RBI’s New Framework Links Bank Capital Rules To Rating Agency Default Performance

The Reserve Bank of India’s proposed framework for external credit assessment institutions is expected to reshape the country’s credit ratings landscape, with experts warning that the changes could make borrowing more difficult for micro, small and medium enterprises (MSMEs). The new regulations, scheduled to come into effect from April 1, 2027, introduce tighter capital norms for banks based on borrower ratings and the historical default performance of rating agencies. Industry observers believe the move could increase the dominance of large rating agencies while putting smaller firms and MSME borrowers under added financial pressure.

Under the revised framework, banks will be required to hold additional capital if loans are rated by agencies whose historical default rates exceed prescribed thresholds. The Reserve Bank of India will monitor the rolling one-year observed default rates of rating agencies across different categories. Analysts say this mechanism may encourage banks to rely more heavily on larger and established agencies such as CRISIL, ICRA and CARE Ratings, which already dominate the market. Smaller agencies that primarily cater to mid-sized firms and MSMEs could struggle to remain competitive under the stricter norms.

The framework also introduces tighter treatment for borrowers classified as “Issuer Not Cooperating” (INC), referring to companies that fail to regularly share financial information with rating agencies. Earlier, such ratings were allowed to lapse after a period of non-cooperation. Under the new rules, however, banks must assign higher risk weights to loans linked to INC-tagged borrowers if the status continues beyond six months. Experts say this could significantly raise borrowing costs for smaller businesses that often face compliance and reporting challenges due to limited resources and weaker financial systems.

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India’s MSME sector, which includes more than 63 million enterprises and contributes nearly 30% of the country’s gross domestic product, is considered especially vulnerable to the changes. Many smaller businesses depend on regional or lesser-known rating agencies because larger firms generally focus on bigger corporate clients. Financial sector expert Abizer Diwanji said the new structure shifts greater responsibility from banks to rating agencies, making agencies more cautious in assigning ratings. He warned that MSMEs may face stricter scrutiny and reduced access to affordable credit as agencies seek to avoid penalties linked to higher default rates.

Industry participants have also raised concerns over the methodology used in the RBI framework, which calculates defaults based on the number of borrowers rather than the total value of defaults. Experts argue this creates an uneven playing field because smaller agencies typically rate a larger volume of financially weaker borrowers. As a result, even relatively small payment delays by MSMEs could disproportionately increase the observed default rate of these agencies. Critics say the approach may further concentrate the market in favor of larger players and reduce competition within the ratings industry over time.

The RBI’s reforms are part of India’s broader effort to align banking regulations with the global Basel III standards introduced after the 2008 financial crisis. The push for stronger oversight intensified following the collapse of Infrastructure Leasing & Financial Services in 2018, when the company defaulted on debt obligations worth around Rs 91,000 crore despite carrying high credit ratings. Subsequent investigations and regulatory action exposed weaknesses in the credit assessment process and led to penalties against several agencies. While the RBI says the new framework is intended to strengthen financial stability and improve risk management, industry experts believe additional refinements may be necessary to prevent unintended consequences for MSMEs and smaller credit rating agencies.

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