e

A PROJECT REPORT ON
CREDIT RATING
SUBMITTED BY:AASTHA. V. JAGAD
T.Y.B.M.S. [SEMESTER V]
MITHIBAI COLLEGE OF MANAGEMENT
VILE PARLE (W), MUMBAI - 400 056
SUBMITTED TO
UNIVERSITY OF MUMBAI
ACADEMIC YEAR
2012-2013
PROJECT GUIDE
MR. NAVEEN ROHATGI
DATE OF SUBMISSION
25TH JULY, 2012

ACKNOWLEDGMENT
At the outset I would like to take the privilege to convey my gratitude to all those
who co-operated, supported, helped and suggested me as to how the project could
be completed. This project bears imprint of advices, from many people who were
either directly or indirectly involved in it
The Internet has been a veritable treasure throve of information .The websites and
the information they contained helped me to do the project in a much easier and
better manner.
I am also desirous of placing on record profound indebtness to my guide Prof.
Naveen Rohatgi for his valuable advices, guidance, precious time and support that
he lent to me.

DECLARATION

I, Ms. AASTHA .V. JAGAD, of MITHIBAI COLLEGE OF MANAGEMENT

of TYBMS [Semester VI] hereby declare that I have completed my project, titled
CREDIT RATING in the Academic Year 2012-2013. The information submitted
herein is true and original to the best of my knowledge.

__________________________
Signature of Student
[Aastha.V.Jagad]

CERTIFICATE

I, MR. NAVEEN ROHATGI, hereby certify that Ms. AASTHA JAGAD of

Mithibai College of TYBMS [Semester VI] has completed her project, titled
CREDIT RATING in the academic year 2012-2013. The information submitted
herein is true and original to the best of my knowledge.

_______________________________
Signature Of The Principal
[Dr. Kiran V. Mangaonkar]

______________________
Signature of External Examiner

______________________
Signature Of The Project Guide
[Mr. NAVEEN ROHATGI]

TABLE OF CONTENTS
INTRODUCTION........................................................................................................... 1
CREDIT RATING- MEANING.......................................................................................... 2
FEATURES.................................................................................................................... 5
IMPETUS...................................................................................................................... 6
ORIGIN........................................................................................................................ 7
THE CREDIT RATING SYSTEM...................................................................................... 9
CREDIT RATING AGENCY........................................................................................... 12
CREDIT RATING SYMBOLS......................................................................................... 17
CORPORATE CREDIT RATING.................................................................................... 21
IPO GRADING/RATING................................................................................................ 23
SOVEREIGN CREDIT RATINGS.................................................................................... 27
INDIVIDUAL CREDIT RATING IN INDIA.......................................................................30
USES OF RATINGS....................................................................................................... 35
FUTURE OF CREDIT RATING IN INDIA........................................................................43
BENEFITS OF CREDIT RATING....................................................................................43
NEED AND IMPORTANCE OF CREDIT RATING.............................................................46
PRACTICAL PROBLEMS WITH CREDIT RATING..........................................................49
REGUALTORY FRAMEWORK...................................................................................... 51
SEBI GUIDELINES....................................................................................................... 53
REGISTRATION OF CREDIT RATING AGENCY.............................................................53
CODE OF CONDUCT.................................................................................................... 58
COMPARISON OF REGULATIONS RELATED TO CREDIT RATING AGENCIES IN INDIA
AND OTHER COUNTRIES............................................................................................ 61
STANDARD & POOR'S................................................................................................. 64
CRISIL SME RATINGS:................................................................................................ 68
RECENT CREDIT RATING ARTICLES AND ACTIVITIES IN INDIA..................................76
CONCLUSION............................................................................................................. 79
BIBLIOGRAPHY.......................................................................................................... 80

EXECUTIVE SUMMARY

A credit rating is an opinion from a credit rating agency about the creditworthiness of an issuer or the
credit quality of a particular debt instrument. Primarily, the rating opinion considers how likely the
issuer of the debt instrument is to meet its stated obligations, and whether investors will receive the
payments they were promised. A failure to meet such payments may be considered a default.
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 products has provided the credit rating
agencies with a tremendous power.
Despite the powerful position, is 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 loose its faith to the
system.

CREDIT RATING
INTRODUCTION

The removal of strict regulatory framework in recent years has led to a spurt in the number of
companies borrowing directly from the capital markets. There have been several instances in the
recent past where the "fly-by-night operators have cheated unwary investors. In such a situation, it
has become increasingly difficult for an ordinary investor to distinguish between 'safe and good
investment opportunities' and 'unsafe and bad investments'. Investors find that a borrower's size or
names are no longer a sufficient guarantee of timely payment of interest and principal. Investors
perceive the need of an independent and credible agency, which judges impartially and in a
professional manner, the credit quality of different companies and assist investors in making their
investment decisions. Credit Rating Agencies, by providing a simple system of gradation of
corporate debt instruments, assist lenders to form an opinion on -the relative capacities of the
borrowers to meet their obligations. These Credit Rating Agencies, thus, assist and form an integral
part of a broader programme of financial disintermediation and broadening and deepening of the
debt market.
Credit rating is used' extensively for evaluating debt instruments. These include long-term
instruments, like bonds and debentures as well as short-term obligations, like Commercial Paper. In
addition, certificates of deposits, inter-corporate deposits, structured obligations including nonconvertible portion of partly Convertible Debentures (PCDs) and preferences shares are also rated.
The Securities and Exchange Board of India (SEBI), the regulator of Indian Capital Market, has now
decided to enforce mandatory rating of all debt instruments irrespective of their maturity.

CREDIT RATING- MEANING

A credit rating estimates the credit worthiness of an individual, corporation, or even a country. It
is an evaluation made by credit bureaus of a borrower's overall credit history. A credit rating is
also known as an evaluation of a potential borrower's ability to repay debt, prepared by a credit
bureau at the request of the lender. Credit ratings are calculated from financial history and current
assets and liabilities. Typically, a credit rating tells a lender or investor the probability of the
subject being able to pay back a loan.
Definition
According to the Moodys, A credit rating is an opinion on the future ability and legal obligation
of the issuer to make timely payments of principal and interest on a specific fixed income security.
The rating measures the probability that the issuer will default on the security over its life, which
depending on the instrument, may be a matter of days to 30 days or more. In addition, long term
ratings incorporate an assessment of the expected monetary loss, should a default occur.
According to Standard & Poors, Credit rating help investors by providing an easily
recognizable, simple tool that couples a possibly unknown issuer with an informative and
meaningful symbol of credit quality
A poor credit rating indicates a high risk of defaulting on a loan, and thus leads to high interest rates
or the refusal of a loan by the creditor.
The following are few factors that contribute to an individuals credit score.
These are conditions that you have to avoid starting from getting your credit card application
approved.
1. When you make late payments, this affects 35% of your credit score negatively. Your creditor
informs your credit bureau and this affects your credit score. Make regular pays to avoid this.
Its the only way to keep that 35%.
2. Worst of the factors that determine your credit score is when you dont pay at all.
3. When you make a loan default. This is when you were not able to comply with the terms and
conditions.
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4. When you have a longer credit history, it is better. 15% of your credit score is from the duration of
your credit history. You might not be so much in control of this factor that contributes to your
credit score because your history depends on the number of years you have been with a social
security number.
5. Another factor that determines credit score is that when you are charged off your account because
your creditors know that you really dont want to pay, you will watch your credit score
backslide.
6. Lenders can send an account charged off to collection agencies. These agencies do the work of
getting you pay your bills. Yes, they could harass you just so you go with what your lenders
wanted and what you are supposed to do in the first place. Be careful with charge offs because
they are minor factors that contribute to your credit score yet they are significant.
7. Of the many factors that contribute to your credit score, when the court intervenes because you
cannot pay your bills, your credit history and score is affected negatively because you will be
considered bankrupt.
8. When you file for bankruptcy yourself, this becomes a factor that contributes to your credit
score. This is not the best last option to get out of debt. These three following, better, few solutions
are more favorable ways:
Credit counseling
Debt settlement
Debt management program
9.

Foreclosure of your home for not paying your mortgage is such a big deal among factors

contributing to credit score negatively.

