Goforthelaw.com - Legal Education and Awareness
  Home  |  About Us  |   R & D   -   LL.B. Previous Question Papers   |  Articles   |  Moot Court   |  Discussion Forum   |  Directories   |  Law Web Journal   |  Contact Us   |   Login  

A. P. LEGAL SERVICES PVT. LTD.
Legal Empowerment through Professional Excellence

Frequently Asked Questions 

Follow Goforthelaw on Facebook Follow Goforthelaw on Twitter Follow Goforthelaw on Blogger Join Goforthelaw on LinkedIn Subscribe - RSS feed here

 
Article Details
 
Login to comment! 4 Comments Login to refer to a friend!
Title Credit Rating in India:An Overview
Log In Here
Email Id
Password

New User ? Click Here to Register
Forgot Password Click Here


Article by Mirza Juned Beg NALSAR University of Law
Category Law Students
Content

 

INTRODUCTION

In providing independent opinions to investors as to the credit quality of debt issuer, credit ratings have become important parameters in market acceptance and pricing of debt[1]. Ratings are now viewed as easily usable tools for differentiating credit quality by both individual investors ill-equipped to assess credit risk, and institutional investors often required to hold instruments of given credit categories in their portfolio[2]. This introductory note reviews the key definitions and features of credit ratings and the bases on which ratings are assigned. It briefly addresses the correlation between credit quality and default rates, and outlines some of the criteria underpinning sub-sovereign credit assessments in emerging and developing economies[3].

 

 With the increasing market orientation of the Indian economy, investors value a systematic assessment of two types of risks, namely “business risk” arising out of the “open economy” and linkages between money, capital and foreign exchange markets and “payments risk”[4]. With a view to protect small investors, who are the main target for unlisted corporate debt in the form of fixed deposits with companies, credit rating has been made mandatory. India was perhaps the first amongst developing countries to set up a credit rating agency in 1988[5].

The function of credit rating was institutionalized when RBI made it mandatory for the issue of Commercial Paper (CP) and subsequently by SEBI. When it made credit rating compulsory for certain categories of debentures and debt instruments. In June 1994, RBI made it mandatory for Non-Banking Financial Companies (NBFCs) to be rated. Credit rating is optional for Public Sector Undertakings (PSUs) bonds and privately placed non-conve11ible debentures upto Rs. 50 million. Fixed deposits of manufacturing companies also come under the purview of optional credit rating[6].

The Ratings industry in India has been built up to its present position over a period of 15 years. Over the years, credit ratings have evolved into a 90-crore market, with four agencies providing rating services, and significant pull from investors for the product[7]. The ratings business in India has seen three phases:

·         First phase, as described above, there was no experience of credit ratings, and virtually no awareness, on the part of investors and issuers.

·         Second phase saw the advent of regulatory support for credit ratings, with the introduction and increasing rigor of regulations covering primarily the markets for public issue of debt and for fixed deposits. Aimed at protecting smaller investors, these measures also amounted to regulatory recognition of the role of credit ratings and the quality of the effort put in till then, in estimating credit quality. With these measures, credit ratings rapidly passed out of the arcane realm of high finance, and into the lexicon of the individual market participant.

·         Third phase recent years have seen a third phase of the market’s development with public issues of debt reducing in volume; the focus has shifted to the market for private placements. Almost all the privately placed debt issued in the Indian market is rated, even though this is not a regulatory requirement. This shift is entirely driven by investors in these securities, who typically tend to be highly sophisticated financial sector entities.

Credit rating is also known as Security Rating in India. It is mandatory for the issuance of debt instruments, debentures; commercial paper issued by corporate and public deposits of all NBFCs (Non Banking Financial Companies).

ORIGIN & DEVELOPMENT

The first Mercantile Credit Rating Agency was set up in New York in 1841 to rate the ability of merchants to pay their financial obligations[8]. Later on, it was taken over by Robert Dun. This agency published its first rating guide in 1859.

The second Agency was established by John Bradstreet in 1849 which was later merged with first Agency to form Dun & Bradstreet in 1933, which became the owner of Moody’s Investor’s Service in 1962. The history of Moody’s can be traced back about 100 years ago. In 1900, John Moody laid stone of Moody’s Investors Service and published his ‘‘Manual of Railroad Securities’’[9].

 Early 1920’s saw the expansion of Credit Rating Industry when the Poor’s Publishing Company published its first rating guide in 1916. Subsequently Fitch Publishing Company and Standard Statistics Company were set up in 1924 and 1922 respectively[10]. Poor and Standard merged together in 1941 to form Standard and Poor’s which was subsequently taken over by McGraw Hill in 1966.

 Between 1924 and 1970, no major new Rating Agencies were set up. But since 1970’s, a number of Credit Rating Agencies have been set up all over the world including countries like Malaysia, Thailand, Korea, Australia, Pakistan and Philippines etc. In India, CRISIL (Credit Rating and Information Services of India Ltd.) was setup in 1987 as the first Rating Agency followed by ICRA Ltd. (formerly known as Investment Information & Credit Rating Agency of India Ltd.) in 1991, and Credit Analysis and Research Ltd. (CARE) in 1994. All the 3 agencies have been promoted by the All-India Financial Institutions[11].

The Rating Agencies have established their creditability through their independence, professionalism, continuous research, consistent efforts and confidentiality of information. Duff and Phelps has tied up with two Indian NBFCs to set up Duff and Phelps Credit Rating India (P) Ltd. in 1996[12].

CONCEPT OF CRADIT RATING

Credit Rating means “an assessment of reputation for trustworthiness in paying debts”. Credit rating is also called as “credit ranking or debt rating”. Credit rating is an assessment of the capacity of the issuer of debt security by an independent agency, to pay interest and repay principal as per the terms of issue of debt[13].

The company which issues debt instruments is called an issuer or issuing company. The issuer, issues these instruments to collect finance from the investors.

