Ratings essential for safety of deposits

Before you decide to deposit your hard-earned money you must be confident that the entity will be able to return your funds upon maturity, as promised. In Sri Lanka, only licensed commercial banks, specialized banks and registered finance companies are allowed to accept public deposits.

As these institutions are also required to obtain and publish their credit ratings, the public would be well advised to check the ratings of these institutions before making their deposit decision.

This is very important especially in the face of some high profile failures of unrated and or unregulated finance companies like Sakvithi Investments and Golden Key Credit Card Co Ltd.

Banks and finance companies offer various deposit options and the vast majority of depositors decide on a particular institution solely on the interest rate they offer.

However, this should not be the case as high returns are accompanied by high risks. In this context, it is important that depositors should have a diverse portfolio of deposits in terms of tenures and institutions in order to achieve the right degree of safety and return for a particular depositor. Here too the depositor has to decide what level of risk he or she is prepared to accept.

Some investors would accept higher risks in return for high interest.

However, in Sri Lanka it could be argued that the risks undertaken by the depositor is not reflected in the return.

Nonetheless, by measuring the ability and willingness of a financial institution to honour its financial commitments, credit ratings are essential inputs that help you make better-informed deposit decisions.

In Sri Lanka there are only two legitimate credit-rating agencies, of which RAM Ratings Lanka is one of them. Each rating agency seeks to provide a rating system that assists depositors to determine the risks associated with depositing in a specific financial institution. Credit ratings can be assigned to entities (ie financial institutions, corporates and insurance companies) or to issues (ie specific borrowings in the form of securities such as debentures, promissory notes,) and reflects an issuer's ability to honour its financial obligations or issue. However, credit ratings are not a buy or sell recommendations, nor do they represent a guarantee against default. Rather, ratings are a measure of an entity's ability and willingness to repay its depositors and or creditors; hence a relative ranking only.

Even though rating symbols and the rating opinion may differ between rating agencies, RAM Ratings Lanka's credit ratings ranges from AAA, which denotes superior repayment capacity or highest credit quality at one end, to "D" or in default at the other.

In other words, from the depositors'/investors' point of view, credit rating provides a simplified measure of the repayment capacity and can be used for deciding the return given the institution's repayment capability.

ie investors should be prepared to accept a lower return attached to a AAA rated instrument as compared to a AA rated paper.

Accordingly, interest rates should increase as one move down the rating scale.

However, these principles are yet to be entrenched in the Sri Lankan financial system.

Hence, the depositors have an opportunity to take advantages of these systemic deficiencies. In addition to the credit rating per se, RAM Ratings Lanka encourages depositors to read credit rating rationales of each financial institution, available on rating agencies' websites.

In this regard, the depositing public is invited to visit RAM Ratings Lanka's website at www.ram.com.lk. RAM Ratings Lanka provides these rationales to be downloaded free of charge or any obligation in the interest of serving the depositing public.