10. Higher credit card balances will lead to credit card utilization. Remember that you should not
exceed your credit limits. Exceeded credit card limits is said to be a major factor contributing to
credit score negatively for over 90% of Americans with bad credit.
11. Connected to the previous factor contributing to bad credit is when you maxed out your credit
limit.
12. If you close your credit when it still contains balances, lenders will get the impression that the
limit is maxed out.

13. 10% of your credit score is from your credit inquiries or when you apply for multiple loans or
credit cards. In a short period of time, when you do credit card application several times, is not a
good thing for your score. It ruins it more.
All these are activities reported in your credit bureaus and are all recorded in your credit history.
These are crucial and must not be taken for granted. Each step you make in your credit deserves
proper thinking; otherwise, it will be a factor that contributes to your credit score negatively

FEATURES

Following are the characteristic features of credit rating

Specificity
The rating is specific to a debt instrument. It is intended as a grade and an analysis of the credit risk
associated with that particular instrument. Rating is neither a general purpose evaluation of the

issuer, nor an overall assessment of the credit risk to be involved in all the debts contracted by such
an entity.
Relativity
The rating is based on relative capability and willingness of the issuer of the instrument to service
debt obligations (both principal and interest), in accordance with the terms of the contract.
Guidance
The rating primarily aims at furnishing guidance to the investors/creditors in determining a credit
risk associated with a debt instrument/credit obligation.
Not a recommendation
The rating does not provide any sort of recommendation to buy, hold or sell an instrument, since it
does not take into consideration, factors such as market prices, personal risk preferences and other
considerations which may influence an investment decision.
Broad parameters
The rating process is based on certain broad parameters of information supplies by the issuer, and
also collected from various other sources, including personal interactions with various entities.
No guarantee
The rating furnished by the agency does not provide any guarantee for the completeness or accuracy
of the information on which the rating is based.

Qualitative and quantitative

While determining the rating grade, both quantitative as well as qualitative factors are employed.
The judgment is qualitative in nature, and the role of quantitative analysis is limited to assist in the
making of the best possible overall judgment

IMPETUS
The credit rating system originated in the United States in the seventies. The high levels of default,
which occurred after the Great Depression in the U.S Capital markets, gave the impetus for the
growth of credit rating. The default of $82 million of commercial paper by Penn Central in the year
1970, and the consequent panic of investors in commercial paper, resulted in massive defaults and
liquidity crisis. This prompted the capital issuers to get their commercial paper programs rated by
independent credit agencies. This according to them would give the required degree of comfort and
reassurance to their investors. Moreover, the real impetus for growth came when regulatory agencies
in the U.S made rating mandatory for institutions such as Government Pension Funds and Insurance
Companies, who could not buy securities rated below a particular grade. In addition, investors
themselves became aware of the rating mechanism, and started using ratings as extensively as a tool
for risk assessment. Merchant bankers, underwriters and other intermediaries involved in the debt
market also found the rating useful for planning and pricing the debt instruments.
Over the last two decades there have been many other factors that have contributed to the growth
and importance of the credit rating system in many parts of the world. They are:

The increasing role of capital and the money markets consequent to disintermediation.
Increased securitization of borrowing and lending consequent to disintermediation
Globalization of the credit market
The continuing growth of information technology
The growth of confidence in the efficiency of the market mechanism
The withdrawal of government safety nets and the trend towards privatization

ORIGIN
Credit rating has its origin in the financial crisis of the U.S. in 1837. Louis Tappan established the
first mercantile credit agency in New York in1841. The agency was used to assess the ability of
merchants to pay their financial obligations. Later on, it was acquired by Robert Dun, and its
first rating guide was published in 1859. In 1849, John Bradstreet set up similar agency, and it
published ratings book in 1857. In 1933, these two agencies were merged together to form Dun and
Bradstreet, which finally acquired the Moody's Investors services in 1962.it is interesting to note
that Moodys have a long history in the rating business, spanning over a period of more than a
hundred years.. In1900, John Moody laid stone of Moodys Investors Services and in 1909 published
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his Manual of Railroad Securities. The rating of utility and industrial bonds in 1904 followed this,
along with the rating of bonds issued by .S. cities and other municipalities in the early 1920s.
Early 1920s saw the expansion of credit rating industry when the POOR Publishing Company
published his first rating guide in 1916. Subsequently Fitch Publishing Company and Standard
Statistics Company were set up in 1924 and 1922 respectively. Poor Publishing Company and
Standard Statistics Company merged together in 1941 to form Standard and Poors which was
subsequently taken over by McGraw Hill in 1966. For almost 50 years after setting up of Fitch
Publishing in 1924, there were no major entrants in the field of credit rating. But since1970s, a
number of credit rating agencies have been set up all over the world. These included the Canadian
Bond rating Service (1972), Thomson Bankwatch (1974) Japanese Bond Rating Institute (1975),
McCarthy Crisanti & Maffei (1975) (acquired by Duff & Phelps in 1991), Dominican Bond Rating
Service (1977), IBCA Limited(1978) and Duff & Phelps Credit Rating Company (1980). There are
other credit rating agencies too in operation in many other countries such as Malaysia, Philippines,
Mexico, Indonesia, Israel, Pakistan, Cyprus, Korea, Thailand, and Australia
In India, CRISIL (Credit Rating and Information Services of India Ltd.) was set up in 1987 as the
first rating agency followed by ICRA (formerly known as Investment Information & Credit Rating
Agency of India Ltd.) in 1991, and Credit Analysis and Research Ltd. (CARE) in 1994. All the three
agencies have been promoted by the All-India Financial Institutions. The rating agencies have
established their credit ability through their independence, professionalism, continuous research,
consistent efforts and confidentiality of information. Duff and Phelps has tied up with two Indian
NBFCS to set up Duff and Phelps Credit Rating India (P) Ltd. in 1996

Exhibit 1 clearly brings out the history and growth of credit rating agencies the world over
chronological order:

Year

Credit Rating Agency

1841

Mercantile credit agency

1900

Moodys Investors Service

1916

Poor Publishing Company (USA)

1922

Standard Publishing Company (USA)

1924

Fitch Publishing Company (USA)

1933

Dun & Bradstreet

1941

Standard & Poor (USA)

1966

McGraw Hill

1972

Canadian Bond rating Services

1974

Thomson Bankwatch (USA)

1975

Japanese Bond rating Service (JAPAN)

1975

McCarthy Crisanti & Maffie

1977

Dominican Bond rating Company

1978

I BCA Limited

1980

Duff & Phelps Credit Rating Company

1987

CRISIL (INDIA)

1991

ICRA (INDIA)

1994

CARE (INDIA)

1996

Duff and Phelps Credit Rating India (P) Limited

THE CREDIT RATING SYSTEM

Credit rating has facilitated authorities around the world to issue mandatory rating requirements.
For instance, specific rules restrict the entry of new issues that are rated below a
particular grade. Moreover they also stipulate different margin requirements for the mortgage of
rated and unrated instruments, and hence prohibit institutional investors from purchasing or holding
instruments that are rated below a particular level.
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Growth Factors

Credibility and Independence

Ratings are considered valuable only as long as they are credible. Credibility arises primarily from
objectivity, which results from the rating agency being independent of the issuers business. The
investor is willing to accept the judgment only where such credibility exists. When increasing
number of investors are willing to accept the judgment of a particular rater, that rater than gaining
recognition as reputed rating agency. As expressed by Moodys The Rating Agency must do all it
can to reserve its credibility and integrity in the market place. As primary ingredient of credibility,
the agency must, maintain independence from all interested market forces, including issuers, security
underwriters, government.
The credibility of a rating agency is also enhanced by other factors such as objectivity of
opinions, analytical integrity and consistency, professionalism, relevant expertise, strict rules of
confidentiality, timeliness of the rating review, announcement of changes, ability to reach a wide
range of investors through press reports, print or electronic publications, an investor friendly
research services.

Capital Market Mechanism.

A strong demand for investment related information is generated due to the reliance on the capital
market for resource allocation. Rating agencies provide this information. Investors consider rating an
important input for their investment decisions only when there is a perceived default risk.

Disclosure requirements.
Rating agencies have assumed importance on account of their task of assigning grades to securities
issued by companies. Moreover, it is becoming incumbent for companies, due to regulatory
guidelines, to have adequate corporate disclosure and to publish all the essential information
required by the investors. These guidelines require a mandatory disclosure of ratings.

