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Bank Loan Ratings for Basel II in India>

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Fitch Ratings is a leading global rating agency committed to providing the worlds credit markets with independent and prospective credit opinions, research and data. Built on a foundation of organic growth and strategic acquisitions, Fitch Ratings has grown rapidly during the past decade, gaining market presence throughout the world and across all xed income markets. Fitch Ratings is dual-headquartered in New York and London, operating ofces and joint ventures in more than 49 locations and covering entities in over 150 countries. In October 2006, Fitch Ratings established Derivative Fitch, a rating agency dedicated to providing ratings and a suite of comprehensive services for the CDO and credit derivatives markets. Fitch Ratings and Derivative Fitch are part of the Fitch Group, a majority-owned subsidiary of Fimalac, S.A., which is headquartered in Paris, France. Hearst Corporation acquired a 20 percent stake in the Fitch Group in 2006. Fitch Ratings currently maintains a signicant coverage on corporate issuers, sovereign, sub-sovereigns and nancial institutions (including banks, insurance companies, nance and leasing companies, broker-dealers, and managed funds). Fitch Ratings maintains surveillance on U.S. municipal transactions; and structured nance transactions including RMBS, CMBS and ABS. Fitch Ratings also maintains surveillance on European and Asia-Pacic structured nance transactions. Derivative Fitch, a wholly owned subsidiary of Fitch Ratings, has a signicant coverage in the global credit derivatives market.

Fitch Ratings in India


Fitch Ratings has been present in India since 2001 through a wholly-owned subsidiary, Fitch Ratings (India) Private Limited. It is recognised by the Reserve Bank of India, Securities Exchange Board of India (SEBI) and National Housing Bank. The Reserve Bank of India has recognised Fitch Ratings as an ECAI for Basel II purposes. Fitch Ratings has four ofces in India located in Mumbai, New Delhi, Chennai and Kolkata and has strong team of analysts across India. Fitch Ratings has rated more than 400 Indian entities since inception, including several large and well-known corporates and public sector entities. Fitch Ratings also has signicant coverage in banks (both public and private sector), nancial institutions, non-banking nancial companies and all major players in structured nance.

Introduction: Bank Loan Ratings in India


The Reserve Bank of India (RBI) has decided to adopt the Standardised Approach for credit risk and the Basic Indicator Approach for operational risk as per the Basel II norms; this is done with a view to achieving consistency and harmony with international standards for banks and nancial institutions. As per Basel II norms, external ratings may be applied in order to determine the amount of capital required for all of a banks current exposures/claims (both funded and non-funded) relating to the credit risk to which they are exposed. RBI guidelines on Basel II norms require the banks, where they use external ratings, to use recognised agencies such as Fitch Ratings to support the measurement of credit risk. The ratings applied for this purpose in India need to be solicited by theborrower. Where a bank opts not to apply external ratings for an exposure to a borrower, it has been prescribed that all fresh sanctions and renewals of unrated exposures in excess of Rs.50 crore will attract a risk weighting of 150% from March 31, 2008 and a similar risk weighting for all unrated exposures in excess of Rs.10 crore from March 31, 2009. This means increased capital costs will apply to banks for many entities which do not have their bank loans rated. In turn, this may lead to higher borrowing costs, if these capital costs are passed on by lenders.

RBI prescribes following risk weights for both long-term and short-term exposures, depending upon their credit rating:

Fitch Ratings Long-Term Ratings


AAA(ind) AA(ind) A(ind) BBB(ind) BB(ind) & below

Risk Weights 20% 30% 50% 100% 100 % 100 %

Fitch Ratings Short-Term Ratings


F1+(ind) F1(ind) F2+/F2(ind) F3(ind) F4(ind)/F5(ind)

Risk Weights 20% 30% 50% 100% 100 % 100 %

Unrated*

Unrated*

* Though RBI guidelines on Basel II norms prescribe a risk weight of 100% for unrated claims, RBI may increase the standard risk weight for unrated claims where a higher risk weight is warranted by the overall default experience. To begin with, for the FY 2008-09, all fresh sanctions or renewals in respect of unrated claims on corporates in excess of Rs. 50 crore will attract a risk weight of 150%.

