Final Project Report on

WORKING AND MANIPULATION OF CREDIT RATING IN INDIA Submitted By SHAMBHU KUMAR ROLL NO. 58 IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR MASTER OF MANAGEMENT STUDIES 2012 2014

UNDER THE GUIDANCE OF CA AJIT JOSHI

UNIVERSITY OF MUMBAI PARLE TILAK VIDYALAYA ASSOCIATIONS INSTITUTE OF MANAGEMENT VILE-PARLE (EAST), MUMBAI 400 057

CERTIFICATE

I, CA Ajit Joshi, hereby certify that Ms. Shambhu Kumar studying in the 2nd year of Master of Management Studies, batch 2012-2014 at Parle Tilak Vidyalaya Associations Institute of Management (PTVAs IM), has completed the project on Working and manipulation of credit rating in India under my guidance as per the norms as prescribed by the University of Mumbai in the academic year 2013-2014.

CA Ajit Joshi Guide

Dr. Harish Kumar S. Purohit Director

DECLARATION
I, Mr. Shambhu Kumar, a student of M.M.S Finance, Semester IV of University of Mumbai, batch 2012-2014 from Parle Tilak Vidyalaya Associations Institute of Management (PTVAs IM) do hereby declare that this report titled Working and manipulation of credit rating in India, carried out by me during this semester under guidance of CA Ajit Joshi is as per the norms prescribed by University of Mumbai & the same work has not been copied directly without acknowledging for the part / section that has been adopted from published/ non-published works & is true to the best of my knowledge.

Date: Place: Mumbai ---------------------------------(Signature) Shambhu Kumar

ACKNOWLEDGEMENT

I owe my deepest gratitude to all the people who helped and supported me during the course of this project. I feel deeply obliged to the most respected faculty CA Ajit Joshi, who guided me like a beacon in the dark. I would like to thank him for giving me his valuable time, suggestions and practical views throughout my project work, without which the completion of the project would have been a difficult journey. I would also thank my institute Parle Tilak Vidyalaya Associations Institute of Management and my faculty members without whom this project would have been a distant reality. I also extend my heartfelt thanks to my family members and well-wishers.

TABEL OF CONTENTS

SR. NO. 1 2 3 4 5 6 7 7.1 7.2 7.3 7.4 7.5 7.5.1 7.5.2 7.5.3 7.5.4 7.5.5 7.5.6 7.6 7.6.1 7.7 7.7.1 7.7.2 7.7.3 7.7.4 7.7.5 7.7.6 8 9 10 11

PARTICULARS Introduction Executive Summary Industry/Sector Overview Literature Review Objectives of the study Research methodology Findings of research Concept of credit rating Types of credit rating Factors involved in credit rating Credit rating process Rating methodology Business risk analysis Financial analysis Management evaluation Geographical analysis Regulatory and competitive environment Fundamental analysis Credit Ratings - Scales Z-score Manipulation of credit rating Credit score Credit Score Rating Scale Factors of calculating Credit score Monitoring of Credit score and Credit rating Manipulation of credit score Credit rating companies in India WorldCom Case study Case Study Conclusion Bibliography, References & Websites

PAGE.NO 6 8 10 11 13 14 15 15 16 16 17 20 20 22 24 24 24 25 25 30 33 33 34 35 38 39 40 43 44 48 49

1. INTRODUCTION
The account information compiled by a credit information company incorporating there in loans or credit card facilities availed from one or many banks, institutions, re-payment record, current balance on each of the facility, new credit facilities obtained, number of new enquiries from lenders., defaults in repayment of dues, suit filed information etc. is referred to as credit history of a borrower or a consumer. A credit score is a number assigned by credit reporting companies based on information available on credit report. Like a test score, the higher the score, the better your credit. A good credit score shows that you have a high probability of repaying loans on time. Therefore, a good credit score will help you take out loans more easily and even get better interest rates. An assessment of the credit worthiness of a borrower in general terms with respect to a particular debt or financial obligation. A credit rating can be assigned to any entity that seeks to borrow money an individual, corporation, state or provincial authority, or sovereign government. Credit assessment and evaluation for companies and governments is generally done by a credit rating agency. These rating agencies are paid by the entity that is seeking a credit rating for itself or for one of its debt issues. For individuals, credit ratings are derived from the credit history maintained by credit-reporting agencies such as Equifax, Experian and Trans Union. Credit ratings for borrowers are based on substantial due diligence conducted by the rating agencies. While a borrower will strive to have the highest possible credit rating since it has a major impact on interest rates charged by lenders, the rating agencies must take a balanced and objective view of the borrowers financial situation and capacity to repay the debt. The credit rating has an inverse relationship with the possibility of debt default. In the opinion of the rating agency, a high credit rating indicates that the borrower has a low probability of defaulting on the debt; conversely, a low credit rating suggests a high probability of default. Credit rating changes can have a significant impact on financial markets. The credit rating is conveyed by means of a numerical credit score that is maintained by credit-reporting agencies. A

high credit score indicates a stronger credit profile and will generally result in lower interest rates charged by lenders. Credit ratings are determined by credit ratings agencies. The credit rating represents the credit rating agency's evaluation of qualitative and quantitative information for a company or government; including non-public information obtained by the credit rating agencies' analysts. Credit ratings are not based on mathematical formulas Instead, credit rating agencies use their judgment and experience in determining what public and private information should be considered in giving a rating to a particular company or government. The credit rating is used by individuals and entities that purchase the bonds issued by companies and governments to determine the likelihood that the government will pay its bond obligations. A poor credit rating indicates a credit rating agency's opinion that the company or government has a high risk of defaulting, based on the agency's analysis of the entity's history and analysis of long term economic prospects.

2. EXECUTIVE SUMMARY
Credit rating agencies are placed as intermediate between investors and issuers of fixed income securities. Their most important role is to minimize the existence of asymmetric information in the marketplace. The role is central in operating the financial markets. The globalization process and development of complex financial products has provided the credit rating agencies with a tremendous power. Despite the powerful position, the credit rating industry subject to very weak regulation. The credit rating agencies are by them self-supposed to manage potential pitfalls in the rating process and rating system. They are said to be self-controlled as no authority control how the agencies manage to avoid potential pitfalls. The weak regulation and self-control provides the agencies with a high level of freedom. The mixture of power and freedom is a dangerous combination, if not managed well. The agencies need to be fully aware of the responsibilities that naturally follow power and freedom. If they dont act as a responsible intermediate and perform trustworthy, the market will lose its faith to the system. The credit rating agencies have through the years been subject to criticism in relation to the management of their responsibility. The criticism has evolved in the wrong direction after focus had been pointed to the agencies role in the corporate scandals of Enron, WorldCom and Pharmalat. The criticism has reached a new high level under the current financial crisis. Many players at the financial scene look upon the credit rating agencies as a direct scapegoat of the current crisis. The criticism has been concentrated on numerous conflicts of interest and the dependence of issuers. It is expected that the criticism have a negative influence on the image of the credit rating agencies and the investors confidence in the credit rating system. The credit rating agencies can only exist if they have a strong reputation and enjoy great confidence. The credit rating agencies has realized the problem and declared that improvements are needed to restore the confidence and image.