Credit Education.
Credit rating serves as an effective educator on the modalities of arriving at valid judgments about
investing in securities. It is to be noted that the information should not only reach the investor, but it
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must also enable them to make meaningful interpretations. The investor should also be aware of the
limitations of credit rating and should realize that the rating is not an insurance or guarantee against
default risk.

Creation of Debt Market

Credit rating is considered as an essential input for guiding investments in bonds. This assumes
significance in the context of substantial risks involved in their subscription. In fact, the continued
growth and evolution of the credit rating business depends on the size and growth of the debt market.
An active primary and secondary debt market is crucial for rating agencies to provide their services.

MAJOR ISSUES

Investment Vs speculative Grades.

Investment and speculative grades are two terms popularized by regulators. For instance, securities
that are rated below BBB (S&P) or Baa (Moodys) are called non investment grade, or
speculative grade, or junk bonds. Rating agencies, however, do not recommend or indicate the
rating levels of instruments up to which one should or should not invest

Continuous Monitoring.
Credit rating agencies keep a constant surveillance during the life of the instrument for any
developments, until it is fully serviced by the company. In the absence of any specific developments,
such reviews are taken up periodically, either quarterly or annually. In addition, a formal and
extensive written review is taken up at least once a year. However there are some specific concerns
about the issuing entity, the review is taken up immediately. The grading is altered on the basis of the
changing debt servicing capability of the issuer.

Grade Surveillance
Where any major deviation from the expected trends of the issuers business occurs, or where any
event has taken place which may have an impact on the debt servicing capability of the issuer,
which could warrant a change in the rating, the rating agency put such ratings under grade
surveillance. This is done till such time the exact impact of the unanticipated developments is
analyzed and a decision is taken regarding the rating change. The grade surveillance listing may also
specify positive or negative outlooks.
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Rating Ceiling
While rating an issue outside the issuer outside the issuers country of domicile, the international
credit rating agencies impose ceiling which is equal to the sovereign rating assigned to the country of
domicile. Accordingly rating of an instrument of any issuer domiciled in that country would be
placed above the sovereign rating of the country of domicile. This concept of sovereign rating
ceiling may not, however be applicable when domicile of the issuer in a country is wholly incidental
to an otherwise internationally dispersed business operation.

Evaluation of Line.
Evaluation of bank line policy is an important component of rating a commercial paper. However, it
is not a part of the rating criteria and the rating decision itself is not predicted on the strength of the
amount of bank lines.

Ownership Consideration.
It is invariably happens that ownership by a strong enterprise enhances the credit rating of an entity,
unless there exists a barrier separating the activities of the patent and subsidiary. The important
issues that are involved in deciding the relationship are mutual dependence, legal relationships, the
entitys ability to influence the business of the other, and the importance of the operation of the
subsidiary to the owner.

CREDIT RATING AGENCY

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A credit ratings agency is a company that assigns credit ratings to institutions that issue debt
obligations (i.e. assets backed by receivables on loans, such as mortgage-backed securities. These
institutions can be companies, cities, non-profit organizations, or national governments, and the
securities they issue can be traded on a secondary market.
A credit rating measures credit worthiness, or the ability to pay back a loan. It affects the interest rate
applied to loans - interest rates vary depending on the risk of the investment. A low-rated security
has a high interest rate, in order to attract buyers to this high-risk investment. Conversely, a highlyrated security (carrying a AAA rating, like a municipal bond which is backed by stable government
agencies) has a lower interest rate, because it is a low-risk investment. These low-risk bonds are
available to a wide range of investors, whereas high-risk bonds cater to a narrow investing
demographic.
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Companies that issue credit scores for individuals are usually called credit bureaus and are distinct
from corporate ratings agencies.
Definition:
"Credit Rating Agency" means any commercial concern engaged in the business of credit rating of
any debt obligation or of any project or programme requiring finance, whether in the form of debt or
otherwise, and includes credit rating of any financial obligation, instrument or security, which has
the purpose of providing a potential investor or any other person any information pertaining to the
relative safety of timely payment of interest or principal; [Section 65 (34)]
GLOBAL CREDIT RATING AGENCIES
John moody, with the publication of the first debt ratings as a a part of his Manual of Railroad
Securities, introduced the rating system in the US bond/securities market in 1909.the ratings were
associated with reports on the financial quality of 250-odd railroad companies operating in the US at
that time. Ratings began to play a more important role in the US capital markets after the Great
Depression, when high levels of default underscored the perception of risk in the fixed income
securities. To help assure the major institutional investors, who were critical to the economy, that
they were not further exposed to high defaults, government regulators stipulated that the big
institutions could not buy securities rated below a certain below a certain level. With the investors
exposing themselves to greater risk, it has become important to use the ratings extensively in bond
purchase and pricing decision. This resulted in a system, which served as a set of self regulatory
functions for the market participants.
In a developed economy, almost all the market participants are familiar with the rating process
and possess the experience to deal with new market developments. The market also helps to support
the value of the rating system to the market participants with factors such as high debt volume
unsupported by the government guarantee, and a liquid secondary market where the rating can be
useful in purchase decisions. The credit rating system is well established in the U.S debt markets.
Euro debt markets and international bank deposit markets are fairly well accepted in countries such
as UK, Canada and Australia, with a number of rating agencies operating in these markets.

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A brief note on the background of the major international rating agencies is as follows
Duff and Phelps Credit Rating Co (DCR)

DCR is a major international source of credit information. It has been in existence for over sixty
years. It rates all major types of fixed-income securities, long term and short term debt of
corporations, sovereign nations and financial institutions. It also rate4s structured financing,
mortgage backed securities and insurance companies. It has established joint ventures, largely in
Latin American countries and since 1992, also in Asian countries such as India and Pakistan.
Japan Credit Rating agency (JCR)

It was established in 1985 and was promoted by financial institutions, banks and insurance
companies in Japan. It provides ratings to foreign and domestic debt issuers.
Thomson BankWatch

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This rating agency is based in Toronto, Canada. It is a subsidiary of the Thomson Corporation. It is a
rating agency exclusively offering grades of rating to financial institutions including banks,
securities firms and finance companies.

Big Three Rating Agencies in U.S are:

Moodys investors service (Moodys)

Standard & Poors corporation (S & P)

Fitch ratings

The Big Three credit rating agencies are Standard & Poor's, Moody's Investor Service, and Fitch
Ratings. Moody's and S&P each control about 40 percent of the market. Third-ranked Fitch
Ratings, which has about a 14 percent market share, sometimes is used as an alternative to one
of the other majors. In the wake of recent credit-market turmoil, some niche agencies are picking
up market share or at least additional visibility. Among the niche agencies are DBRS and EganJones.

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There are 5 credit rating agencies in India. Namely

Credit Rating Information Services of India Limited (CRISIL)

Investment Information and Credit Rating Agency of India (ICRA)
Credit Analysis & Research Limited (CARE)
Duff & Phelps Credit Rating India Private Ltd. (DCR India)
ONICRA Credit Rating Agency of India Ltd.

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CREDIT RATING SYMBOLS

Meaning
Credit Rating Agencies rate an instrument by assigning a definite symbol. Each symbol has a
definite meaning. These symbols have been explained in descending order of safety or in ascending
order of risk of non-payment.
For example, CRISIL has prescribed the following system for debenture issues:

CRISIL

Instruments with this rating are considered to have the

AAA highest degree of safety regarding timely servicing of

(Highest financial obligations. Such instruments carry lowest
Safety) credit risk.
CRISIL AA Instruments with this rating are considered to have high degree
(High Safety) of safety regarding timely servicing of financial obligations.
Such instruments carry very low credit risk.
CRISIL A Instruments with this rating are considered to have adequate
(Adequate degree of safety regarding timely servicing of financial
Safety) obligations. Such instruments carry low credit risk.
CRISIL BBB Instruments with this rating are considered to have moderate
(Moderate degree of safety regarding timely servicing of financial
Safety) obligations. Such instruments carry moderate credit risk.
CRISIL BB Instruments with this rating are considered to have moderate
(Moderate risk of default regarding timely servicing of financial obligations.
Risk)
CRISIL B Instruments with this rating are considered to have high risk of
(High Risk) default regarding timely servicing of financial obligations.
CRISIL C Instruments with this rating are considered to have very high
(Very High risk of default regarding timely servicing of financial obligations.
Risk)
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CRISIL D Instruments with this rating are in default or are expected to be

Default in default soon.
Note: 1) CRISIL may apply '+' (plus) or '-' (minus) signs for ratings from FAA to FC to indicate the
relative position within the rating category.
You will note that as the value of symbol is reduced say from AAA to AA, the safety of timely
payment of interest and principal is decreased. While AAA indicates highest safety of timely
repayment, D indicates actual default or expected default on maturity. Different symbols indicate
different degrees of risk of repayment of principal and interest.