The investor looks at the credit rating of the instrument and the issuer before investing. If the credit rating is a high, investor will invest in the company. That is, he will purchase the debentures, fixed deposits, bonds, etc. issued by that company[14]. If the credit rating is low, he will not purchase the debentures, etc. of that company. So, credit rating guides the investor while investing.

DEFINITION

A credit rating defines the financial strength of a borrower and helps the investor determine the likelihood that the bond issuer will pay coupon payments in a timely fashion and more importantly the initial investment at maturity[15].

According to Moody: “Ratings are designed exclusively for the purpose of grading bonds according to their investments qualities”[16].

According to Australian Ratings: ‘‘A corporate credit rating provides lenders with a simple system of gradation by which the relative capacities of companies to make timely repayment of interest and principal on a particular type of debt can be noted’’[17].

Indian Credit Rating Agencies define Credit Rating as follows:

According to CARE: “Credit Ratings are essentially, the opinion of the Rating Agency on the relative ability and willingness of the issuer of a debt instrument to meet the debt service obligation as and when they arise”[18].

According to CRISIL: “Credit Rating is an unbiased, objective and independent opinion to an issuer’s capacity to meet financial obligation, it is the current opinion as to the relative safety of timely payment of interest and principal on a particular debt instruments”[19]. Thus, rating applies to a particular debt obligation of the company and is not a rating for the company as a whole.

According to ICRA: “Credit Rating is a simple and easy to understand symbolic indicator of the opinion of the Credit Rating Agency about the risk involved in a borrowing program of an issuer neither a general purpose evaluation of the company nor the recommendation to buy, hold or sell a debt instrument”[20].

Thus, precisely, rating is a measure of credit risks and is only element in the investment decision making.

NATURE OF CREDIT RATING

1. Rating is based on information[21]: Any rating based entirely on published information has serious limitations and the success of a rating agency will depend, to a great extent, on its ability to access privileged information.

2. Many factors affect rating: Rating does not come out of a predetermined mathematical formula[22]. Final rating is given taking into account the quality of management, corporate strategy, economic outlook and international environment. To ensure consistency and reliability a number of qualified professionals are involved in the rating process[23]. Rating agencies also ensure that the rating process is free from any possible clash of interest[24].

3. Rating by more than one agency: In the well developed capital markets, debt issues are, more often than not, rated by more than one agency[25]. And it is only natural that ratings given by two or more agencies differ from each other e.g., a debt issue, may be rated ‘AA+’ by one agency and ‘AA’ or ‘AA-’ by another. It will indeed be unusual if one agency assigns a rating of AA while another gives a ‘BBB’.

4. Monitoring the already rated issues: A rating is an opinion given on the basis of information available at particular point of time[26]. Many factors may affect the debt servicing capabilities of the issuer. It is, therefore, essential that rating agencies monitor all outstanding debt issues rated by them as part of their investor service

5. Publication of ratings: In India, ratings are undertaken only at the request of the issuers and only those ratings which are accepted by the issuers are published[27]. Thus, once a rating is accepted it is published.

6. Right of appeal against assigned rating: Where an issuer is not satisfied with the rating assigned, he may request for a review, furnishing additional information, if any, considered relevant[28]. The rating agency will undertake a review and thereafter give its final decision.

7. Rating is for instrument and not for the issuer company: The important thing to note is that rating is done always for a particular issue and not for a company or the Issuer[29].

8. Rating not applicable to equity shares: By definition, credit rating is an opinion on the issuer’s capacity to service debt. In the case of equity there is no pre-determined servicing obligation, as equity is in the nature of venture capital. So, credit rating does not apply to equity shares[30].

9. Credit vs. financial analysis: Credit rating is much broader concept than financial analysis[31]. One important factor which needs consideration is that the rating is normally done at the request of and with the active co-operation of the issuer.Necessary adjustments are made to the published accounts for the purpose of analysis.

11. Time taken in rating process: The rating process is a fairly detailed exercise. It involves, among other things analysis of published financial information, visits to the issuer’s offices and works, ‘intensive discussion with the senior executives of issuers, discussions with auditors, bankers, creditors etc. It also involves an in-depth study of the industry itself and a degree of environment scanning, all this takes time rating[32].

NEED OF CREDIT RATING

Credit Ratings made a bridge between risk and return. They, thus, provide a yardstick against which to measure the risk inherent in any instrument. An investor uses the ratings to assess the risk level and compares the offered rate of return with his expected rate of return to optimize his risk-return trade-off[33].

Thus, the need for Credit Rating in today’s world cannot be over emphasized. It is of great assistance to the investors in making investment decisions. It also helps the issuers of the debt instruments to price their issues correctly and to reach out to new investors. Regulators like Reserve Bank of India (RBI) and Securities and Exchange Board of India (SEBI) use credit rating to determine eligibility criteria for some instruments. For instance, the RBI has stipulated a minimum Credit Rating by an approved Agency for issue of commercial paper. In general, Credit Rating is expected to improve quality consciousness in the market and establish over a period of time, a more meaningful relationship between the quality of debt and the yield from it. Credit Rating is also a valuable input in establishing business relationships of various types. However, Credit Rating by a Rating Agency is not a recommendation to purchase or sale of a security.The increasing levels of default resulting from easy availability of finance, has led to the growing importance of the credit rating. The other factors are[34]:

i. The growth of information technology.

ii. Globalization of financial markets.

iii. Increasing role of capital and money markets.

iv. Lack of government safety measures.

v. The trend towards privatization.

vi. Securitization of debt.

UTILITY OF CREDIT RATING

Credit ratings are used by investors, issuers, investment banks, broker-dealers, and governments[35]. For investors, credit rating agencies increase the range of investment alternatives and provide independent, easy-to-use measurements of relative credit risk; this generally increases the efficiency of the market, lowering costs for both borrowers and lenders. It also opens the capital markets to categories of borrower who might otherwise be shut out altogether: small governments, startup companies, hospitals, and universities.