This situation motivates an investigation of the nature of the criticism and the influence on investors reactions on changes in long-term corporate credit rating. Have the investors as a result of low confidence ignored the changes or are they reacting on information from criticized credit rating agencies. Agencies who, by them self, have admitted the many problems the critics have pointed out. The main findings reveal that investors only react significant on downgrades during the current crisis. There is no significant reaction in the months before the crisis. This is seen as an expected result of the criticism and an erosion of the investors trust in the credit rating system. The sudden reaction during the crisis is much more significant, than results in earlier studies. The investor reaction measured as negative abnormal stock returns can be characterized as a panic-drop. It is believed to be a psychological reaction and not a sudden rebuild trust in the credit rating system. In the case of upgrades, no significant reaction was found.

3 . I N DU S T R Y O V E R VI E W
A credit rating agency is a company that objectively analyses the credit worthiness of a company or security, and indicates that credit quality by means of a grade, or credit rating. Issuers, lenders, fixed-income investors, and government regulators use these risk assessments for several purposes, including evaluating lending or investment in a company. Beginning in 2008, the volatile movement of credit ratings on certain fixed-income securities specifically mortgage-backed securities called the accuracy and effectiveness of the ratings agency. Critics of the rating agencies argue that conflicts of interest between an issuer and an agency coupled with a lack of transparency in the ratings process have produced an inherently flawed system. Since issuers primarily use credit rating agencies, a lack of competition may have also compromised the validity of credit ratings. To ensure more efficient and fully functioning capital markets, it is essential that there is a review of the credit ratings process and the quality of ratings. These are important steps to restoring investor confidence and trust in markets. The important role of credit ratings agencies and their credit ratings provide in the overall functioning of financial markets. They support reforms to ensure the on going quality, transparency and integrity of the rating process. Credit rating agency also educates the investing public and promotes the importance of independent risk assessments.

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4. LITERATURE REVIEW
Credit rating serves as a valuable input in the decision-making process of different participants in the capital market including regulators, issuers and investors. Therefore, it has been attracting the attention of thinkers in the field of finance to study various dynamics of this fast emerging subject. Various studies have been conducted in India as well as in different parts of the world by different bodies and individuals and thus contributing a lot to explore new insights into the concept of credit rating. The area of concern of the studies conducted so far has been mainly to find out the relevance of credit rating in the Indian context as well as at the global level and the extent of awareness among the investors, about the concept of credit rating. The present chapter provides a brief review of the research studies conducted on credit rating at the national and international level. Czarnitzki and Kraft (2007)1, in their study, tested whether the credit ratings give more specific information about creditworthiness of the firms as compared to the publicly available information (which is available to the potential investors without any substantial cost). They selected a sample of about 8000 firms of German manufacturing sector for the purpose of study and the time period of study was 1999-00.They compared the ratings given by leading German credit rating agency Credit Reform with the publicly available information. The study revealed that the young firms were more likely to default than the established ones. Further, the lower the productivity the more would be the probability of default. They further inferred that credit rating has some additional informational value for lenders but the rating agencies overemphasized the factor firm size in construction of rating index. Jain and Sharma (2008)2, in their paper, attempted to examine the working of credit rating agencies in the light of role played by them in the capital market as information disseminators. The authors identified conflicts of interest affecting the rating decisions and the manner in which the regulations have attempted to address them. Further, they also studied the regulatory
1

Czarnitzki, D.; and Kraft, K. (2007), Are Credit Ratings Valuable Information, Applied Financial Economics, Vol. 17, pp. 1061-1070.
2

Jain, T.; and Sharma, R. (2008), Credit Rating Agencies in India: A Case of Authority without Responsibility, Working Paper Series, Supreme Court of India and National Law University, April, ssrn abstract id 1111553[available at www.ssrn.com].

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framework for credit rating agencies in India. The authors revealed that credit rating agencies play a central role in the capital markets through their informed and independent analysis. The various conflicts of interest highlighted in the study were relating to the fee charged, ancillary services of credit rating agencies, ownership interest of credit rating agencies in client securities and the problem of notching. The study highlighted that despite the significant role played by credit rating agencies in capital markets, they are not properly regulated as not much responsibility is put on them in respect of their rating actions. Reddy and Gowda (2008)3, in their paper, explained the importance and problems of credit rating in India. They also highlighted the basis of credit rating and credit rating practices prevalent in India. For this purpose, the opinions of sample of investors from Hyderabad were taken. The results of the study inferred that majority of the respondents were aware of the existence of various credit rating agencies including CRISIL, CARE, ICRA, etc. About 40 per cent (80 out of 200) of the respondents depend on credit rating for their investment in debt instrument but more than 50 percent from them (94 out of 180) rely on CRISIL for their investment than the other credit rating agencies. The study worked out that though there is confusion among various investors due to existence of more than one credit rating agency but majority of them are satisfied with the guidance of credit rating agencies. Bhattacharyya (2009)4, in her paper, evaluated the issuer rating system in India with special reference to ICRA issuer rating model. The author identified various quantitative variables having major impact on the issuer rating along with their relative importance with the help of discriminant analysis. The time period of the study is from the date when the issuer rating started in 2005 to March 2008 and the sample consists of 17 companies which have been rated by ICRA during this period. The study highlighted that out of the ten variables being used by ICRA for issuer rating the PBIT & Debt plus net worth ratio, current ratio and net sales growth rate play an important role but the qualitative factors can also affect the ratings at any time.

Reddy, R.B.; and Gowda, R.M. (2008), Some Aspects of Credit Rating: A Case Study, the Management Accountant, Vol. 43, No. 6, June. [available at www.ssrn.com]
4

Bhattacharyya, M. (2009), A Study of Issuer Rating Service with an Appraisal of ICRA Rating Model, Indian Journal of Accounting, Vol. XXXIX (2), June. [available at www.ideas.repec.org]

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5. OBJECTIVES OF RESEARCH
The objective for doing this research is to make myself capable for moving forward in corporate world, to gain knowledge and to know how credit rating affect corporate world. It will help me to gain more and more about corporate sector which was very essential for me to do. Therefore I am doing research on working and manipulation of credit rating in India to improve my capabilities. The main purpose of my study was To gain the theoretical knowledge in the credit rating. To know manipulation of credit rating. To trained myself properly before working with an organization To properly deal with the problems in the company. The primary objective of this project is the study of the working and manipulation of credit rating. Along with this one objective is to find out how the organisation or person will maximize their credit score. Collection of data, analysis and case study is the main part of the study which will help to give certain suggestion to industry regarding credit analysis.

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6. RESEARCH METHODOLOGY
Research Methodology refers to search of knowledge. One can also define research methodology as a scientific and systematic search for required information on a specific topic. In Research Methodology we study the various steps that are generally adopted by a researcher in his research problem along with the logic behind them. In a research various methods are used. The selection of method depends on the nature and type of research. Research was performed to gain detailed knowledge and understanding of the credit rating in the country by using secondary data.

Source of Data
For this project secondary data is used. Secondary data is the data compiled by someone other than the user. It includes published data in the form of documents, research papers, web pages and other organisational records.. All secondary data used in this project was in the electronic form, and was obtained from the internet. Computerised databases used in this project 1. Bibliographical data base is the one which is obtained from journals, government publications, magazines, newspapers etc. Such online publications were accessed to obtain definitions of terms used in this article. 2. Full text database was obtained from the websites of CRISIL, CRAB, ICRA and CIBIL to get the details of working and manipulation of credit rating. 3. External secondary data is the data which is obtained from sources external to the organisation as commercial publications, government publications, professional organisations, trade associations professional marketing research agencies etc.