CRISIL Rating Symbols for Fixed Deposits

FAAA

This rating indicates that the degree of safety

("F Triple A") Highest regarding timely payment of interest and

Safety principal is very strong.
FAA

This rating indicates that the degree of safety regarding

("F Double A") High timely payment of interest and principal is strong.
Safety However, the relative degree of safety is not as high as
for fixed deposits with 'FAAA' ratings.
FA

This rating indicates that the degree of safety regarding

Adequate Safety timely payment of interest and principal is satisfactory.

Changes in circumstances can affect such issues more
than those in the higher rated categories.
FB

This rating indicates inadequate safety of timely

Inadequate Safety payment of interest and principal. Such issues are less
susceptible to default than fixed deposits rated below
this category, but the uncertainties that the issuer
faces could lead to inadequate capacity to make timely
interest and principal payments.

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FC

This rating indicates that the degree of safety regarding

High Risk timely payment of interest and principal is doubtful.

Such issues have factors at present that make them
vulnerable to default; adverse business or economic
conditions would lead to lack of ability or willingness to
pay interest or principal.
FD

This rating indicates that the fixed deposits are either in

Default default or are expected to be in default upon maturity.

NM

Instruments rated 'NM' have factors present in them,

Not Meaningful which render the outstanding rating meaningless.

These include reorganization or liquidation of the
issuer, the obligation being under dispute in a court of
law or before a statutory authority etc.

Note: 1) CRISIL may apply '+' (plus) or '-' (minus) signs for ratings from FAA to FC to indicate the
relative position within the rating category.

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CORPORATE CREDIT RATING

The credit rating of a corporation is a financial indicator to potential investors of debt securities
such as bonds. Credit rating is usually of a financial instrument such as a bond, rather than the
21

whole corporation. These are assigned by credit rating agencies such as A. M. Best, Dun &
Bradstreet, Standard & Poor's, Moody's or Fitch Ratings and have letter designations such as
A, B, C.
The Standard & Poor's rating scale is as follows, from excellent to poor: AAA, AA+, AA, AA-,
A+, A, A-, BBB+, BBB, BBB-, BB+, BB, BB-, B+, B, B-, CCC+, CCC, CCC-, CC, C, D. Anything
lower than a BBB- rating is considered a speculative or junk bond.
The Moody's rating system is similar in concept but the naming is a little different. It is
as follows, from excellent to poor: Aaa, Aa1, Aa2, Aa3, A1, A2, A3, Baa1, Baa2, Baa3,
Ba1, Ba2, Ba3, B1, B2, B3, Caa1, Caa2, Caa3, Ca, C.

A.M. Best rates from excellent to poor in the following manner: A++, A+, A, A-, B++, B+, B, B-,
C++, C+, C, C-, D, E, F, and S. The CTRISKS rating system is as follows: CT3A, CT2A, CT1A,
CT3B, CT2B, CT1B, CT3C, CT2C and CT1C. All these CTRISKS grades are mapped to one-year
probability of default.

22

A.

IPO GRADING/RATING

When the Securities and Exchange Board of India (SEBI) decided to scrap discretionary allotment
for qualified institutional buyers (QIBs) and switch to the more transparent proportionate allotment
system, it became the first regulator to stand up to the powerful investment banking community
anywhere in the world. Once the decision was taken, it was evident that the exaggerated outrage and
predictions that large institutional investors would shun IPOs were completely baseless.
That decision recognized the specific needs of the Indian capital market and was the result of
pressure from investor groups. The path to mandatory grading of IPOs has been rocky, with
enormous opposition from companies, investment bankers, fund managers, market experts and SEBI
board members. We learn that the final decision came about in the face of strong opposition by
certain board members (apparently not full-time) and that too only, with a twist in the tail, which
dilutes the original proposal. The alleged opposition of the regulators board members raises an
interesting question. All board-level discussions must, indeed, remain confidential in order to ensure
free and frank expression, but what is the fiduciary responsibility of board members of a watchdog
organization, who have no knowledge, training or expertise about capital markets, when they choose
to oppose recommendations of the Primary Market Advisory Committee that are endorsed by the
regulator? It is also important to remember that investor groups have been pressing for IPO grading
for several years; first with the Investor Education and Protection Fund(attached to the ministry of
23

company affairs), which developed cold feet and dropped even its plans for a pilot project and later
with the capital market regulator.
Over the years, those opposed to IPO grading have constructed several elegant arguments to rubbish
its utility, but from an investor standpoint, the logic is simple. The disclosure-based model adopted
by the regulator, leads to a bulky, jargon-filled prospectus that can neither be read nor understood by
the average investor; consequently, a simple, one-page evaluation of disclosures by an expert agency,
which also helpfully condenses its findings into a single numerical grade on a scale of five, is clearly
a blessing. The offer price of the IPO will remain an important factor in the final investment decision
after all, even the best companies can be bad investments at the wrong price. But that is a
reasonable decision to leave to the investor.
Introduction

IPO grading is the grade assigned by a Credit Rating Agency registered with SEBI, to the initial
public offering (IPO) of equity shares or any other security which may be converted into or
exchanged with equity shares at a later date. The grade represents a relative assessment of the
fundamentals of that issue in relation to the other listed equity securities in India. Such grading is
generally assigned on a five-point point scale with a higher score indicating stronger fundamentals
and vice versa as below.
IPO grade1: Poor fundamentals
IPO grade2: Below-average fundamentals
IPO grade3: Average fundamentals
IPO grade4: Above-average fundamentals
IPO grade5: Strong fundamentals

IPO grading has been introduced as an endeavor to make additional information available for the
investors in order to facilitate their assessment of equity issues offered through an IPO.

IPO grading can be done either before filing the draft offer documents with SEBI or thereafter.
However, the Prospectus/Red Herring Prospectus, as the case may be, must contain the grade/s given
to the IPO by all CRAs approached by the company for grading such IPO.

The company desirous of making the IPO is required to bear the expenses incurred for
grading such IPO.

The company desirous of making the IPO is required to bear the expenses incurred for grading
such IPO.

24

IPO grading is not optional. A company which has filed the draft offer document for its IPO with
SEBI, on or after 1st May, 2007, is required to obtain a grade for the IPO from at least one CRA.

IPO grade/s cannot be rejected. Irrespective of whether the issuer finds the grade given by the
rating agency acceptable or not, the grade has to be disclosed as required under the DIP Guidelines.
However the issuer has the option of opting for another grading by a different agency. In such an
event all grades obtained for the IPO will have to be disclosed in the offer documents,
advertisements

IPO grading is intended to run parallel to the filing of offer document with SEBI and the
consequent issuance of observations. Since issuance of observation by SEBI and the grading
process, function independently, IPO grading is not expected to delay the issue process.

The IPO grading process is expected to take into account the prospects of the industry in which
the company operates, the competitive strengths of the company that would allow it to address the
risks inherent in the business(es) and capitalize on the opportunities available, as well as the
companys financial position.

While the actual factors considered for grading may not be identical or limited to the following,
the areas listed below are generally looked into by the rating agencies, while arriving at an IPO grade

Business Prospects and Competitive Position

Industry Prospects etc.
Company Prospects
Financial Position
Management Quality
Corporate Governance Practices
Compliance and Litigation History
New ProjectsRisks and Prospects

It may be noted that the above is only indicative of some of the factors considered in the IPO

i.
ii.

grading process and may vary on a case to case basis.

IPO grading is done without taking into account the price at which the security is offered in the
IPO. Since IPO grading does not consider the issue price, the investor needs to make an independent

judgment regarding the price at which to bid for/subscribe to the shares offered through the IPO.
IPO Grading is intended to provide the investor with an informed and
objective opinion expressed by a professional rating agency after analyzing
factors like business and financial prospects, management quality and
25

corporate governance practices etc. However, irrespective of the grade

obtained by the issuer, the investor needs to make his/her own independent
decision regarding investing in any issue after studying the contents of the
prospectus including risk factors carefully.