Ratings use by bond issuers

Issuers rely on credit ratings as an independent verification of their own credit-worthiness and the resultant value of the instruments they issue[36].  A significant bond issuance must have at least one rating from a respected CRA for the issuance to be successful.

Ratings use by government regulators

Regulators use credit ratings as well, or permit ratings to be used for regulatory purposes[37].

Ratings use in structured finance

Credit rating agencies may also play a key role in structured financial transactions[38]. Unlike a "typical" loan or bond issuance, where a borrower offers to pay a certain return on a loan, structured financial transactions may be viewed as either a series of loans with different characteristics, or else a number of small loans of a similar type packaged together into a series of "buckets".

CLASSIFICATION OF CREDIT RATINGS

There are 2 types of Credit Rating have been noticed[39]:

1) Traditional Debt Rating (TDR)

2) Private Placement Rating (PPR)

Traditional Debt Ratings (TDR): Traditional Debt Ratings are a symbolic prediction about the debt security probability resulting in a default in timely payment of interest and principal. In other words, traditional debt rating reflects the current opinion of a credit rating agency of the relative capability and willingness of an issuer of a debt instrument to service the debt obligation as per the term of contract .Traditional debt rating is specific to specific to to a debt instrument in termofcreditrisk associated with such instrument .Traditional debtrating enable an investor to establih a link  between risk and return and provide a symbolic yardstick to identify the risk level associated with the instrument and the return it offers to match with his preferences with expectations.

Private Placement Rating (PPR): Privately Rating is newly introduced Credit Rating System finding in the literature generated by standard & poor on Credit Rating, Private Placement Rating is not much different to traditional debt rating but it goes one step ahead to traditional debt rating, i.e. Apart from evaluating a risk of default in timely payment it also evaluates the likelihood of loss to an investor in the event of default according on the investment. Never the less, either or both of the two types of rating can be used for new issues of debt securities or structured obligations.

Never the less, either or both of the two types of rating can be used for new issues of debt securities or structured obligations.  

Other then this there are some other category of credit rating:

·         Sovereign Ratings: A sovereign credit rating is the credit rating of a sovereign entity, i.e., a national government. The sovereign credit rating indicates the risk level of the investing environment of a country and is used by investors looking to invest abroad. It takes political risk into account[40].  Asses the country credit risk & is used as a point of reference for country borrowing from WB, IMF, ADB, IDB, etc.,

·         Entity Ratings: The credit rating of a corporation is a financial indicator to potential investors of debt securities such as bonds. Credit rating is usually of a financial instrument such as a bond, rather than the whole corporation[41]. Risk rating of corporate entities.

·         Instrument Ratings: Ratings of the bond issued by different corporations & municipalities.

TYPES OF INSTRUMENT RATED

Followings are the Bodies or Organization which can be rated[42]: Manufacturing Companies; Banks; Non Banking Financial Institution; Financial Institutions; Housing Finance Companies; Municipal Bodies; Companies in Infrastructure Sector; 

To keep the pace with the changing credit requirements of new instruments the rating agencies have been upgrading the technology and bringing in analytical innovation. The instrument being rated by such agencies include: Mortgage & Asset –Backed Securities; Letter Of Credit Backed Bonds, Commercial Paper and Structure Finance for Global Market; Project Finance; Municipal and Corporate Bond Insurance; Bonds and Money Market Funds; and Syndicated Banks Loans.

IN INDIAN CONTEXTS

With reference to India the Rating Agencies have been rating the following types of debts & debt obligations[43]:

1) Debenture Bonds

2) Fixed Deposits

3) Commercial Paper 

4) Structured Obligations

5) Other ratings:

a) Utilities Rating

b) State Government Ratings

c) Asset Backed Securities

d) Mutual Funds Rating

e) Equity Grading/Assessment

f) Bank Lines Of Credit

RATING OTHER THAN DEBT INSTRUMENTS

Credit Rating has been extended to all those activities where uncertainty and risk is involved. Now-a-days credit rating is not just limited to debts instruments but also covers the following[44]:

I. Country Rating: A country may be rated whenever a loan is to be extended or some major investment is to be made in it by international investors to determine the safety and security of their investments. A number of factors such as growth rate, industrial and agricultural production, government policies, inflation, fiscal deficit etc. are taken into consideration to arrive at such rating[45].

II. Rating of Real Estate Builders and Developers: CRISIL has started assigning rating to the builders and developers with the objective of helping and guiding prospective real estate buyers. CRISIL thoroughly scrutinizes the sale deed papers, sanctioned plan, and lawyers’ report government clearance certificates before assigning rating to the builder or developer[46].

III. Chit Funds: Chit funds registered as a company are sometimes rated on their ability to make timely payment of prize money to subscribers. The rating helps the chit funds in better marketing of their fund and in widening of the subscribers base. This service is provided by CRISIL[47].

IV. Rating of States: States of India have also approached rating agencies for rating. Rating helps the State to attract investors both from India and abroad to make investments. Investors find safety of their funds while investing in a state with good rating. Foreign companies also come forward and set up projects in such states with positive rating. States like Maharashtra, Madhya Pradesh, Tamil Nadu, Andhra Pradesh and Kerala have already been rated by CRISIL[48].

V. Rating of Banks: CRISIL and ICRA both are engaged in rating of banks based on the following six parameters also called CAMELS[49].

C - C stands for capital adequacy of banks.

A - A stands for asset quality.

M - M stands for management evaluation.

L - L indicates liquidity position.

S - S stands for Systems and Control.

Thus, the above six parameters are analyzed in detail by the rating agency and then final rating is given to a particular bank.