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7 . FI NDI NG S O F R E S E A R CH
The objectives of credit rating are to provide superior information to the investors at a low cost, provide a sound basis for proper risk return structure, subject borrowers to a healthy discipline and assist in the framing of public policy guidelines on institutional investment. The findings which I got during study of credit rating are as follows.

7 . 1 : Co n c e p t o f c r e d i t r a t i n g
Ratings, usually expressed in alphabetical symbols, are a simple and easily understood tool enabling the investor to differentiate between instruments on the basis of their credit quality. Credit rating is the symbolic indicator of the current opinion of the service debt obligations in a timely fashion with specific reference to the instrument being rated. It is focused on communicating to investors the relative ranking of the different loss probability for a given fixed income investment, in comparison with other rated instruments. The term Credit Rating comprises two words: credit and rating. Credit is trust in a persons ability and intention to pay or reputation of solvency and honesty. Rating means to classify a persons position with reference to a particular subject matter. In other words, credit is an act of assigning values by estimating worth or reputation of solvency and honesty so as to repose trust in a persons ability and intention to repay. Thus, credit rating could be defined as an expression of an opinion through symbols about credit quality of the issuer of securities or company with reference to sell that security. It provides risk which is one of the several factors in investor decision making. It does not indicate market risk or forecast future market price. It is always a specific evaluation done for a particular instrument. The rating process is itself based on certain givens. The agency, for instance, does not perform an audit. Instead its required information and opinion provided by the issuer and collected by analysts from different sources, including personal interaction with various entities. In determining rating, both quantitative and qualitative analyses are employed. The judgment is qualitative it nature and the use of quantitative analysis is to make the best possible overall qualitative judgment because ultimately the rating is an opinion.
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7.2: Types of credit ratings

1. Bond rating: it refers to the rating of bonds or debt securities issued by a corporate, governmental or quasi-governmental, body, such as rating of debentures, public sector bonds, municipal bonds, etc.

2. Equity rating: it refers to the rating of equity shares issued by a company. Short-term instruments rating refers to the rating of short-term debt instruments, such as commercial papers issued by companies.

3. Customer rating: it refers to the assessment of creditworthiness of a customer to whom credit sales are to be made.

4. Borrower rating: it requires the assessment of the ability to repay of a borrower to whom a grant of loan is under consideration. If the customer or borrower is a country in which an investment is envisaged or to which a loan is to be given, the evaluation of the creditworthiness of such a country is referred to as sovereign rating.

7.3: Factors Involved in Credit Rating

Credit rating depends on several factors, some of which are tangible and some of which are judgmental and intangible. These factors are fundamentals and earnings capacity of the company and volatility of the same company, Overall macro-economics and industry environment, Liquidity position of the company, Requirement of funds to meet commitments, Financial flexibility of the company to raise funds from outside sources to meet temporary financial needs, Guarantee and support from financially strong external bodies, Level of existing leverage (borrowings) and financial risk.

As mentioned earlier ratings are assigned to instruments and not to companies and two different ratings may be assigned to two different instruments of the same company. E.g. a company may
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be in a fundamentally weak business and may have a poor rating assigned for 5 year debentures while its liquidity position may be good, leading to the highest possible rating for a 3 month commercial paper. Very few companies may be assigned the highest rating for a long term 5 or 7 year instrument e.g. CRISIL has only 20 companies rated as AAA for long term instruments and these companies include unquestionable blue chips like Videsh Sanchar Nigam, Bajaj Auto, Bharat Petroleum, Nestle India apart from institutions like ICICI, IDBI, HDFC and SBI.

7.4: Credit Rating Process

The rating process begins with the receipt of formal request from a company desirous of having its issue obligations rated by credit rating agency. A credit rating agency constantly monitors all ratings with reference to new political, economic and financial developments and industry trends. The process followed by all the major credit rating agencies in the country is almost similar and usually comprises of the following steps.

1. Receipt of the request: The rating process begins, with the receipt of formal request for rating from a company desirous of having its issue obligations under proposed instrument rated by credit rating agencies. An agreement is entered into between the rating agency and the issuer company. The agreement is that the Credit Rating Agency keeps the information confidential; its the right of Issuer Company to accept or not to accept the rating and the issuer company have to provide all information to the Credit Rating Agency for rating and subsequent surveillance.

2. Assignment to analytical team: the Credit Rating Agency assigns the job to an analytical team. The team usually comprises of two analysts who have expertise in the relevant business area and are responsible for carrying out the rating assignments.

3. Obtaining information: The analytical team obtains the necessary required information from the client company. Issuers are usually provided a list of information requirements and broad framework for discussions. These requirements are derived from the experience of the issuers
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business and broadly confirms to all the aspects which have a bearing on the rating. The analytical team analyses the information relating to its financial statements, cash flow projections and other relevant information etc. 4. Site visits and meeting with management: To obtain better understanding of the clients operations, the team visits and interacts with the companys executives. Site visits facilitate understanding of the production process, assess the state of equipment and main facilities, evaluate the quality of technical personnel and form an opinion on the key variables that influence level, quality and cost of production. A management meeting is held with the issuer company as this enables the Credit Rating Agency to get non-public information in a rating decision. The topics discussed during the management meeting are competitive position, strategies, financial policies, historical performance, risk profile and strategies in addition to reviewing financial data.

5. Presentation of findings: After the analysis, the findings are discussed at length in the Internal Committee, comprising senior analysts of the credit rating agency. All the issue having a bearing on rating is identified. An opinion on the rating is also formed. The reports are finally presented to Rating Committee.

6. Rating committee meeting: This is the final authority for assigning ratings. The rating committee meeting is the process in which the issuer does not participate directly. The rating is arrived at after composite assessment of all the factors concerning the issuer, with the key issues getting greater attention.

7. Communication of decision: The assigned rating grade is communicated finally to the issuer along with reasons or rationale supporting the rating. The ratings which are not accepted are either rejected or reviewed in the light of additional facts provided by the issuer. The rejected ratings are not disclosed and complete confidential.

8. Dissemination to the public: Once the issuer accepts the rating, the credit rating agencies disseminate it through printed reports to the public.
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9. Monitoring for possible change: Once the company has decided to use the rating, credit rating agencies are obliged to monitor the accepted ratings over the life of the instrument. The credit rating agency constantly monitors all ratings with reference to new political, economic and financial developments and industry trends. All this information is reviewed regularly to find companies for, major rating changes. Any changes in the rating are made public through published reports by credit rating agency.