As on date the following four credit rating agencies are registered with SEBI.
a) Credit Analysis & Research Ltd (CARE)
b) ICRA Limited
c) CRISIL
d) FITCH Ratings

SOVEREIGN CREDIT RATINGS

A sovereign credit rating is the credit rating of a sovereign entity, i.e., a national government. The
sovereign credit rating indicates the risk level of the investing environment of a country and is used
by investors looking to invest abroad. It takes political risk into account
The table shows the ten least-risky countries for investment as of June 2012. Ratings are further
broken down into components including political risk, economic risk. Euro moneys bi-annual
country risk index monitors the political and economic stability of 185 sovereign countries. Results
focus foremost on economics, specifically sovereign default risk and/or payment default risk for
exporters (a.k.a. "trade credit" risk).
26

A. M. Best defines "country risk" as the risk that country-specific factors could adversely affect an
insurer's ability to meet its financial obligations.

COUNTRY RISK RANKINGS (JUNE 2012)

Least risky countries, Score out of 100

Rank

Previo
us

Country

Overall
score

Norway

90.37

Switzerland

88.83

Singapore

88.03

Luxembourg

87.90

Sweden

86.79

Finland

84.30

Canada

84.26

Denmark

83.52

Netherlands

83.07

10

Germany

82.24

WORLD COUNTRIES STANDARD & POOR'S RATINGS

27

S&P'S RATINGS OF EUROPEAN COUNTRIES (MAY 2012)

28

AAA
AA
A
BBB
BB
B
CCC
CC
C
Default
no rating
29

INDIVIDUAL CREDIT RATING IN INDIA

Primer for Individuals
When it comes to risk management in Banks, the risk that takes the priority is "the credit risk".
The credit risk by definition means, risk of loans disbursed to various corporate and retail clients
will be paid back or not. For layman's understanding, a bank broadly has two main functions viz.
Assets and Liabilities. The main job of the liabilities side of a bank is to channelize savings in the
economy, designs various instruments, by which; money can be collected from the economy. This
could be in the form of saving bank accounts, current accounts, FDs etc. The money so collected,
is a liability on the bank as it has to repay the same to its customers with certain prevailing rate of
interest and hence the function is called Liability. Once money is collected from various sources,
the same has to be deployed at a profitable rate of return. The deployment could be in the form of
corporate lending, investing in projects or simply retail lending in the form of Personal Loans,
Vehicle loans, home loans, SME lending etc.
The basic principle of managing Credit Risk is diversification of portfolio. This means, that
lending to corporate borrowers is diversified in terms of different industries and within an
industry to different corporate. Lending is based on as per the underwriting standards of the bank
e.g. the repute of the company, past financials of the company including profitability over last
several years, shareholding pattern, qualitative study of management, project feasibility of the
project to be funded, future cash lows etc. Although all banks into corporate lending develop their
own individual underwriting policies, they also depend on the credit rating of a corporate by
accredited Credit Rating Agencies like CRISIL, ICRA and CARE. Even the Basel Committee on
Banking Regulation has accentuated on the importance of use of external credit ratings.
The retail segment in India, however, has been devoid of external agencies, which are into credit
rating of individuals i.e. retail customers. The lending to retail customers is done basis purely on
the lending policy of the bank, which vary from bank to bank, depending on the banks risk
appetite. In the United States, there are government funded repositories like Equifax, Trans-world,
Trans Union, Dun &Bradstreet etc, which act as credit rating agencies for retail borrowers. They
provide member banks/NBFCs with credit history of an individual in terms of loans that he has
paid in the past, loans that he is currently running, Credit Cards that he has held or currently
active with repayment history of the same. There are other vital information that the agency report
provide viz., if the borrower has ever filed for bankruptcy or if there is any litigation, court case
etc. pending against him. Based on the overall credit history of the customer, he/she is given a
30

credit rating, more popularly called, FICO score. This may vary from agency to agency but the
variation may not be more than 10%.However, the US system of credit rating individual could not
be replicated in India because of some practical difficulties. The most important being, absence of
a mechanism for identifying an individual. In the United States, each individual is issued a Social
Security Number or the SSN, when he/she is born. This SSN is a unique number and all
information related an individual, including social history, financial history, criminal history etc is
linked to ones SSN and therefore, collecting information about individual becomes much easier.
This is further facilitated by the presence of a system, which ensures that the information flows
freely between well coordinated government and public departments. Hence, information related
to individual can be stored at a common place and retrieved when required. Also, there are proper
laws in place, which requires all the public/private entities like banks, NBFCs etc. to share their
customer related data with the credit rating agencies. In India, the scenario has been different. The
is no concept of Social Security Number to identify an individual. The only way to identify a
customer is through name, address, Date of Birth (DoB) etc. However, with no sanctity of DoB
proofs or address proofs, it is very easy to fool the system. Till sometime bank, the only way for a
bank to know the credit history of a prospective customer was through its collection or field
verification agencies, which may or may not had information about the customer. Besides, banks
also did not pay any strict attention to the data sanctity of the customer at their end. This is,
particularly true to banks issuing Credit Cards.
With rising competition in the retail sector, there was a sharp rise in delinquency level of banks.
The need for Credit Rating Agency which could work like a repository for credit information of
individual was widely felt. As a first attempt in this direction, The Credit Information Bureau of
India Ltd or the CIBIL was incorporated in 2000. CIBIL was an effort of The Government of
India and the Reserve Bank of India. The first promoters and the member banks were the State
Bank of India (SBI) and HDFC. Necessary logistics and technology was provided by
internationally reputed credit rating agencies like Dun & Bradstreet and Trans-union. However,
the attempt was not efficacious initially, since most banks were reluctant about sharing their
customer data with other banks. This was further aggravated by the fact that the banks were not
under any legal obligation to share their data. However, with RBI's efforts, more and more banks
and NBFCs have joined hand in providing customer data to CIBIL and in return get data on the
customers on payment of some fees from CIBIL. This initiative called CIBIL has really been
helpful in curbing delinquency and banks have starting weaving their credit lending policy around
CIBIL.
31

The quality of CIBIL reports have further been helped by certain government measures like
introduction of PAN numbers and making the same mandatory for availing most banking services.
The PAN number may be considered as a very crude form of a Social Security Number, since
only taxpaying individuals apply for it i.e. people not falling in tax bracket or not wanting to pay
tax, may or may not have PAN no. But with regulators like RBI, Tax Departments etc making
PAN no. mandatory for availing banking and investment services, more and more percentage of
population (at least those wanting to avail credit) are now having a valid PAN no., which to a
large extent has done the same job what SSN does in the United States. Any technological
advancement in future, which may lead to better networking between banks, government agencies
like judiciary, RBI and CIBIL will only further improve the quality of CIBIL reporting. As of
now, CIBIL has not introduced any system of assigning any Credit Rating to individuals like the
FICO scoring as mentioned above. But this may be just round the corner. Also, a competition in
the credit rating field i.e. more set ups like CIBIL will not only see a further improvement in
quality in terms of services being provided to the banks and NBFCs but will also see cost
rationalization. Prior to CIBIL and along with CIBIL, there was information available in the
market but it was more scattered and specific. For example, Satyam Database, more popularly
known as MCNF database (Master Card Negative Feedback), is available in the market. The
MCNF database is the data of database of all delinquent customers who have defaulted in their
Master Card Credit Card. The customer could belong to any bank which issues Master Card
Credit Card. Besides this, most of the verification agencies in any particular area, are a rich source
of credit information, specially derogatory. Since most of these verification agencies are also
invariably collection agencies for multiple banks, they have their own database for derogatory
customers. There is a basic limitation to both MCNF database and data available with verification
agencies. One the data is very limited and does not cover sizable proportion of the credit seeking
population. MCNF covers only Master Card Credit Card while verification agencies have data of
their client banks only. Most of these verification agencies have their area of operation limited to
only one city or couple of cities in the same state but not beyond that. Second, the MCNF and
Verification Agencies have only derogatory data. So, if a match is found, then, the customer is a
bad credit or risky to lend, but if there is no match, it will not be prudent to assume that the
customer is a good credit or not risky to lend. CIBIL is however, a balanced approach, as it
contains all the credit history available for the customer, both good and bad.