VI. Rating (Recommendation) for Equities

These days analysts specialized in equity ratings make a forecast of the stock prices of a company. They study thoroughly the trend of sales, operating profits and other variables and make a forecast of the earning capacity and profitability position of a company. The following are some of the recommendations made by the equity analysts for its investors[50]:

i. Buy: It shows the stock is worth buying at its current price.

ii. Buy on Declines: This recommendation indicates stock is basically good but overpriced now. The investor should go for buying whenever the price declines.

iii. Long-term Buy: This recommendation suggests that a stock should be bought and held for a longer period at least a year in order to realize gains.

iv. Strong Buy: This buy recommendation strongly favors the purchase of a stock because analysts expect a steep rise in the prices of stock from its current price.

v. Out-performer: This recommendation shows that whatever may be the mood of the stock market the stock will perform better than the market.

vi. Overweight: This refers to that investor can increase the quantum or weight of that stock in his portfolio.

vii. Hold: This recommendation is a suggestion to the investor to exit because stock prices are not likely to be appreciated significantly from the current price level.

viii. Sell/Dispose/Sub-Standard/Under-weight: It indicates to the investor to sell/dispose off or decrease the weight of stock from its portfolio because stock is fundamentally overvalued at its current level and the investor’ should exit from it immediately.

FACTORS AFFECTING ASSINGNED RATINGS

The following factors generally influence the ratings to be assigned by a credit rating agency[51]:

1. The security issuer’s ability to service its debt. In order, they calculate the past and likely future cash flows and compare with fixed interest obligations of the issuer.

2. The volume and composition of outstanding debt.

3. The stability of the future cash flows and earning capacity of company.

4. The interest coverage ratio i.e. how many number of times the issuer is able to meet its fixed interest obligations.

5. Ratio of current assets to current liabilities (i.e. current ratio (CR)) is calculated to assess the liquidity position of the issuing firm.

6. The value of assets pledged as collateral security and the security’s priority of claim against the issuing firm’s assets.

7. Market position of the company products is judged by the demand for the products, competitor’s market share, distribution channels etc.

8. Operational efficiency is judged by capacity utilization, prospects of expansion, modernization and diversification, availability of raw material etc.

9. Track record of promoters, directors and expertise of staff also affect the rating of a company.

RATING SYMBOLS

Rating Agencies use symbols such as AAA, AA, BBB, B, C, and D, to convey the safety grade to the investor. Ratings are classified into three grades[52]:

·         High investment grades,

·         Investment grades, and

·         Speculative grades.

In all ratings is classified into 14 or 15 categories. Signs “+” or “-”are used to show the certainty of timely payment. The suffix + or – may be used to indicate the comparative position of the instrument within the group covered by the symbol. Thus FAA- lays one notch above FA+. To provide finer gradations, Rating Industry attach + or – to their ratings. The rating symbols for different instruments of the same company need not necessarily be the same.

High Investment Grades:

AAA: - Triple A denotes highest safety in terms of timely payment of interest and principal

AA: - Double A denotes high safety in terms of timely payment of interest and principal.

Investment Grades: 

A: - denotes adequate safety in terms of timely payment of interest and principal.

BB: - Triple B denotes moderate safety in terms of timely payment of interest and principal speculative grades.

Speculative Grades: 

BB: - Double B denotes inadequate safety terms of timely payment of interest and principal.

B: - denotes high risk. Adverse changes could lead to inability or unwillingness to pay timely payment. 

C: - denotes substantial risk. Issue rated is vulnerable to default.

D: - denoted default in terms of timely payment of interest and principal.

These symbols are just a current opinion of an agency and they are not recommendations to invest or not to invest. The rating assigned applies to a particular instrument of the company and is not a general evaluation of the company.

SECTOR WHERE CREDIT RATING PLAYS A VITAL ROLE

The sector where Credit Rating plays an important role is as follows[53]:

·         Commercial Banks

·         Mutual Funds

·         Investment Banks

·         Leasing Companies

·         Insurance Companies

·         Bonds & Securitization etc.

THE RATING PROCESS

The entire rating process is normally completed in three stages in practical scenario-

1) Primary or Initial Stages.

2) Facts Finding & Analysis Stage.

3) Rating Finalization Stage.

 

·         Step I: Decision and documents

·         Step II: Rating Presentations – meetings, conference calls, and /or site visits

·         Step III: Rating Committee, communication, press release, report

·         Appeal process, if necessary

·         Surveillance

              I) The rating process begins at the request of the company. 

II) The team consisting of professionally qualified analyst well versed with the workings of the industry in which the company operates, first visits the company plants and inspect the operations first hand.

III) Meeting with different levels of management follow culminating with the meeting with chief executive officer.

IV) Generally, middle & top level management meeting cover the field of operations, finance marketing, project, etc.

V) In completion of the assignment, the tem interacts with the backup tem that has separately collected the additional industry information and prepares a report

VI) The report is then placed before n internal committee consisting of senior executives of Credit Rating Agency who themselves have hands on experience in rating assignments.

VII) The internal committee then has an open discussion with the tem member and amongst themselves arrives at rating.

VIII) To avoid any type ort of bias, the ratings proposed are placed before an external committee consisting of eminent people unconnected with credit rating agency.

IX) The external committee then takes the final decision which is communicated to the company.

X) The company may volunteer further information at this point which could affect the ratings; it is passed on to the external committee again for affirmation/change.

XI) The company has the option to request the agency for review of the rating.

 

Some certain method is used to rate a company or financial institution. The following factors are used to determine the credit rating by credit rating agency[54].

1- Ownership

2- Industry risk

3- Market ups and down

4- Cash flows

5- Fund flows

6- Earnings

7- Performance in past years

8- Management structure

9- Capital and debt structure

10- Corporate governance

11- Debt equity ratio

12-otherfactors


Rating agency gives the rating on the point of time in which the rating is done. The rating can be changed as the pass of time with change in enviourment, change in government policies, change in management or any changes happens with the passage of time. So credit rating agencies issue the guidelines to the financial companies as well as other companies to make their rating according to time. However, there is no policy of government to re-rate the companies in some years or month. But it’s essential for telling the better and correct information to the investors.