Source of above figure- crisil

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7.5: Rating methodology

Rating methodology used by the major Indian credit rating agencies is more or less the same. The rating methodology involves an analysis of all the factors affecting the creditworthiness of an issuer company e.g. business, financial and industry characteristics, operational efficiency, management quality, competitive position of the issuer and commitment to new projects etc. A detailed analysis of the past financial statements is made to assess the performance and to estimate the future earnings. The companys ability to service the debt obligations over the tenure of the instrument being rated is also evaluated. In fact, it is the relative comfort level of the issuer to service obligations that determine the rating. While assessing the instrument, the following are the main factors that are analyzed into detail by the credit rating agencies. 1. Business Risk Analysis 2. Financial Risk Analysis 3. Management Evaluation 4. Geographical Analysis 5. Regulatory and Competitive Environment 6. Fundamental Analysis

7.5.1: Business Risk Analysis Business risk analysis aims at analyzing the industry risk, market position of the company, operating efficiency and legal position of the company. This includes an analysis of industry risk, market position of the company, operating efficiency of the company and legal position of the company.

a. Industry risk: The rating agencies evaluates the industry risk by taking into consideration various factors like strength of the industry prospect, nature and basis of competition, demand and supply position, structure of industry, pattern of business cycle etc. Industries compete with each other on the basis of price, product quality, distribution capabilities etc. Industries with

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stable growth in demand and flexibility in the timing of capital outlays are in a stronger position and therefore enjoy better credit rating.

b. Market position of the company: Rating agencies evaluate the market standing of a company taking into account: i. Percentage of market share ii. Marketing infrastructure iii. Competitive advantages iv. Selling and distribution channel v. Diversity of products vi. Customers base vii. Research and development projects undertaken to identify obsolete products viii. Quality Improvement programs etc.

c. Operating efficiency: Favorable location advantages, management and labor relationships, cost structure, availability of raw-material, labor, compliance to pollution control programs, level of capital employed and technological advantages etc. affect the operating efficiency of every issuer company and hence the credit rating.

d. Legal position: Legal position of a debt instrument is assessed by letter of offer containing terms of issue, trustees and their responsibilities, mode of payment of interest and principal in time, provision for protection against fraud etc.

e. Size of business: The size of business of a company is a relevant factor in the rating decision. Smaller companies are more prone to risk due to business cycle changes as compared to larger companies. Smaller companies operations are limited in terms of product, geographical area and number of customers. Whereas large companies

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7.5.2: Financial Risk Analysis Financial risk analysis involves thorough evaluation of the financials of the small and medium enterprises. Careful analysis of the audited financials, observations of auditors in the auditors report and notes to accounts, consistent treatment of financials play an important role. Key ratio analysis, trend ratios, and financial disclosures and off Balance sheet items and their impact on the profitability is studied and analyzed in depth. Further the source of financial funding and their impact on the capital employed structure needs to be analyzed.

Availability of liquid investments, unutilized lines of credit, financial strength of group companies, market reputation, relationship with financial institutions and banks, enterprise perceptions and experience of tapping funds from different sources also play an important role in financial analysis. Past performance of the company, level of financial transparency i.e. quality of documents and future plans plays an important role in the determination of rating.

a. Asset quality: Asset quality plays an important role in indicating the future financial performance of a company. The Focus of asset quality evaluation is on lifetime losses, variability in losses under various scenarios, the impact of likely credit costs on profitability, and the cushions available (in the form capital or provisions) to protect the debt holders from unexpected deterioration in asset quality. In evaluating the quality of the companys credit appraisal ,the process and lending norms, the riskiness of its loan mix, its risk appetite, the availability of data to facilitate credit decision making, and its track record in managing its loan book through lifecycles. b. Liquidity: It is important for a company to maintain a favourable liquidity profile for the smooth functioning of its funding activity (fresh asset creation) and to honour its debt commitments in a timely manner. It is also important that an NBFC manage its interest rate risk, as the same could impact its future profitability. In assessing company liquidity profile, rating company evaluates the companys policy on liquidity, the maturity profiles of its assets and liabilities, the asset-liability maturity gaps, and
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the backups available to plug such gaps. The evaluation also focuses on the diversity of the company funding sources and their quality (i.e. availability of these sources in a stress situation).

C. profitability: A company ability to generate adequate returns is important from the perspective of both its shareholders and debt holders. The purpose of credit rating Companys evaluation here is to assess the level of future earnings and the quality of earnings of the company concerned, which is done by looking closely at the building blocks: interest spreads, fee income, operating expenses, and credit costs. The evaluation of a company profitability starts with the interest spreads and the likely trajectory of the same in the light of the changes in the operating environment, the companys liquid ity position, and its strategy. A large income allows greater diversification, which in turn can improve the resilience of earnings, thereby improving a company risk profile. After assessing the income stream, Credit Rating Company evaluates the company operating efficiency (operating expenses in relation to total assets, and cost to income ratio) and compares the same with that of its peers. The credit costs are estimated on the basis of the companys asset quality profile, and the profitability indicators to compare across peers. Importantly, a very high return on equity may not necessarily translate into a high credit rating, given that the underlying risk could be very high as well, and being so it could be more volatile or difficult to predict. d. Accounting Quality: Consistent and fair accounting policies are a prerequisite for financial evaluation and peer group comparisons. By virtue of being incorporated under the Companies Act, 1956, NBFCs are required to follow the Accounting Standards prescribed by the Institute of Chartered Accountants of India. Further, the RBI has also issued prudential norms for NBFCs specifying the accounting methods to be used for income recognition, provisioning for bad and doubtful advances, and valuation of investments. In evaluating an NBFCs accounting quality, Credit Rating Company reviews the companys accounting policies, notes to the accounts, and auditors comments in detail. Deviations from the Generally Accepted Accounting Practices are noted and the financial statements of the NBFC adjusted to reflect the impact of such deviations.

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e.capital Adequacy: An NBFCs capital provides the second level of protection to debt holders (earnings being the first) and therefore its adequacy (in relation to the embedded credit, market, and operational risk) is an important consideration for ratings. Riskiness of the product and granularly of the portfolio is factor that has a significant bearing on the amount of capital required to provide the desired degree of protection to an NBFCs debt holders. The requirement of risk capital varies with the concentration and the riskiness of the product mix.

7.5.3: Management Evaluation Quality of management, systems and policies, shareholder expectations and the strategy followed to manage these expectations, and accounting quality are the foundation stones on which an NBFCs credit risk profile is built. The importance of these factors is even higher for a new NBFC, one with a shorter track record, or one with a changing business profile. In evaluating an NBFCs management, systems and strategy, credit rating company assesses the companys competitive position (ability to change lending norms and/or yields), reliance on outsourcing, pace of growth and responsiveness to market changes, track record, and management experience (in relation to growth plans and the lifecycle of the loans extended), besides the extent of diversification in its loan book.

7.5.4: Geographical Analysis Geographical analysis is undertaken to determine the locational advantages enjoyed by the issuer company. An issuer company having its business spread over large geographical area enjoys the benefits of diversification and hence gets better credit rating. A company located in backward area may enjoy subsidies from government thus enjoying the benefit of lower cost of operation. Thus geographical analysis is undertaken to determine the locational advantages enjoyed by the issuer company.

7.5.5: Regulatory and Competitive Environment Credit rating agencies evaluate structure and regulatory framework of the financial system in which it works. While assigning the rating symbols, Credit rating companies evaluate the impact of regulation/deregulation on the issuer company.
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7.5.6: Fundamental Analysis Fundamental analysis includes an analysis of liquidity management, profitability and financial position, interest and tax rates sensitivity of the company.