32

How Does It Impacts Individuals

With set ups like CIBIL, there is a free flow of credit information between banks. All members
have access to the CIBIL database. Hence, it is becoming, increasingly difficult for chronic
defaulters to obtain credit from the banks. As mentioned before, most bank are weaving their
credit policy around CIBIL, MCNF and Verification Agency records, it is very important for
individuals to be aware and sensitive to their credit history.
It is a common observation with the people of younger age group, that, they carry multiple credit
cards, more as a matter of style statement, than, having an actual requirement of the same. This is
coupled with over spending and in their juvenile spirit, not paying. What they do not realize is
that this derogatory information is actually being stored against their name, add or PAN no.
somewhere, and when, later in their life, they are in actual need for credit, they do not get it. The
above given example is of a willful customer, but there are also common instances service related
issues with the banks, specially, credit card issuing banks e.g. annual fee levied when free credit
card promised or insurance premium charged without customer's knowledge. Instances could be
numerous, but unfortunately, itis the individual, who is impacted negatively in such a situation.
Often, after charging multiple late fees, interests etc, the default amount reported to CIBIL or
Satyam database, is quite high. Lending institution, prima facie, do not investigate in the
derogatory information and decline a loan or a credit card application upfront. Since, all banks are
free to make their own credit policy, a bank with low risk appetite and hence strict credit policy is
not likely to reconsider credit application, even if, in reality, it was not customer's fault.
What to Do / What Not to Do
The importance of a clean credit history is understood when emergency credit is required, for
example, a personal loan in order to meet immediate medical expenses or a home loan and the
same is denied because one did not bother to repay his credit card debts or his auto loan EMI or
resolve the dispute with a financier in the past. Since, most of us, especially in the middle class,
salaried or businessmen, will require a credit at some point of time either for a personal need,
building a house or for business purpose or a credit card, there are a few precautions that an
individual must take in his financial dealings. One must be very diligent and disciplined in
repaying his debts, EMIs, Credit Card payments etc. In rarity, if there is a delay in payment, one
should make sure, that, the payment with late payment charges if any, should not cross 30 days
past due. If late payment charges or any other charges are waived off by the bank specifically in
written, then only, such charges are not to be paid. If there is a dispute in payment, especially in
33

credit card related payments, one should make sure that the dispute is resolved and he has a
written record of the same in his possession. Some people think that settling an account for
something less than what is actual due is an easy way out. The settlement will only give them a
settlement letter, which is an indicator that they did not pay the full amount. Neither is their name
or record taken off from the derogatory history of the bank and hence CIBIL/Satyam records. In
case, the bank is at a fault, which it agrees on also, it is very important to acquire an apology letter
from the bank, clearly stating the issue and bank's apology on the same.
Most of us, keep getting calls from various Credit Card issuing bank's DSA (Direct Selling
Associates), which would make loads of promises and would request us to at least keep the card
for a year and then destroy the same after informing the bank of your intention of not using the
same. Such offers should be avoided, if one is NOT in need of that credit card. Since, one does
not need that card; it will be lying dormant in his pocket for a year. He would even forget the date
as to when the card is to be blocked. Since the card is free for only the first year, next year
beginning, he would receive a statement with annual fees levied. He will dispute it, not pay it. The
bank will keep following up and levying late payment and other incidentals charges, and report it
as a derogatory card to the CIBIL. The bank cannot blamed for the same, since, as per its terms
and conditions, the card was free for first year only and the customer did not bother to cancel it at
the end of the year. So, why, unnecessarily, call for a problem, when it can be easily avoided by
politely declining to accept for the card in the first place. The principle is simple. Do NOT avail a
credit if you DON'T need it.

SHORT-TERM RATING
A short-term rating is a probability factor of an individual going into default within a year. This is in
contrast to long-term rating which is evaluated over a long timeframe. In the past institutional
investors preferred to consider long-term ratings. Nowadays, short-term ratings are commonly used.
First, the Basel II agreement requires banks to report their one-year probability if they applied
internal-ratings-based approach for capital requirements. Second, many institutional investors can
easily manage their credit/bond portfolios with derivatives on monthly or quarterly basis. Therefore,
some rating agencies simply report short-term ratings.

34

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

Ratings use by bond issuers

Issuers rely on credit ratings as an independent verification of their own credit-worthiness and the
resultant value of the instruments they issue. In most cases, a significant bond issuance must have at
least one rating from a respected CRA for the issuance to be successful (without such a rating, the
issuance may be undersubscribed or the price offered by investors too low for the issuer's purposes).
Studies by the Bond Market Association note that many institutional investors now prefer that a debt
issuance have at least three ratings.
Issuers also use credit ratings in certain structured finance transactions. For example, a company
with a very high credit rating wishing to undertake a particularly risky research project could create a
legally separate entity with certain assets that would own and conduct the research work. This
"special purpose entity" would then assume all of the research risk and issue its own debt securities
to finance the research. The SPE's credit rating likely would be very low, and the issuer would have
to pay a high rate of return on the bonds issued.
However, this risk would not lower the parent company's overall credit rating because the SPE
would be a legally separate entity. Conversely, a company with a low credit rating might be able to
borrow on better terms if it were to form an SPE and transfer significant assets to that subsidiary and
issue secured debt securities. That way, if the venture were to fail, the lenders would have recourse
to the assets owned by the SPE. This would lower the interest rate the SPE would need to pay as part
of the debt offering.
The same issuer also may have different credit ratings for different bonds. This difference results
from the bond's structure, how it is secured, and the degree to which the bond is subordinated to
other debt. Many larger CRAs offer "credit rating advisory services" that essentially advise an issuer
on how to structure its bond offerings and SPEs so as to achieve a given credit rating for a certain
35

debt tranche. This creates a potential conflict of interest; of course, as the CRA may feel obligated to
provide the issuer with that given rating if the issuer followed its advice on structuring the offering.
Some CRAs avoid this conflict by refusing to rate debt offerings for which its advisory services were
sought.

Ratings use by government regulators

Regulators use credit ratings as well, or permit ratings to be used for regulatory purposes. For
example, under the Basel II agreement of the Basel Committee on Banking Supervision, banking
regulators can allow banks to use credit ratings from certain approved CRAs (called "ECAIs", or
"External Credit Assessment Institutions") when calculating their net capital reserve requirements. In
the United States, the Securities and Exchange Commission (SEC) permits investment banks and
broker-dealers to use credit ratings from "Nationally Recognized Statistical Rating Organizations"
(NRSRO) for similar purposes. The idea is that banks and other financial institutions should not need
keep in reserve the same amount of capital to protect the institution against (for example) a run on
the bank, if the financial institution is heavily invested in highly liquid and very "safe" securities
(such as U.S. government bonds or short-term commercial paper from very stable companies).
CRA ratings are also used for other regulatory purposes as well. The US SEC, for example, permits
certain bond issuers to use a shortened prospectus form when issuing bonds if the issuer is older, has
issued bonds before, and has a credit rating above a certain level. SEC regulations also require that
money market funds (mutual funds that mimic the safety and liquidity of a bank savings deposit, but
without Federal Deposit Insurance Corporation insurance) comprise only securities with a very high
NRSRO rating. Likewise, insurance regulators use credit ratings to ascertain the strength of the
reserves held by insurance companies.
In 2008, the US SEC voted unanimously to propose amendments to its rules[2] that would remove
credit ratings as one of the conditions for companies seeking to use short-form registration when
registering securities for public sale.
This marks the first in a series of upcoming SEC proposals in accordance with Dodd-Frank to
remove references to credit ratings contained within existing Commission rules and replace them
with alternative criteria.