 

TIME FRAME FOR RATING PROCESS

From                                                    To                                                Timeframe

Initial request Meeting           Meeting with management                         4-6 weeks

 With management                   initial rating indication                              4-6 weeks

Initial rating indication          Publication of rating                                   Time depends upon      

FUNDAMNETAL PRINCIPLE OF RATING & GRADING

The basic requirement in risk grading is that it should reflect a clear and fine distinction between credit grades covering default risks and safe risks in the short run. While there is no ideal number of grades covering default risk in the short run. While there is no ideal number of grades that would facilitate achieving this objective, it is expected that more granularity may serve the following purpose: 

1) Objective analysis of portfolio risks.

2) Appropriate pricing of various risks grade borrowers, with a focus on low risk borrower in term of lower pricing

3) Allocation of risk capital for high risk graded exposures

4) Achieving accuracy and consistency. According to the RBI, there should be an ideal balance (in numbers) between ‘acceptable credit risk and unacceptable credit risk” in a grading system. It is suggested that:

1) A rating scale may consist of 8 – 9 levels.

2) Of the above, the first levels may represent acceptable credit risks

3) The remaining four levels may represent unacceptable credit risks.

MECHANISIM OF CREDIT RATING

The quantitative & qualitative factors in the case of whole sale exposure and four type factors in the case of retail sector needed to be accorded “weight” or scores. The aggregate outcome will reflect the rating /grade of an exposure against a benchmark. Hence the mechanism must lay down the following:

1)      For wholesale exposure :

The marks for each parameter, with a range of marks for various ranges of a parameter have to be fixed.

If the growth in the last completed year compared with the previous year is:

20% & above                          4 marks

15% to less than 20%             3 marks

5% to less than 15%               2 marks

0% to less than 5%                 1 marks 

Negative growth:                    0 marks

For qualitative factors, also, there can be suitable scoring based on ‘excellent’ (maximum marks) and the lowest one ‘non satisfactory’ (zero marks) may be fixed.

2) Aggregate marks for all the applicable parameters for each category may then be mapped into various grades taking the maximum marks as 100, as shown below.

3) Wherever a particular parameter is not applicable for an exposure, it may beignored and the aggregate marks are readjusted / graded accordingly.

ADVANTAGES OF CREDIT RATING

Different benefits accrue from use of rated instruments to different class of investors or the company. These are explained as under[55]:

A. BENEFITS TO INVESTORS

1. Safety of investments: - Credit rating gives an idea in advance to the investors about the degree of financial strength of the issuer company. Highly rated issues give an assurance to the investors of safety of Investments and minimize his risk.

2. Recognition of risk and returns: - Credit rating symbols indicate both the returns expected and the risk attached to a particular issue. It becomes easier for the investor to understand the worth of the issuer company just by looking at the symbol because the issue is backed by the financial strength of the company.

3. Freedom of investment decisions: - Investors need not seek advice from the stock brokers, merchant bankers or the portfolio managers before making investments. Investors today are free and independent to take investment decisions themselves. They base their decisions on rating symbols attached to a particular security.

4. Wider choice of investments: - As it is mandatory to rate debt obligations for every issuer company, at any particular time, wide range of credit rated instruments are available for making investment.

5. Dependable credibility of issuer: - Absence of any link between the rater and rated firm ensures dependable credibility of issuer and attracts investors. As rating agency has no vested interest in issue to be rated, and has no business connections or links with the Board of Directors.

6. Easy understanding of investment proposals: - Investors require no analytical knowledge on their part about the issuer company. Depending upon rating symbols assigned by the rating agencies they can proceed with decisions to make investment in any particular rated security of a company.

7. Relief from botheration to know company:-Credit agencies relieve investors from botheration of knowing the details of the company, its history, nature of business, financial position, liquidity and profitability position, composition of management staff and Board of Directors etc.

8. Advantages of continuous monitoring: - Credit rating agencies not only assign rating symbols but also continuously monitor them.

B. BENEFITS OF RATING TO THE COMPANY

A company who has got its credit instrument or security rated is benefited in the following ways[56]:

1. Easy to raise resources: - A company with highly rated instrument finds it easy to raise resources from the public.

2. Reduced cost of borrowing: - Investors always like to make investments in such instrument, which ensure safety and easy liquidity rather than high rate of return. A company can reduce the cost of borrowings by quoting lesser interest on those fixed deposits or debentures or bonds, which are highly rated.

3. Reduced cost of public issues: - A company with highly rated instruments has to make least efforts in raising funds through public. It can reduce its expenditure on press and publicity.

4. Rating builds up image: - Companies with highly rated instrument enjoy better goodwill and corporate image in the eyes of customers, shareholders, investors and creditors

5. Rating facilitates growth: - Rating motivates the promoters to undertake expansion of their operations or diversify their production activities, thus, leading to the growth of the company in future.

6. Recognition to unknown companies: - Credit rating provides recognition to relatively unknown companies going for public issues through wide investor base.

C. BENEFITS TO INTERMEDIARIES

Stock brokers have to make less effort in persuading their clients to select an investment proposal of making investment in highly rated instruments. Thus rating enables brokers and other financial intermediaries to save time, energy costs and manpower in convincing their clients[57].

DISADVANTAGES OF CREDIT RATING

Credit rating suffers from the following limitations[58]:

1. Non-disclosure of significant information: Firm being rated may not provide significant or material information, which is likely to affect the investor’s decision as to investment, to the investigation team of the credit rating company. Thus any decisions taken in the absence of such significant information may put investors at a loss.

2. Static study: Rating is a static study of present and past historic data of the company at one particular point of time. Any changes after the assignment of rating symbols may defeat the very purpose of risk inductiveness of rating.