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Bank Loan Rating Methodology


1) For rating corporate borrowers, Fitch Ratings would typically apply its corporate rating methodology as used for rating bonds and other capital market instruments. a. Qualitative Analysis: Covers Industry Risk, Operating Environment, Market Position, Management, Accounting and Corporate Governance. b. Quantitative Analysis: Covers Earnings and Cash Flow, Capital Structure and Financial Flexibility. 2) For rating NBFCs Fitch Ratings would typically apply the following methodology. a. Qualitative Analysis: Analysis of market share, peculiar characteristics of its core market, appetite for risk, risk management systems, effectiveness of management, its strategy and corporate governance practices. b. Capitalisation: Regulatory capital adequacy ratios, equity/ assets, debt/equity, managed assets/ equity, internal capital generation and ability to generate additional capital. c. Liquidity: Covers sources & nature of funding, asset liability management, liquidity support and liquid assets/ total assets. d. Credit Risk: Analysis of gross non performing loans ratio, loan loss coverage, individual/ industry concentrations and net NPL/Equity. e. Earnings: Covers net interest margin, non interest income, ROA and diversity of income. f. Support: Analysis of the owners extent support in case of need.

c. Earning Measures: Analysis of FFO, EBITDAR, After Tax Cash Flows, Net Free Cash Flows, Coverage Ratios (FFO/Gross Interest Expense, FCF/Capital Expenditure). d. Leverage Measures: Debt/EBITDA (Cash Leverage), Net Debt/Equity (Gearing). e. Protability Measures: Analyses EBITDA/Operating Income and Return on Equity/Return on Capital Employed.

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Bank Loan Rating Process

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Basel II FAQs
1. What is Basel II? Basel II is a revised framework on Capital Adequacy by the Basel Committee on the Banking and Supervision. Under this system assets on the balance sheet, together with non-funded commitments and other similar exposures, are assigned prescribed risk weights. Banks must maintain minimum capital funds equal to a prescribed ratio of the aggregate risk weighted assets and exposures. With a view to maintaining consistency and harmony with international standards, RBI has decided that all commercial banks in India will adopt the Standardised Approach for measuring credit risk under Basel II. 3. How does it affect my organisation? As banks have to set aside higher capital for exposures with a higher credit risk, or a lower credit rating may well mean increased borrowing costs. Banks will have to pass on the cost of higher capital requirements to exposures that are unrated or have a lower credit rating. This may affect your organisations borrowing costs. 4. When will Basel II be effective for Indian Banks? All Indian Banks with an operational presence outside India and Foreign Banks in India will have to migrate to Basel II by March 31, 2008 and all other banks by March 31, 2009. 5. What are the existing risk weights and what are risk weights under RBI Basel II guidelines? The current risk weightings for all corporate exposures, rated or unrated, is 100% and banks have to set aside 9% of their capital towards each exposure on an ongoing basis. Under Basel II guidelines, RBI prescribes the risk weights for both long-term and short-term exposures noted on page 2. 6. What difference will a rating make to my borrowing costs? A rating will not guarantee lower borrowing costs. Individual banks will still be free to set lending margins at any level that makes commercial sense for their strategy. Additionally, at low levels of rating, the capital costs applied may be the same whether or not a borrower is rated, or may in fact be higher (for example, if a borrower has both a small exposure and a very low rating). However, to the general benet of higher-rated entities, implementation of Basel II in India is expected to make the bank system in general more discriminating in its allocation of capital, and more risk-sensitive in assigning lending margins.

2. What is a bank loan rating? Bank loan ratings will be assigned to various facilities provided by banks, such as working capital demand loans, cash credit, project loans, loans for general corporate purposes, and non-fund-based facilities. Bank loan ratings indicate the degree of risk with regard to timely payment of interest and principal on the facility being rated.

