on them. Hence, there is a lot of value that is brought to the table.

The Securities and Exchange Board of India’s (Sebi) draft paper that explores the widening of such ratings to companies or instruments that come under different financial regulators is noteworthy. As a number of financial products are reaching the retail level, it is a timely discussion.

A wider range would help investors in general make better-informed decisions. Sebi has already noted that these new ratings would be ring-fenced from the rating business through separate outfits to minimize conflicts of interest.

In the past, CRAs have graded non-debt instruments too. They have graded initial public offerings (IPO) of equity and also real estate. However, these services did not quite catch on. One lesson learnt was that unless such a grading was mandatory, entities were unlikely to opt for one.

For IPOs, it began as a useful tool to denote how true the company was to what it stated in its issue prospectus. It was not to be an indicator of how well that stock would later do.

However, the concept got undermined as critics attempted to link the stock’s post-listing market performance with its grading. So such gradings were left to the choice of stock issuers, which gave up on the idea.

Real estate grading was also not very successful, with mostly lesser-known builders opting for an evaluation. Bigger developers had their brand names to see them through, while others faced the risk of a low grading that could work against them.

Without regulatory compulsion, real estate companies preferred not to get graded.

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Now that ratings or gradings seem likely to be extended to other regulatory domains, services such as insurance and pension would qualify for such evaluations. There are a plethora of schemes offered by insurers to cover life and other general risks.

Their finer points, however, often go into the fine print, which customers are rarely aware of. As insurance agents tend to push products that suit their own interests, customers often end up making inferior decisions.

Having a grading for each product will ensure that the customer can evaluate the options available on that basis.

The grading could cover aspects such as the policy’s promised benefits, the insurer’s financial strength, record of response to claims, turnaround times and so on. These are key inputs for the customer.

A similar rationale holds for pension funds, which showcase past returns with the caveat that these are not indicative of the future. A grading of such schemes can be especially useful for investors.

In fact, even mutual funds, under the domain of Sebi, should have their schemes graded in a manner that offers investors a clear picture based on metrics other than returns.

There are several similar-focused schemes run by asset management companies that need to be evaluated independently.

Presently, independent agencies do give star ratings that are based not on performance but how portfolios are handled by investment managers. This idea should also be explored for the purpose of ratings.

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Note that the Reserve Bank of India mandates banks to use only ratings issued by an external credit rating agency for determining risk weights while calculating the capital that must be maintained by banks to cover the risks of their asset portfolios.

Therefore, it can be argued that ratings are in a way already being prescribed by financial regulators other than Sebi.

Much effort by regulators in all fields has gone into improving India’s level of financial literacy and nudging people to try different products. This is welcome, as it helps investors plan their finances better.

But in the absence of knowledge, people often take investment decisions based on influencer tips, which can result in sub-optimal outcomes. Having ratings for a wide range of financial products , therefore, will be of help.

That said, there are steps that need to be taken to make this initiative successful.

First, the idea needs the buy-in of the relevant sector’s regulator. Prima facie, there cannot be any objection as anything that benefits the customer should be welcomed.

Second, gradings must be made mandatory. If not, players may not go for such a rating or grading as these could work out unfavourably for them.

Third, the rating or grading methodology needs to be formulated in discussion with all market participants and the field’s regulator, so that it has wide acceptability. As this exercise would be novel, consultation with insurers and pension funds would be required.

Fourth, a major campaign must be launched to spread awareness of these ratings, so that the public is nudged to take them into consideration as envisaged.

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This idea of extending ratings to financial products beyond debt is a chance to strengthen public confidence and should be taken up by all regulators.

These are the author’s personal views.

The author is chief economist, Bank of Baroda, and author of ‘Corporate Quirks: The Darker Side of the Sun’