3. Rating is no certificate of soundness: Rating grades by the rating agencies are only an opinion about the capability of the company to meets its interest obligations. Rating symbols do not pinpoint towards quality of products or management or staff etc.

4. Rating may be biased. Personal bias of the investigating team might affect the quality of the rating. The companies having lower grade rating do not advertise or use the rating while raising funds from the public. In such a case the investors cannot get the true information about the risk involved in the instrument.

5. Rating under unfavorable conditions. Rating grades are not always representative of the true image of a company. A company might be given low grade because it was passing through unfavorable conditions when rated. Thus, misleading conclusions may be drawn by the investors which hamper the company’s interest.

CREDIT RATING AGENCY

 A Credit Ratings Agency (CRA) is a company that assigns credit ratings to institutions that issue debt obligations (i.e. assets backed by receivables on loans, such as mortgage-backed securities)[59]. These institutions can be companies, special purpose entities, non-profit organizations, or local and national governments, and the securities they issue can be traded on a secondary market.

EVOLUTION OF CREDIT RATING AGENCY IN INDIA

 The Prominent Rating Agencies in India are[60]: -

i)                    CRISIL: - Credit Rating Information Services of India Limited.

ii)                  ICRA: - Investment Information and Credit Rating Agency of India Limited.

iii)                CARE: - Credit Analysis and Research Limited.

iv)                Fitch Ratings India Private Limited

Fitch Rating India Limited was formally known as DCR India- Duff and Phelps Credit Rating Co. USA and DCR India merged to form a new entity called Fitch India. Fitch India is a 100% subsidiary of Fitch IBCA, and is the only wholly owned foreign operator in India. Fitch is the only international rating agency with a presence on the ground in India.

The Indian credit rating industry is next to US in terms of number of ratings issued and in the number of agencies. Between the four Rating Agencies in India, over 5,000 ratings have been issued for around 1,400 issuers. CRISIL is the market leader in Credit Rating Agency with a 65% market share. The regulators support played an important role in the development of the Credit Rating industry.

 In 1992, for the first time, the Reserve Bank of India introduced the requirement of ratings for commercial papers. SEBI followed up by introducing mandatory ratings of bonds. In 1997, the penetration of rating, that is, the number of rated issues, out of the total number of issues was 35%. In the year 2002, it was 97%. This means that the Credit Rating Industry has transited from a regulatory driven market to an investor driven market in the growing debt markets. Between fiscal 1997 and 2001, rated debt volumes increased from Rs. 13,743 crore to Rs. 52,746 crore, which is 84% of the total issuance.

SEBI REGULATIONS FOR CREDIT RATING AGENCIES

SEBI issued regulations for credit rating agencies in 1999. These regulations are called as Securities and Exchange board of India. (Credit Rating Agencies) Regulations, 1999[61].

1) Only commercial banks, public financial institutions, foreign banks operating in India, foreign credit rating agencies, and companies with a minimum net worth of Rs 100 crore as per its audited annual accounts for the previous five years are eligible to promote rating agencies in India.

2) Rating Agencies are required to have a minimum net worth of Rs 5 crore.

3) Rating Agencies cannot assess financial instruments of their promoters who have 10 % stake in them.

4) Rating Agencies cannot rate a security issued by an entity, which is (a) a borrower of its promoter. (b) A subsidiary of its promoter. (c) An associate of its promoter.

5) Rating Agencies cannot rate a security issued by its associated or subsidiary, if the Credit Rating Agency or its rating committee has a chairman, director or employee, who is also a chairman, director or employee of any such entity.

6)A penalty of suspension of the certificate of registration or a penalty of cancellation of registration may be imposed on the rating agency if it fails to comply with the condition or contravenes any of the provisions of the Act.

REGISTRATION OF CREDIT RATING AGENCIES

1) Grant of Certificate: i) any person proposing to commence any activity as a Credit Rating Agency on or after the date of commencement of these regulations shall make an application to the Board for the grant of a certificate of registration for the purpose.

ii) A non- refundable application fee shall accompany an application for the grant of a certificate.

2) Promoter of Credit Rating Agency

 The Board shall not consider an application under unless a person belonging to any of the following categories promotes the applicant:

a) A Public Financial Institution.

b) A Scheduled Commercial Bank.

c) A Foreign Bank operating in India.

d) A Foreign Credit Rating Agency having at least five years experience in rating securities.

e) Any company or a body corporate, having continuous net worth of minimum rupees of one hundred crores for the previous five years prior to filling of the application with the board for the grant of certificate under these regulations.

3) Eligibility Criteria

The Board shall not consider an application for the grant of a certificate unless the applicant satisfies the following condition: -

a) The applicant is set up and registered as a company under the Companies Act, 1956;

b) The applicant has, in its memorandum of Association, specified rating activity as one of its main objects;

c) The applicant has a minimum net worth of rupees five crores.

d) The applicant has adequate infrastructure, to enable it to provide rating service.

e) The applicant and the promoters of the applicant have professional competence, financial soundness and general reputation of fairness and integrity in business transactions, to the satisfaction of the Board.

f) Neither the applicant, nor its promoter, nor any director of the applicant or its promoter, involved in any legal proceeding connected with the securities market, which may have an adverse effect on the interest of the investors;

g) Neither the applicant, nor its promoters, nor any director, or its promoter has at any time in the past been convicted of any offence involving moral turpitude or any economic offence.

h) The applicant has, in its employment, persons having adequate professional and other relevant experience to the satisfaction of the Board.

i) The applicant in all other respects is a fit and a proper person for the grant of a certificate.

 j) The grant of certificate to the applicant is in the interest of the investors and the securities market.