7.6: CREDIT RATINGS - SCALES

1. Credit Ratings - Long Term Scale: It contain rating of sectors, including financial and non-financial corporations, sovereigns and insurance companies, are generally assigned Issuer Default Ratings (IDRs). IDRs opine on an entity's relative vulnerability to default on financial obligations. The "threshold" default risk addressed by the IDR is generally that of the financial obligations whose non-payment would best reflect the uncured failure of that entity. As such, IDRs also address relative vulnerability to bankruptcy, administrative receivership or similar concepts, although the agency recognizes that issuers may also make pre-emptive and therefore voluntary use of such mechanisms. AAA: Highest credit quality. 'AAA' ratings denote the lowest expectation of default risk. They are assigned only in cases of exceptionally strong capacity for payment of financial commitments. This capacity is highly unlikely to be adversely affected by foreseeable events. AA: Very high credit quality. 'AA' ratings denote expectations of very low default risk. They indicate very strong capacity for payment of financial commitments. This capacity is not significantly vulnerable to foreseeable events. A: High credit quality. 'A' ratings denote expectations of low default risk. The capacity for payment of financial commitments is considered strong. This capacity may, nevertheless, be more vulnerable to adverse business or economic conditions than is the case for higher ratings.

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BBB: Good credit quality. 'BBB' ratings indicate that expectations of default risk are currently low. The capacity for payment of financial commitments is considered adequate but adverse business or economic conditions are more likely to impair this capacity. BB: Speculative. 'BB' ratings indicate an elevated vulnerability to default risk, particularly in the event of adverse changes in business or economic conditions over time; however, business or financial flexibility exists which supports the servicing of financial commitments. B: Highly speculative. 'B' ratings indicate that material default risk is present, but a limited margin of safety remains. Financial commitments are currently being met; however, capacity for continued payment is vulnerable to deterioration in the business and economic environment. C: Exceptionally high levels of credit risk. Default is imminent or inevitable, or the issuer is in standstill. Conditions that are indicative of a 'C' category rating for an issuer include: D: Default. 'D' ratings indicate an issuer that entered into bankruptcy filings, administration, receivership, liquidation or other formal winding-up procedure, or which has otherwise ceased business. Default ratings are not assigned prospectively to entities or their obligations; within this context, non-payment on an instrument that contains a deferral feature or grace period will generally not be considered a default until after the expiration of the deferral or grace period, unless a default is otherwise driven by bankruptcy or other similar circumstance, or by a distressed debt exchange. 2. Credit Ratings - Short Term Scale A1: lowest credit risk. Instruments with this rating are considered to have very strong degree of safety regarding timely payment of financial obligations. Such instruments carry lowest credit risk. A2: low credit risk. Instruments with this rating are considered to have strong degree of safety regarding timely payment of financial obligations. Such instruments carry low credit risk.

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A3: higher credit risk. Instruments with this rating are considered to have moderate degree of safety regarding timely payment of financial obligations. Such instruments carry higher credit risk as compared to instruments rated in the two higher categories. A4: very high credit risk. Instruments with this rating are considered to have minimal degree of safety regarding timely payment of financial obligations. Such instruments carry very high credit risk and are susceptible to default. D: default. Instruments with this rating are in default or expected to be in default on maturity. 3. Credit Ratings - Long Term Structured Finance Scale Ratings of individual securities or financial obligations of a corporate issuer address relative vulnerability to default on an ordinal scale. In addition, for financial obligations in corporate finance, a measure of recovery given default on that liability is also included in the rating assessment. This notably applies to covered bonds ratings, which incorporate both an indication of the probability of default and of the recovery given a default of this debt instrument. AAA (SO): Highest Safety. Instruments with this rating are considered to have the highest degree of safety regarding timely servicing of financial obligations. Such instruments carry lowest credit risk. AA (SO): High Safety. Instruments with this rating are considered to have high degree of safety regarding timely servicing of financial obligations. Such instruments carry very low credit risk. A (SO): Adequate Safety. Instruments with this rating are considered to have adequate degree of safety regarding timely servicing of financial obligations. Such instruments carry low credit risk. BBB (SO): Moderate Safety. Instruments with this rating are considered to have moderate degree of safety regarding timely servicing of financial obligations. Such instruments carry moderate credit risk.

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BB (SO): Moderate Risk. Instruments with this rating are considered to have moderate risk of default regarding timely servicing of financial obligations. B (SO): High Risk. Instruments with this rating are considered to have high risk of default regarding timely servicing of financial obligations.

C (SO): Very High Risk. Instruments with this rating are considered to have very high likelihood of default regarding timely payment of financial obligations. D (SO): Default. Instruments with this rating are in default or are expected to be in default soon. 4. Credit rating Short-term structured finance scale A1 (SO): lowest credit risk. Instruments with this rating are considered to have very strong degree of safety regarding timely payment of financial obligations. Such instruments carry lowest credit risk. A2 (SO): low credit risk. Instruments with this rating are considered to have strong degree of safety regarding timely payment of financial obligations. Such instruments carry low credit risk. A3 (SO): higher credit risk. Instruments with this rating are considered to have moderate degree of safety regarding timely payment of financial obligations. Such instruments carry higher credit risk as compared to instruments rated in the two higher categories. A4 (SO): very high credit risk. Instruments with this rating are considered to have minimal degree of safety regarding timely payment of financial obligations. Such instruments carry very high credit risk and are susceptible to default. D (SO): default. Instruments with this rating are in default or expected to be in default on maturity. 5. Mutual Fund Long term Credit Ratings Scale

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AAAmfs: highest degree of safety. Schemes with this rating are considered to have the highest degree of safety regarding timely receipt of payments from the investments that they have made. AAmfs: high degree of safety. Schemes with this rating are considered to have the high degree of safety regarding timely receipt of payments from the investments that they have made. Amfs: adequate degree of safety. Schemes with this rating are considered to have the adequate degree of safety regarding timely receipt of payments from the investments that they have made. BBBmfs: moderate degree of safety. Schemes with this rating are considered to have the moderate degree of safety regarding timely receipt of payments from the investments that they have made. BBmfs: moderate risk of default. Schemes with this rating are considered to have moderate risk of default regarding timely receipt of payments from the investments that they have made. Bmfs: high risk of default. Schemes with this rating are considered to have high risk of default regarding timely receipt of payments from the investments that they have made. Cmfs: very high risk of default. Schemes with this rating are considered to have very high risk of default regarding timely receipt of payments from the investments that they have made.

6. Mutual Fund Long term Credit Ratings Scale A1mfs: very strong degree of safety. Schemes with this rating are considered to have very strong degree of safety regarding timely receipt of payments from the investments that they have made. A2mfs: strong degree of safety. Schemes with this rating are considered to have strong degree of safety regarding timely receipt of payments from the investments that they have made. A3mfs: moderate degree of safety. Schemes with this rating are considered to have moderate degree of safety regarding timely receipt of payments from the investments that they have made.
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A4mfs: minimal degree of safety. Schemes with this rating are considered to have minimal degree of safety regarding timely receipt of payments from the investments that they have made.