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7. Which claims have to be rated? Do guarantees and Letters of Credit (L.Cs) have to be rated? RBI guidelines include all fund based and non-fund based exposures. This includes all funded, off balance sheet and market exposures. Hence, guarantees and L.Cs also have to be rated. All claims with contractual maturity of more than one year have to be mapped to the long-term rating scale and claims with contractual maturity of less than a year have to be mapped to a short-term scale. Cash credit facilities are rolling facilities and are perennial, hence, mapped to a long-term scale. 8. Does every bank facility have to be rated separately? Individual ratings will be assigned to each bank facility and will be monitored for the length of that facility. 9. In the case of consortium lending, does the borrower need to take a separate rating for each banker? A company that has borrowed from a consortium of lenders can get the entire loan amount or facility rated in one process by Fitch Ratings; a rating letter issued for the entire facility can be submitted to all the banks in the consortium. 10. Why should I choose Fitch Ratings? Fitch Ratings provides you with: Quality research, clarity of opinion Superior surveillance, calling split/ recovering credits Access to an experienced analytical team with product expertise Transparent ratings analysis A clear explanation of the credit story Methodologies consistent with international standards Ratings that reect global trends A global rating committee process Global templates used for ratings and rationales And, importantly the ability to provide domestic and international ratings under the same brand.

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Bank Loan Ratings: Scale and Symbols


The Bank Loan Rating scale and symbols are similar to those being used for rating corporate debt instruments. Fitch Ratings Long-Term rating scale is applicable to ratings on instruments with an original maturity of more than one year. AAA(ind) AAA national ratings denote the highest rating assigned by Fitch Ratings in its national rating scale for the country. This rating is assigned to the best credit risk relative to all other issuers or issues in the same country. BBB(ind) 'BBB' national ratings denote an adequate credit risk relative to other issuers or issues in the country. However, changes in circumstances or economic conditions are more likely to affect the capacity for timely repayment of these nancial commitments than for nancial commitments denoted by a higher rated category. BB(ind) 'BB' national ratings denote a fairly weak credit risk relative to other issuers or issues in the country. Within the context of the country, payment of these nancial commitments is uncertain to some degree and capacity for timely repayment remains more vulnerable to adverse economic change over time. B(ind) 'B' national ratings denote a signicantly weak credit risk relative to other issuers or issues in the country. Financial commitments are currently being met but a limited margin of safety remains and capacity for continued timely payments is contingent upon a sustained, favorable business and economic environment. C(ind) This category of national ratings denote an extremely weak credit risk relative to other issuers or issues in the country. Capacity for meeting nancial commitments is solely reliant upon sustained, favorable business or economic developments. D(ind) This category of national ratings are assigned to entities or nancial commitments which are currently in default.

AA(ind) 'AA' national ratings denote a very strong credit risk relative to other issuers or issues in the country. The credit risk inherent in these financial commitments differs only slightly from the country's highest rated issuers or issues. A(ind) 'A' national ratings denote a strong credit risk relative to other issuers or issues in the country. However, changes in circumstances or economic conditions may affect the capacity for timely repayment of these nancial commitments to a greater degree than for nancial commitments denoted by a higher rated category.

Fitch Ratings assigns Rating Outlooks for all long-ter m ratings. A Ratings Outlook can be Positive, Stable or Negative. Rating Outlooks indicate the dir ection in which a rating may move over a medium-ter m horizon of one-to-two years. Fitch Ratings may apply + or - signs for ratings from AA to B to reect comparative standing within the categor y.

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Fitch Ratings Short-Term rating scale is applicable to ratings on instruments with an original maturity of up to one year F1(ind) Indicates the strongest capacity for timely payment of nancial commitments relative to other issuers or issues in the country. Under the national rating scale, this rating is assigned to the "best" credit risk relative to all others in the country. F2(ind) Indicates a satisfactory capacity for timely payment of nancial commitment relative to other issuers or issues in the country. However, the margin of safety is not as great as in the case of the higher ratings. F3(ind) Indicates an adequate capacity for timely payment of nancial commitments relative to other issuers or issues in the country. However, such capacity is more susceptible to near-term adverse changes than for nancial commitments in higher rated categories.

F5(ind) Indicates actual or imminent payment default.

Fitch Ratings may apply +sign for ratings from F1 to F2 to re ect comparative standing within the category.

F4(ind) Indicates a highly uncertain capacity for timely payment of nancial commitments relative to other issuers or issues in the country. Capacity or meeting nancial commitments is solely reliant upon a sustained, favorable business and economic environment.

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A Different Kind of Rating Agency


Fitch Ratings works hard to be different. To combine knowledge, insight, service, innovation, responsiveness and transparency in a way not available from any other ratimg agency.

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