36

Under both Basel II and SEC regulations, not just any CRA's ratings can be used for regulatory
purposes. (If this were the case, it would present a moral hazard). Rather, there is a vetting process of
varying sorts. The Basel II guidelines for example, describe certain criteria that bank regulators
should look to when permitting the ratings from a particular CRA to be used. These include
"objectivity," "independence," "transparency," and others. Banking regulators from a number of
jurisdictions have since issued their own discussion papers on this subject, to further define how
these terms will be used in practice. (See The Committee of European Banking Supervisors
Discussion Paper, or the State Bank of Pakistan ECAI Criteria).
In the United States, since 1975, NRSRO recognition has been granted through a "No Action Letter"
sent by the SEC staff. Following this approach, if a CRA (or investment bank or broker-dealer) were
interested in using the ratings from a particular CRA for regulatory purposes, the SEC staff would
research the market to determine whether ratings from that particular CRA are widely used and
considered "reliable and credible." If the SEC staff determines that this is the case, it sends a letter to
the CRA indicating that if a regulated entity were to rely on the CRA's ratings, the SEC staff will not
recommend enforcement action against that entity. These "No Action" letters are made public and
can be relied upon by other regulated entities, not just the entity making the original request. The
SEC has since sought to further define the criteria it uses when making this assessment, and in
March 2005 published a proposed regulation to this effect.
On September 29, 2006, US President George W. Bush signed into law the Credit Rating Reform
Act of 2006.This law requires the US Securities and Exchange Commission to clarify how NRSRO
recognition is granted, eliminates the "No Action Letter" approach and makes NRSRO recognition a
Commission (rather than SEC staff) decision, and requires NRSROs to register with, and be
regulated by, the SEC. S & P protested the Act on the grounds that it is an unconstitutional violation
of freedom of speech. In the Summer of 2007 the SEC issued regulations implementing the act,
requiring rating agencies to have policies to prevent misuse of nonpublic information, disclosure of
conflicts of interest and prohibitions against "unfair practices".
Recognizing CRAs' role in capital formation, some governments have attempted to jump-start their
domestic rating-agency businesses with various kinds of regulatory relief or encouragement. This
may, however, be counterproductive, if it dulls the market mechanism by which agencies compete,
subsidizing less-capable agencies and penalizing agencies that devote resources to higher-quality
opinions.

37

Ratings use in structured finance

Credit rating agencies may also play a key role in structured financial transactions. Unlike a
"typical" loan or bond issuance, where a borrower offers to pay a certain return on a loan, structured
financial transactions may be viewed as either a series of loans with different characteristics, or else
a number of small loans of a similar type packaged together into a series of "buckets" (with the
"buckets" or different loans called "tranches"). Credit ratings often determine the interest rate or
price ascribed to a particular tranche, based on the quality of loans or quality of assets contained
within that grouping.
Companies involved in structured financing arrangements often consult with credit rating agencies to
help them determine how to structure the individual tranches so that each receives a desired credit
rating. For example, a firm may wish to borrow a large sum of money by issuing debt securities.
However, the amount is so large that the return investors may demand on a single issuance would be
prohibitive. Instead, it decides to issue three separate bonds, with three separate credit ratingsA
(medium low risk), BBB (medium risk), and BB (speculative) (using Standard & Poor's rating
system).
The firm expects that the effective interest rate it pays on the A-rated bonds will be much less than
the rate it must pay on the BB-rated bonds, but that, overall, the amount it must pay for the total
capital it raises will be less than it would pay if the entire amount were raised from a single bond
offering. As this transaction is devised, the firm may consult with a credit rating agency to see how it
must structure each tranchein other words, what types of assets must be used to secure the debt in
each tranchein order for that tranche to receive the desired rating when it is issued.
There has been criticism in the wake of large losses in the collateralized debt obligation (CDO)
market that occurred despite being assigned top ratings by the CRAs. For instance, losses on $340.7
million worth of CDOs issued by Credit Suisse Group added up to about $125 million, despite being
rated AAA or Aaa by Standard & Poor's, Moody's Investors Service and Fitch Group.
The rating agencies respond that their advice constitutes only a "point in time" analysis, that they
make clear that they never promise or guarantee a certain rating to a tranche, and that they also make
clear that any change in circumstance regarding the risk factors of a particular tranche will invalidate
their analysis and result in a different credit rating. In addition, some CRAs do not rate bond
issuances upon which they have offered such advice.

38

Complicating matters, particularly where structured finance transactions are concerned, the rating
agencies state that their ratings are opinions (and as such, are protected free speech, granted to them
by the "personhood" of corporations) regarding the likelihood that a given debt security will fail to
be serviced over a given period of time, and not an opinion on the volatility of that security and
certainly not the wisdom of investing in that security. In the past, most highly rated (AAA or Aaa)
debt securities were characterized by low volatility and high liquidityin other words, the price of a
highly rated bond did not fluctuate greatly day-to-day, and sellers of such securities could easily find
buyers.
However, structured transactions that involve the bundling of hundreds or thousands of similar (and
similarly rated) securities tend to concentrate similar risk in such a way that even a slight change on
a chance of default can have an enormous effect on the price of the bundled security. This means that
even though a rating agency could be correct in its opinion that the chance of default of a structured
product is very low, even a slight change in the market's perception of the risk of that product can
have a disproportionate effect on the product's market price, with the result that an ostensibly AAA
or Aaa-rated security can collapse in price even without there being any default (or significant
chance of default). This possibility raises significant regulatory issues because the use of ratings in
securities and banking regulation (as noted above) assumes that high ratings correspond with low
volatility and high liquidity.

Credit rating agencies do not downgrade companies promptly enough. For example, Enron's rating
remained at investment grade four days before the company went bankrupt, despite the fact that credit
rating agencies had been aware of the company's problems for months. Some empirical studies have
documented that yield spreads of corporate bonds start to expand as credit quality deteriorates but
before a rating downgrade, implying that the market often leads a downgrade and questioning the
informational value of credit ratings. This has led to suggestions that, rather than rely on CRA ratings in
financial regulation, financial regulators should instead require banks, broker-dealers and insurance
firms (among others) to use credit spreads when calculating the risk in their portfolio.

Large corporate rating agencies have been criticized for having too familiar a relationship with
company management, possibly opening themselves to undue influence or the vulnerability of being
misled. These agencies meet frequently in person with the management of many companies, and advise
on actions the company should take to maintain a certain rating .Furthermore, because information
about ratings changes from the larger CRAs can spread so quickly (by word of mouth, email, etc.), the
39

larger CRAs charge debt issuers, rather than investors, for their ratings. This has led to accusations that
these CRAs are plagued by conflicts of interest that might inhibit them from providing accurate and
honest ratings. At the same time, more generally, the largest agencies (Moody's and Standard &
Poor's)are often seen as agents of globalization and/or "Anglo-American" market forces, that drive
companies to consider how a proposed activity might affect their credit rating, possibly at the expense
of employees, the environment, or long-term research and development. These accusations are not
entirely consistent: on one hand, the larger CRAs are accused of being too cozy with the companies
they rate, and on the other hand they are accused of being too focused on a company's bottom line"
and unwilling to listen to a company's explanations for its actions.

The lowering of a credit score by a CRA can create a vicious cycle, as not only interest rates for that
company would go up, but other contracts with financial institutions may be affected adversely, causing
an increase in expenses and ensuing decrease in credit worthiness. In some cases, large loans to
companies contain a clause that makes the loan due in full if the companies credit rating is lowered
beyond a certain point (usually a speculative" or junk bond" rating). The purpose of these "ratings
triggers is to ensure that the bank is able to lay claim to a weak company's assets before the company
declares bankruptcy and a receiver is appointed to divide up the claims against the company. The effect
of such ratings triggers, however, can be devastating: under a worst-case scenario, once the company's
debt is downgraded by a CRA, the company's loans become due in full; since the troubled company
likely is incapable of paying all of these loans in full at once, it is forced into bankruptcy (a so-called
"death spiral").These rating triggers were instrumental in the collapse of Enron. Since that time, major
agencies have put extra effort into detecting these triggers and discouraging their use, and the U.S.
Securities and Exchange Commission requires that public companies in the United States disclose their
existence.

Agencies are sometimes accused of being oligopolists because barriers to market entry are high and
rating agency business is itself reputation-based (and the finance industry pays little attention to a rating
that is not widely recognized). Of the large agencies, only Moody's is a separate, publicly held
corporation that discloses its financial results without dilution by non-ratings businesses, and its high
profit margins (which at times have been greater than 50 percent of gross margin) can be construed as
consistent with the type of returns one might expect in an industry which has high barriers to entry.