Source of above figure- riskencyclopedia.com

7.6.1: Z-Score
When a company is at risk of corporate collapse, to detect any signs of looming bankruptcy, investors calculate and analyse all kinds of financial ratios: working capital, profitability, debt levels and liquidity. The trouble is, each ratio is unique and tells a different story about a firm's financial health. At times they can even appear to contradict each other. Having to rely on a bunch of individual ratios, the investor may find it confusing and difficult to know when a stock is going to the wall. To resolve this conundrum, Professor Edward Altman introduced the Z-score formula in the late 1960s. Rather than search for a single best ratio, Altman built a model that distils five key performance ratios into a single score. As it turns out, the Z-score gives investors a pretty good snapshot of corporate financial health. Here we look at how to calculate the Z-score and how investors can use it to help make buy and sell decisions. It determines how likely a company is to fail. The formula does this by evaluating seven simple pieces of data, all of which should be available in the company's public disclosure.
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The Standard Z-Score The formula for the Z-Score (which incorporates those seven simple pieces of data) is: Z-Score = ([Working Capital / Total Assets] x 1.2) + ([Retained Earnings / Total Assets] x 1.4) + ([Operating Earnings / Total Assets] x 3.3) + ([Market Capitalization / Total Liabilities] x 0.6) + ([Sales / Total Assets] x 1.0) In general, the lower the score, the higher the chance of bankruptcy. For example, a ZScore above 3.0 indicates financial soundness; below 1.8 suggests a high likelihood of bankruptcy. Z-Score for Private Companies In 2002, Altman advocated a revised Z-Score formula for private companies. The private company version weights the variables differently and uses book value of equity in place of market capitalization. The formula is: Z-Score = ([Working Capital / Total Assets] x 0.717) + ([Retained Earnings / Total Assets] x 0.847) + ([Operating Earnings / Total Assets] x 3.107) + ([Book Value of Equity / Total Liabilities] x 0.420) + ([Sales / Total Assets] x 0.998) Z-Score for Non-manufacturers Altman originally developed the Z-Score for manufacturers, primarily because those were the companies in his original sample. However, the emergence of large, public service companies prompted him to develop a second Z-Score model for non-manufacturing companies. The formula is essentially the same as before; it just excludes the last component (sales / total assets) because Altman wanted to minimize the effects of manufacturing-intensive asset turnover. Z-Score = ([Working Capital / Total Assets] x 1.2) + ([Retained Earnings / Total Assets] x 1.4) + ([Operating Earnings / Total Assets] x 3.3) + ([Market Capitalization / Total Liabilities] x 0.6)

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In the above given formula the first ratio (working capital / total assets) is a good indicator of a firm's ability to make good on what it owes in the next few months. The second ratio is a good indicator of how in debt the company is and whether it has a history of profitability. The third ratio is a measure of efficiency in that it indicates how many cents the company generates in earnings for every dollar of assets it owns. The fourth ratio is a fluid measure of the market's "confidence" in the company. The fifth ratio is similar to the third ratio in that it measures the company's efficiency in delivering sales from its assets. Why Z-Score is important: The Z-Score has proved to be one of the most reliable predictors of bankruptcy. So much so that analysts often equate certain Z-Scores with corresponding bond ratings. In fact, when Altman reevaluated his methods by examining 86 distressed companies from 1969 to 1975 and then 110 bankrupt companies from 1976 to 1995 and later 120 bankrupt companies from 1996 to 1999, the Z-Score was between 82% and 94% accurate. The old "garbage in, garbage out" motto applies, however: if the company financials are misleading or incorrect, the Z-Score will be, too. To keep an eye on their investments, investors should consider checking their companies' Zscore on a regular basis. A deteriorating Z-score can signal trouble ahead and provide a simpler conclusion than the mass of ratios. Given its shortcomings, the Z-score is probably better used as a gauge of relative financial health rather than as a predictor. Arguably, it's best to use the model as a quick check of financial health, but if the score indicates a problem, it's a good idea to conduct a more detailed analysis.

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7.7: MANIPULATION OF CREDIT RATING

Our credit history, other than our income, is the single most important tool used by a Loan provider to evaluate our application for any loan or credit card application. Naturally, its important that we understand our Credit Information Report (CREDIT REPORT) and what it takes to maintain a credit history, so that is viewed favorably by Loan provider. Some time we are not able to maintain our credit report, as a result we think about bankruptcy. Bankruptcy is often a painful decision. When many folks think about bankruptcy, they think about losing their personal effects. They wonder what it would be like to lose a car, say goodbye to a house, or put their family heirlooms up for sale.

However, bankruptcy can also lead to less tangible losses. Many people may need to dip into retirement accounts or savings that were intended to pay for a child's education. While these are all real-life consequences of a bankruptcy filing, bankruptcy does offer more protection than we might think. Bankruptcy can also affect the credit scores, People with a 780 score could find their score drop 240 points after filing for bankruptcy, according to Consumer Affairs. But someone with a score of 680 would likely experience only a 150-point decrease.

Our credit score can dramatically affect our life, and, luckily, we hold the power to change it. Knowing how to improve our score has become an important skill in today's credit-dependent society. To learn how to improve it, we need to understand what it means and how it's calculated. Our score is based on our debt history and our existing lines of credit. The companies we do business with report information about our account activity to credit reporting agencies. The agencies gather your information and pull it together in a credit report. Before manipulation here is explanation about the base of credit rating that is credit score.

7.7.1: Credit Score

A credit score is a number which is assigned to borrower, generated by the credit bureaus by reviewing their past credit history. It helps the lenders in determining whether borrower have the financial strength to return the money within the given time period. In a nut shell it is like a synopsis of your credit worthiness.
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When borrower applies for a loan, their credit score plays a vital role in the approval of the loan. This is because credit score reflects their ability to repay their credit. Our credit score is the most important feature of our credit health. The approval of a loan depends on an individuals credit history. This again is relevant in terms of interest rate, fees, and other charges which are usually charged and varies from one person to another.

7.7.2: Credit Score Rating Scale

A credit score is a statistical figure used to determine the probability of an individual, paying back the money he has borrowed, within a specific period of time from a financial institution. When we borrow money, our lender sends detailed information to the credit rating agency, to create a credit report that analyzes how well we handle our debts. The credit bureaus that issue these ratings have various evaluation systems, which depend upon many factors. Whether we apply for a credit card or mortgage, our credit score report is always checked. Accordingly, a lender can analyze what risk we pose to him. Increased credit risk implies that a risk premium has to be added to the price at which the money is being borrowed. For example, if we have a poor credit score, our lender will lend us at a higher rate than somebody with a better credit score. Score 800 -850 750 -799 700 -749 650 -699 600 -649 550 -599 500 -549 300 -499 Description Incredibly Good Excellent Really Good Good/Average Fair Poor Very Poor Exceedingly Poor Source of above data is CRISIL

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Source of this scale -FICO

7.7.3: Factors for calculating Credit Score

Various types of account information related to borrower credit accounts, loan accounts, and finance company accounts are taken into consideration. Public records: This type of payment information is considered very serious because this deal with reports of bankruptcies, wage attachments and judgments etc. Hence, any recent report of larger amounts will decrease our score heavily. Accounts reflecting no late payments: If the accounts which borrower owe show no late payments then it will definitely improve his credit score.