4) Application to Conform to the Requirements

The Board shall reject any application for a certificate, which is not complete in all aspects or does not confirm to the requirements of regulation or instructions. Providing that, before rejecting any such application, the applicant shall be given an opportunity to remove. Within 30 days of the date of receipt of relevant communication, from the Board such objections as may be indicated by the Board. Provided further, that the Board may, on sufficient reason being shown, extend the time for removal of objections by such further time, not exceeding thirty days, as the Board may consider fit to enable the applicant to remove such objections.

5) Furnishing of Information, Clarification and Personal Representation

The Board may require the applicant to furnish such further information or clarification, as the Board may consider necessary, for the purpose of processing of the application. The Board, if it so desires, may ask the applicant or its authorized representative to appear before the Board, for personal representation in connection with the grant of a certificate.

6) Grant of Certificate

i) The Board. On being satisfied that the applicant is eligible for the grant of a certificate of registration, shall grant a certificate.

ii) The grant of certificate of registration shall be subject to the payment of the registration fee specified.

7) Conditions of Certificate and Validity Period

The certificate shall be granted subject to the following conditions, namely;

a) The credit rating agency shall comply with the provisions of the Act, the regulations made there under and the guidelines, directives, circulars and instructions issued by the Board from time to time on the subject of credit rating.

b) Where any information furnished to the Board by a credit rating agency:

i) Is found to be false or misleading in any material particular; or 

ii) has under gone change subsequently to its furnishing at the time of the application for the certificate; the credit rating agency shall forthwith inform the Board in writing;

c) The period of validity of the certificate of registration shall be three years.

PROCEDURE FOR ACTION IN CASE OF DEFAULT

Liability for action in case of default

A credit rating agency which[62] -

(a) fails to comply with any condition subject to which a certificate has been granted; 

(b) contravenes any of the provisions of the Act or these regulations or any other regulations made under the Act;

Shall be dealt with in the manner provided under the Securities and Exchange Board of India

(Procedure for holding Enquiry by Enquiry officer and Imposing penalty) Regulations, 2002.

PENALITIES

Suspension of Registration: A penalty of suspension of the certificate of registration of a credit rating agency may be imposed by the Board if CRA is fails to comply with any condition subject to which a certificate has been granted[63].

Cancellation of Registration: A penalty of cancellation of certificate of registration of a credit rating agency may be imposed by the Board, if[64]:

(a) The Credit Rating Agency is guilty of fraud, or has been convicted of an offence involving moral turpitude or an economic offence; or

 (b) The credit rating agency is declared insolvent or wound up.

The Board shall furnish to the credit rating agency reasons in writing for cancellation of registration.

Appeal to the Securities Appellate Tribunal

Any person aggrieved by an order of the Board made, on and after the commencement of the Securities Laws (Second Amendment) Act, 1999, (i.e., after 16th December 1999), under these regulations may prefer an appeal to a Securities Appellate Tribunal having jurisdiction in the matter[65].

Appeal to the Central Government

Any person aggrieved by an order of the Board under these Regulations[66];

(a) Suspending a certificate of registration;

(b) Cancelling certificate of registration,

May prefer an appeal to the Central Government against such order, in accordance with the Securities and Exchange Board of India (Appeal to Central Government) Rules, 1993].

CONCLUSION

Credit ratings may be used by investors and other market participants in making investment and business decisions that are aligned with their risk tolerance or credit risk guidelines. Credit ratings are opinions about the perceived credit risk of a particular debt issue. In general, the greater the credit risk, the higher the return investors may expect for assuming that risk. For that reason, credit ratings may be useful for both issuers and investors when a debt issue is first issued in the primary markets and continues to be so for investors who trade securities in secondary markets.

A credit rating is a useful tool not only for the investor, but also for the entities looking for investors. An investment grade rating can put a security, company or country on the global radar, attracting foreign money and boosting a nation's economy[67]. Indeed, for emerging market economies, the credit rating is key to showing their worthiness of money from foreign investors. And because the credit rating acts to facilitate investments, many countries and companies will strive to maintain and improve their ratings, hence ensuring a stable political environment and a more transparent capital market. 

The Credit Rating Agencies are rating finance-friendly policies, not the strength of national economies and the debt they issue. CRAs play a key role in financial markets by helping to reduce the informative asymmetry between lenders and investors, on one side, and issuers on the other side, about the credit worthiness of companies (corporate risk) or countries (sovereign risk).

In making their ratings, CRAs analyse public and non-public financial and accounting data as well as information about economic and political factors that may affect the ability and willingness of a government or firms to meet their obligations in a timely manner. However, CRAs lack transparency and do not provide clear information about their methodologies.

Ratings tend to be sticky, lagging markets, and then to overreact when they do change.

 

 

BIBLIOGRAPHY

BOOKS

·         Mamta Arora, Credit rating in India: Institutions, Method and Evaluation, New Century Publication, 2003.

·         Micael K. Ong, Credit Ratings: Methodology, Rationale & Default Risk, Risk Book, 2002.

·          John B. Caouette, Managing Credit Rating:The Great Challenge for Global Finance Market, Global Association of Risk Professionals,(3rd Ed.), (2011).

·         E.I.Daher, Samir, Credit Rating: An Introduction, World Bank, (2009).

·         Bahl, Roy and Barbara D. Miller, Local Govt. Finance in the Third World, World Praegar Publishers, (1983).

 ARTICLES

·         Rajesh Chandramauli, India Inc faces more downgrades: Crisil, 9th Aug. 2011.

·         Rajesh Chandramauli, Credit ratings of companies improve, 11th April 2009.

·         Jayadev M., Associate Professor-IIM-B, FUZZY LOGIC IN CREDIT RATING

·         Osbornes’ Recovery Plan Receive Doubt Boost, 26th Oct.2010.

·         Fitch and Moody’s Heap Pressure on Ireland, 7th Oct. 2010.