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Late payments detail: Information on borrower late payment accounts like the amount borrower owe, age of those accounts, number of those accounts are considered for evaluating credit score. Amount: Borrower may have credit accounts but that does not mean that his credit score will be lowered or the lender will undertake greater risk, if lender approves loan. The risk factor arises when the credit amounts go beyond borrower affordability level. This might give some red signal to the lender about loan repayment credibility. In determining credit score the credit bureaus consider the amount borrower owe on specific type of accounts such as credit card accounts, and installment loans. The basic principle considered for determining credit score is how much excess money borrower owe when compared to his income. Duration of your credit history: Credit score as an individual will increase if borrower has a long credit history which will borrower at the time borrower seek to avail another loan. Availing new credit: Its our general tendency among us to open many credit accounts. We have the desire to open or own multiple credit accounts but that may affect our credit score. This happens because this aspect increases our credit risk especially if we do not have a long credit history. If we have multiple credit requests then it increases our credit risk further. In general while determining our credit scores the credit bureaus does consider the type of accounts we have opened, the age of those accounts etc. Credit Mix: our score will bring into consideration our credit cards; retail accounts; installment loan accounts; finance company accounts and mortgage loan accounts. For the purpose of increasing our credit score it is not a good idea to open credit accounts which we have not intend to use.

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The above factors are depicted in graphic images

Risks associated with Credit Score Our credit score reflects our financial status and our credibility for future financial privileges. We need to be very careful about our credit score as it is the most important financial document. With a low credit score our credibility factor becomes risky. A respectable credit score is considered as 650 and above.

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7.7.4: Monitoring Credit Score and Credit Report

Bad credit can result in unfavorable interest rates that cost thousands when we take out a mortgage, a car loan or a student loan. It could block us from leasing that apartment youve been pining for. And it can be a black mark on our record that even prevents us from landing our dream job. So it pays to know the essentials of our credit report and related score, the behaviors that can make our score rise or plummet, and the services that help us monitor our credit. Credit report is a summary of our borrowing and repayment historyany new accounts, closed accounts, unpaid bills, late bills, and other activity. If we have a loan, mortgage or credit card, it will show up here. Our credit report provides the basis for our credit score. Our credit score is a three-digit number between 300 and 850 calculated from a formula thats designed to gauge your creditworthiness. The bureaus use our personal data and crunch the
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numbers differently, so our score will vary slightly at each agency. When a lender considers our application for credit, they turn to one of the credit agencies for our score, which indicates our reliability as a borrower.

7.7.5: Manipulation of Credit Score

1. We should pay our bills on time. Late payments are viewed negatively by Loan providers and may affect the chances of our loan getting approved. 2. We should review our credit reports at least once every year/every 12 months.

3. We should clean up our own credit report by disputing inaccurate information for free! We havent fall for any promises to improve our credit report or credit scores overnight. We can dispute the in accurate information ourselves for free! 4. Dont close existing credit accounts. Instead, we keep credit cards away in a safe and secure place and stop accumulating debt. 5. We have to create a debt worksheet and include the information like: annual percentage rate, name of the creditor and address, last four numbers of our account number, telephone number, limit, and amount owe by borrower, minimum payment and billing date. 6. We should contact our creditors to work out a plan to rebuild our credit issues if we can afford the payment: we can ask our bank or credit union if they offer a secured credit card or secured loan and verify that our on time payment history will be reported to the three major credit reporting agencies. We may be able to make a deposit to our account and have a credit limit or loan in the amount of our deposit. 7. Use the Snowball Effect to completely pay off one debtor at a time. 8. We have to know our credit limits and pay down our credit card balances to no more than 30% of total available credit limit.
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9. We need to get our yearly credit report and make sure it doesnt have any errors. If it does have errors, we need to challenge them. We might also consider challenging some items on our credit report, such as a collection thats been paid off already, to see if we can get the company to remove it.

7.7.6: Credit rating companies in India

1. Crisil Limited CRISIL is the largest and first credit rating agency in India. It was established in 1987. Its corporate office is in Mumbai, maharshatra.The worlds largest rating agency Standard & Poor's now holds majority stake in CRISIL. It is a global leader in research, ratings and risk & policy advisory services. It is one of the top credit rating agencies in India which has won many prestigious awards in the credit rating category and had assessed more than 61000 entities.

2. Credit Information Bureau India Limited (CIBIL) CIBIL was established in 2000.its corporate office is at Mumbai Maharashtra. it is an Credit Information Company which maintains records of an individuals payments related to credit cards and loans. The information about users credit cards and loans is later used by the CBIL to generate Credit information reports which are used to approve loan applications. 3. Fitch Ratings India Private Ltd. Fitch Ratings, a Fitch Group company is among the top credit rating agencies in India incorporated in 1913 in New York, USA. Fitch Ratings provides financial information services in more than 30 countries and has over 2000 employees working at 50+ offices worldwide. 4. Equifax

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Equifax Inc started operations in 1899 and has managed to be among the top credit rating agencies in India and at global level. Equifax Inc provides information management services that process thousands of records of its members which can be used by them for various purposes and to supply risk management solutions, credit risk management and analysis, fraud detection triggers, decision technologies, marketing tools etc. 5. Credit Analysis & Research Ltd. (CARE) CARE Ratings is second-largest among the credit rating agencies in India as far as Indian Origin Company is concerned. It is established in 1993 having corporate office in Mumbai, Maharashtra. CAREs rating businesses can be divided into various segments like for banks, IPO grading and sub-sovereigns. Companys shareholders include leading domestic banks and financial institutions in India.

6. ICRA Limited ICRA limited is a joint venture between Moodys Investors and various financial services companies is a part of ICRA group which was founded in 1991. It is a Credit rating agency listed on the National Stock Exchange and Bombay Stock Exchange. ICRA has four subsidiaries ICRA Management Consulting Services Ltd, ICRA Techno Analytics Ltd, ICRA Online Ltd, PT. ICRA Indonesia and ICRA Lanka Ltd.its corporate office in Gurgaon, Haryana.

7. ONICRA Onicra Credit Rating Agency is a Credit and Performance Rating company based in Gurgaon and founded in 1993. Onicra is among the top 10 credit rating agencies in India offering smart and innovative solutions like risk assessment, analytical solutions and ratings to MSMEs, corporate and individuals.

8. High Mark Credit Information Services

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High Mark Credit Information Services is a recognized credit rating company in India. It provides bureau services, analytic solutions and risk management to banks and financial institutions operating in Micro-finance, Retail consumer finance, MSME, Rural & Cooperative Sectors.

9. SME Rating Agency of India Ltd. (SMERA) MERA Ratings Ltd a Mumbai based company now expanded to 13 more locations was founded in year 2005. SMERA a joint venture of SIDBI, several private sector banks in the country and Dun & Bradstreet Information Services India Pvt. Ltd. (D&B). Since 2005 SMERA rated over 23,000 MSMEs pan India. 10. Brickwork Ratings India Private Ltd Brickwork Ratings was established in 2007 by Sangeeta Kulkarni as a credit rating firm. The company is registered with SEBI, RBI & NSIC and operates in wide range of areas such as NCD, Bank Loan, Commercial paper, MSME ratings. It is among the leading credit rating companies in India having already rated Rs 200,000 corers of bonds and bank loans. Its corporate office is in Bengaluru, Karnataka.

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8: WorldCom Test case study

To demonstrate the power of the Z-score, let's look at how it holds up with a tricky test case. Consider the infamous collapse of telecommunications giant WorldCom in 2002. WorldCom's bankruptcy created $100 billion in losses for its investors after management falsely recorded billions of dollars as capital expenditures rather than operating costs. When I calculate Z-score for WorldCom by using annual report for year 1999, 2000 and 2001.Indeed, WorldCom's Z-score suffered a sharp fall. Also note that the Z-score moved from the gray area into the danger zone in 2000 and 2001, before declaring bankruptcy in 2002. Input X1 X2 X3 X4 X5 Z-score Financial ratio Working capital/Total Assets Retained earnings/Total Assets EBIT/Total Assets Market Value/Total Liabilities Sales/Total Assets 2.5 1999 -0.09 -0.02 .09 3.7 0.51 1.4 2000 -0.08 0.03 .08 1.2 0.42 .85 2001 0 0.04 .02 .50 0.3

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9. CASE STUDY
Five years ago Mr Kumar took a loan of 4 lacs which he paid with interest on a fix duration given by bank, also he secure a good credit score. Again Mr Kumar needs an auto loan of 6.29 lacs. He applied for a loan in bank A, who offered him a quote of 11.70% for a 5 year period; the EMI would be 13,897.he summated all documents and security regarding loan, also Mr Kumar credit history, credit score and financial discipline earned good repo and he got the auto loan. Payment History (35% IMPACT)-In previous loan Mr. Kumar paid all his EMI on time, but in this loan he is paying in irregular manner at Rs 13,897 per month. Interpretation: As we know that 35 percent of credit score comes from payment history once a payment is 30 days late, a creditor can report the payment to the credit bureau. Late payments create a negative hit to score and take time to repair. OUTSTANDING BALANCES(30% IMPACT) -: In previous loan Mr Kumar took loan of amount of 4 lacs and paid all due on time, but this time he owes a loan of 6.29 lacs and also facing some problem during payment as it is huge amount for him. Interpretation: This factor marks the ratio between the outstanding balance and available credit. Ideally, Mr. Kumar should make an effort to keep balances as close to zero as possible, and definitely below 30% of the available credit limit. As in previous loan he maintain the ratio and secure a good percent of score that is 30%.this time he is not able to maintaining it, it may create a negative hit to score. CREDIT HISTORY (15% IMPACT): The previous loan of 4 lacs was taken by Mr. Kumar for first time as a personal loan, but after clearing first loan dues, there is a gap of six months when Mr. Kumar took a loan of 6.29 lacs. Interpretation: In general, a more seasoned credit history will increase our credit score. Lenders want to see that borrower can responsibly manage their credit accounts over time. However, even those borrowers who have not used credit for an extended period of time may get high scores, depending on how the other information in their credit report appears.

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TYPE OF CREDIT (10% IMPACT): The previous loan taken by Mr Kumar was personal loan. But this time after paying first loan he took auto loan. Back to back he uses credit from financial institution. Interpretation: Opening several credit accounts in a short period of time can represent a greater risk, especially for those with newer credit histories. A mix of auto loans, credit cards and mortgages may create a negative hit to score. INQUIRIES (10% IMPACT): This percentage of the credit score quantifies the number of inquiries made on a Mr Kumar credit within a twelve-month period. Interpretation: Each hard inquiry can cost from three to fifteen points on a credit score, depending on the amount of points left in this factor. If Mr Kumar pulls his credit report himself, it will have no effect on his score.

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The credit score is a computerized calculation; Personal factors are not taken into consideration when a credit report is generated. It is merely a snapshot of today's credit profile for any given borrower, and it can fluctuate dramatically within the course of a week.

In the above case study Mr.kumar able to score a good credit score in his previous loan of 4 lacs that is 750 by maintaining every aspect of credit rating during payment of credit amount with interest. As a result of good credit score, bank offered him the loan of 6.29 lacs at 11.70%.But during the payment of EMI of auto loan worth 6.29 lacs; he faced some financial problem and loses the continuity of EMI payment every month. As a result the credit score is minimize that is 620. Interpretation: the credit score reflects Mr. Kumar financial status and credibility for future financial privileges. He need to be very careful about his credit score as it is the most important financial document. With a low credit score Mr. Kumar credibility factor becomes risky. As due to low credit score when Mr. Kumar is going to apply for any loan in coming future, maybe he will charges more interest by lenders or may be lenders deny for loan. Interpretation: If anyone has low scores or problematic reports, lenders will either deny you flat out or penalize you with such exorbitant rates that the outcome ranges from completely undesirable to impossible. If anyone has lower credit scores, he will have to pay a lower interest rate on his loan. What Mr. Kumar should do to improve his credit score? 1. Mr. Kumar should always try to maintain a good track record of paying his bills on time. This will help him to enhance the credit score. 2. Mr. Kumar should be aware of the fact that when he miss a payment on any collection accounts and try to close the account the report of the account will always be there on his credit report. So try to avoid it. 3. Visiting a credit counsellor will not affect his credit score or make him lose some points. Instead if he can manage his credit well then surely his score will be improving in due course of time.
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4. He should always try to keep a gap in taking loan. He should minimize the rate of taking loan. 5. Try to pay off his debts instead of postponing the payment. Stop closing unused credit accounts with a view to increase his score. 6. Avoid applying for a number of new credit which he do not need in order to increase his score as this may put him in trouble later on.

Conclusion: After taking loan and maintaining proper discipline during paying EMI, taking care of credit history and of course on other activity regarding loan can maximize the credit score, whereas negligence in paying EMI of loan may tend to suffer lender as it minimize the credit score. In above case study Mr. Kumar got his auto loan because of only good credit score earn during his first loan. As he done some carelessness during payment of second loan, it will affect his credit score and in future it may create problem during loan or credit need. Whereas those who have bad credit, it may seem like it is impossible to improve credit report but it can be improve. By ignoring the problem, that credit report will continue to stay poor, and person will face the repercussions of bad credit. With time and effort there can be an improvement. Remember, the credit report did not get damaged overnight and will not improve overnight.

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10: CONCLUSION

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 nations economy. 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. They can best serve markets when they operate independent, adopt and enforce internal guidelines to avoid conflicts of interest and protect confidential information received from issuers. Credit rating agencies cannot afford to commit too many mistakes as it the investors who pays the price for their mistakes. Credit rating agencies should be made accountable for any faulty rating by panellizing them or even de-recognizing them, if needed.

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11: Bibliography

www.crab.com www.crisil.com www.icra.com www.fitchratings.com www.cibil.com www.careratings.com http://shodhganga.inflibnet.ac.in/bitstream/10603/4466/11/11_chapter%202.pdf http://www.investinganswers.com/financial-dictionary/financial-statement-analysis http://www.buzzle.com/articles/credit-score-rating-scale.html http://guides.wsj.com/personal-finance/credit/how-to-monitor-your-credit-score-and-creditreport/ For literature Review Czarnitzki, D.; and Kraft, K. (2007), Are Credit Ratings Valuable Information, Applied Financial Economics, Vol. 17, pp. 1061-1070. Jain, T.; and Sharma, R. (2008), Credit Rating Agencies in India: A Case of Authority without Responsibility, Working Paper Series, Supreme Court of India and National Law University, April, ssrn abstract id 1111553. Reddy, R.B.; and Gowda, R.M. (2008), Some Aspects of Credit Rating: A Case Study, the Management Accountant, Vol. 43, No. 6, June. Bhattacharyya, M. (2009), A Study of Issuer Rating Service with an Appraisal of ICRA Rating Model,Indian Journal of Accounting, Vol. XXXIX (2), June.

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