E-RESOURCES

(1)    www.westlaw.com

(2)    www.heinonline.com

(3)    www.jstore.in

  1. www.manupatra.com
  2. www.lexisnexis.com

(6)    www.sebi.gov.in

(7)    www.psnacet.edu.in

 

 

 

 

 

 

 




 

 

 

 

 

 

 

 

 

 



[1] http://www-wds.worldbank.org/servlet/.../WDSP/IB/.../multi_page.pdf accessed on March 2012

[2] Ibid

[3] Ibid

[4] http://www.psnacet.edu.in/courses/MBA/Financial%20services/16.pdf accessed on March 2012

[5] Ibid

[6] Ibid

[7] El Daher, Samir, “Credit ratings : an introduction (and the case of sub-sovereign ratings)” The World Bank Study2012

   

 

 

[8] http://www.psnacet.edu.in/courses/MBA/Financial%20services/16.pdf accessed on March 2012

[9] http://www.psnacet.edu.in/courses/MBA/Financial%20services/16.pdf accessed on March 2012

[10] Ibid

[11] http://www.psnacet.edu.in/courses/MBA/Financial%20services/17s.pdf accessed on March 2012

[12] Ibid

[13] Moody's special comment (August 2006:1). "A Guide to Moody's Sovereign Ratings" accessed on March 2012

[14] http://www.sec.gov/rules/concepts/s71203/rapid110603.htm#P69_8177#P69_8177 accessed on March 2012

[15]http:// www.mysmp.com/bonds/credit-rating.html - United States. accessed on March 2012

[16] "Ratings Definitions" moodys.com. Moody's Investors Service. 2011. Retrieved 30 August 2011 accessed on March 2012

[17] http:// www.australiaratings.com accessed on March 2012

[18] http:// www.careratings.com accessed on March 2012

[19] http:// www.crisil.com/.../ratings/standardisation-rating-symbols-definitions accessed on March 2012

[20] http:// www.icra.in/files/content/ratingsscale-2008.pdf accessed on March 2012

[21] Ibid

[22] Ibid

[23] http://www.psnacet.edu.in/courses/MBA/Financial%20services/16.pdf accessed on March 2012

[24] Ibid

[25] Ibid

[26] http://www.psnacet.edu.in/courses/MBA/Financial%20services/18.pdf accessed on March 2012

[27] Ibid

[28] Ibid

[29]Ibid

[30] http://www.psnacet.edu.in/courses/MBA/Financial%20services/16.pdf accessed on March 2012

[31] http://www.psnacet.edu.in/courses/MBA/Financial%30services/18.pdf accessed on March 2012

[32] http://www.psnacet.edu.in/courses/MBA/Financial%30services/18.pdf accessed on March 2012

[33] http://www.psnacet.edu.in/courses/MBA/Financial%20services/16.pdf accessed on March 2012

[34] Ibid

[35] http:// en.wikipedia.org/wiki/Credit_rating_agency accessed on March 2012

[36] Ibid

[37] Ibid

[38] Ibid

[39] http:// www.scribd.com/doc/58566290/8/TYPES-OF-CREDIT-RATINGS

[40]  "Credit rating companies and their impact on the economy". Forexpromos.com. Retrieved 2011-08-08 accessed on March 2012

[41]  de Servigny, Arnaud and Olivier Renault (2004). The Standard & Poor's Guide to Measuring and Managing Credit Risk. McGraw-Hill. ISBN 978-0071417556 accessed on March 2012

 

 

[42] http:// www.scribd.com/doc/58566290/8/TYPES-OF-CREDIT-RATINGS accessed on March 2012

 

 

[43] Ibid

[44] http:// www.psnacet.edu.in/courses/MBA/Financial%20services/16.pdf accessed on March 2012

[45] Ibid

[46] Ibid

[47] Ibid

[48] http:// www.psnacet.edu.in/courses/MBA/Financial%20services/16.pdf accessed on March 2012

[49] Ibid

[50] http:// www.psnacet.edu.in/courses/MBA/Financial%20services/16.pdf accessed on March 2012

[51] http://www.psnacet.edu.in/courses/MBA/Financial%20services/16.pdf accessed on March 2012

[52] http:// www.scribd.com/doc/58566290/8/TYPES-OF-CREDIT-RATINGS accessed on March 2012

 

[53] http:// www.scribd.com/doc/10924780/Credit-Rating-Processs accessed on March 2012

 

[54] http://freeworking.hubpages.com › ... › Business and the Environment

[55] http:// www.psnacet.edu.in/courses/MBA/Financial%20services/16.pdf accessed on March 2012

 

[56] http:// www.psnacet.edu.in/courses/MBA/Financial%20services/16.pdf accessed on March 2012

[57] http:// www.psnacet.edu.in/courses/MBA/Financial%20services/16.pdf accessed on March 2012

[58] http:// www.psnacet.edu.in/courses/MBA/Financial%20services/16.pdf accessed on March 2012

[59] http:// www.egyankosh.ac.in/bitstream/123456789/25902/1/Unit13.pdf

[60] Ibid

[61] http:// www.sebi.gov.in/acts/CreditRatingAgencies.pdf

[62] http:// www.sebi.gov.in/acts/CreditRatingAgencies.pdf accessed on March 2012

[63] Ibid

[64]Ibid

[65]Ibid

[66] Ibid

[67] http://www.investopedia.com/articles/03/102203.asp#ixzz1oyJTJ7Ek accessed on March 2012

 

You have to be logged in to view the contact details of the author.
Login to comment! 4 Comments Login to refer to a friend!
View Comments
test test 1
test test 1
test test 1
test test 1
 
WorldLII (World Legal Information Institute) Supreme Court of India - Judgements from 1950 - Legislation (ACTS) from 1836 - Law Commission of India - Reports from 1999 -
Causelist Websites A.P High Court Daily Causelist | Central Administrative Tribunal | A.P State Administrative Tribunal  |   Supreme Court of India  |   Causelists for all Courts |
Terms and conditions - Disclaimer - Website Map    | Copyright 2009 - 10 www.goforthelaw.com. All rights reserved