Credit Rating Agencies have made errors of judgment in rating structured products, particularly in
assigning AAA ratings to structured debt, which in a large number of cases has subsequently been
downgraded or defaulted. The actual method by which Moody's rates CDOs has also come under
40

scrutiny. If default models are biased to include arbitrary default data and "Ratings Factors are biased
low compared to the true level of expected defaults, the Moodys [method] will not generate an
appropriate level of average defaults in its default distribution process. As a result, the perceived default
probability of rated tranches from a high yield CDO will be in correctly biased downward, providing a
false sense of confidence to rating agencies and investors." Little has been done by rating agencies to
address these shortcomings indicating a lack of incentive for quality ratings of credit in the modern
CRA industry. This has led to problems for several banks whose capital requirements depend on the
rating of the structured assets they hold, as well as large losses in the banking industry. AAA rated
mortgage securities trading at only 80 cents on the dollar, implying a greater than 20% chance of
default, and 8.9% of AAA rated structured CDOs are being considered for downgrade by Fitch, which
expects most to downgrade to an average of BBB to BB-. These levels of reassessment are surprising
for AAA rated bonds, which have the same rating class as US government bonds. Most rating agencies
do not draw a distinction between AAA on structured finance and AAA on corporate or government
bonds (though their ratings releases typically describe the type of security being rated). Many banks,
such as AIG, made the mistake of not holding enough capital in reserve in the event of downgrades to
their CDO portfolio. The structure of the Basel II agreements meant that CDOs capital requirement rose
'exponentially'. This made CDO portfolios vulnerable to multiple downgrades, essentially precipitating
a large margin call. For example under Basel II, a AAA rated securitization requires capital allocation
of only 0.6%, a BBB requires 4.8%, a BB requires 34%, whilst a BB (-) securitization requires a 52%
allocation. For a number of reasons(frequently having to do with inadequate staff expertise and the
costs that risk management programs entail), many institutional investors relied solely on the ratings
agencies rather than conducting their own analysis of the risks these instruments posed. (As an example
of the complexity involved in analyzing some CDOs, the Aquarius CDO structure has 51 issues behind
the cash CDO component of the structure and another 129 issues that serve as reference entities for
$1.4 billion in CDS contracts for a total of 180. In a sample of just 40 of these, they had on average
6500 loans at origination. Projecting that number to all 180 issues implies that the Aquarius CDO has
exposure to about 1.2 million loans.)

Ratings agencies, in particular Fitch, Moody's and Standard and Poors have been implicitly allowed
by the government to fill a quasi-regulatory role, but because they are for-profit entities their incentives
may be misaligned. Conflicts of interest often arise because the rating agencies are paid by the
companies issuing the securities an arrangement that has come under fire as a disincentive for the
agencies to be vigilant on behalf of investors. Many market participants no longer rely on the credit
agencies ratings systems, even before the economic crisis of 2007-8, preferring instead to use credit
41

spreads to benchmarks like Treasuries or an index. However, since the Federal Reserve requires that
structured financial entities be rated by at least two of the three credit agencies, they have a continued
obligation.

Many of the structured financial products that were responsible for rating, consisted of lower
quality 'BBB' rated loans, but were, when pooled together into CDOs, assigned an AAA rating. The
strength of the CDO was not wholly dependent on the strength of the underlying loans, but in fact
the structure assigned to the CDO in question. CDOs are usually paid out in a waterfall' style
fashion, where income received gets paid out first to the highest tranches, with the remaining income
flowing down to the lower quality tranches i.e. <AAA. CDOs were typically structured such that
AAA tranches which were to receive first lien (claim) on the BBB rated loans cash flows, and losses
would trickle up from the lowest quality tranches first. Cash flow was well insulated even against
heavy levels of home owner defaults. Credit rating agencies only accounted for a ~5% decline in
national housing prices at worst, allowing for a confidence in rating the many of these CDOs that
had poor underlying loan qualities as AAA. It did not help that an incestuous relationship between
financial institutions and the credit agencies developed such that, banks began to leverage the credit
ratings off one another and 'shop' around amongst the three big credit agencies until they found the
best ratings for their CDOs. Often they would add and remove loans of various quality until they met
the minimum standards for a desired rating, usually, AAA rating. Often the fees on such ratings
were$300,000 - $500,000, but ran up to $1 million.

As part of the Sarbanes-Oxley Act of 2002, Congress ordered the U.S. SEC to develop a report,
titled Report on the Role and Function of Credit Rating Agencies in the Operation of the Securities
Markets detailing how credit ratings are used in U.S. regulation and the policy issues this use raises.
Partly as a result of this report, in June 2003, the SEC published a "concept release" called Rating
Agencies and the Use of Credit Ratings under the Federal Securities Laws hat sought public
comment on many of the issues raised in its report. Public comments on this concept release have
also been published on the SEC's website. In December 2004, the International Organization of
Securities Commissions (IOSCO) published a Code of Conduct for CRAs that, among other things,
is designed to address the types of conflicts of interest that CRAs face. All of the major CRAs have
agreed to sign on to this Code of Conduct and it has been praised by regulators ranging from the
European Commission to the U.S. Securities and Exchange Commission.

42

FUTURE OF CREDIT RATING IN INDIA

At present, commercial paper, k bonds and debentures with maturities exceeding18 months & fixed
deposits of large non-banking companies registered with RBI are required to be compulsorily rated.
These are moves to make rating compulsorily for other types of borrowings such as fixed deposit
programme of manufacturing companies. In addition, the rating agencies are expected to be called
upon to enlarge volumes of securitization of debt & structuring of customized instruments to meet
the needs of issuers or different class of investors. There are number of areas where rating agencies
will have to cover new grounds in the coming years. The rating of municipal bonds, state govt.
borrowings, commercial banks & public sector

BENEFITS OF CREDIT RATING

Low Cost Information

Quick Investment Decision
Independent Investment Decision
Investment Protection
Spending too much on credit risk research diminishes the return on investment. In addition, unlike
underwriters and main banks, credit rating agencies are valued for their neutral viewpoint and
expertise in credit risk analysis. For these reasons, investors rely heavily on credit rating data.

Benefits to Rated Companies

Sources of additional certification

Attracting higher number of investors
Forewarns risk
Encourages financial discipline amongst the corporate and better financial planning
Merchant bankers job made easy
Foreign collaboration made easy
Low cost of borrowing
Rating as a marketing tool
Competitive rates of interest
Added investors confidence
Ability to raise money from foreign markets at cheaper rates
Helps to build reputation in the market.
43

Benefits for the investors

Saves the time and energy in studying companys financials,

Strong indicator of companys financial capacity,
Ratings represent the informed opinion of a neutral third party.
Identification of the risk involved in the debt instrument.
Guidance in making an investment decision by being presented with a wide variety of safe

choices.
Constant monitoring and surveillance by the agency on the debt instrument leading to effective

risk management strategies.

Periodical evaluation of companys financial capacity by rating agency helps the investor to exit
the investment, in case rating is downgraded subsequently.

Benefits for the issuer

Expanded access to capital markets.

Lower financing cost.
Recognition to a first time and unknown issuer in order to establish his market credibility.
Enhancement of goodwill.
Motivation for better performance.
Economic Benefits of Credit Reporting and Scoring
Credit scoring offers multiple benefits at every level of the economy. Credit scores have enabled
lenders to extend into historically underserved market segments. In addition, decisions are now
faster and more objective with the majority of applicants receiving answers within minutes, rather
than days. Finally, by using credit scores to predict risk more effectively, lenders have been able to
reduce the cost of such vital services as mortgages, personal loans and credit cards. Despite this
expansion into traditionally underserved markets, moral hazard rates are actually lower with credit
scores because lenders can more proactively monitor risk and maintain it at more appropriate levels.
Credit scoring plays a vital role in economic growth by helping expand access to credit markets,
lowering the price of credit and reducing delinquencies and defaults. In the United States, credit
scoring helps drive the American economy and makes credit affordable. For consumers, scoring is
the key to homeownership and consumer credit. It increases competition among lenders, which
drives down prices. Decisions can be made faster and cheaper and more consumers can be approved.
44

It helps spread risk more fairly so vital resources, such as insurance and mortgages, are priced more
fairly. For businesses, especially small and medium-sized enterprises, credit scoring increases access
to financial resources, reduce costs and helps manage risk. For the national economy, credit scoring
helps smooth consumption during cyclical periods of unemployment and reduces the swings of the
business cycle. By enabling loans and credit products to be bundled according to risk and sold as
securitized derivatives, credit scoring connects consumers to secondary capital markets and increases
the amount of capital that is available to be extended or invested in economic growth.

NEED AND IMPORTANCE OF CREDIT RATING

A wide range of industries take advantage of credit scores to improve fairness, effectiveness and
efficiency. Financial companies use credit scores to predict the risk of delinquencies and losses,
which enables them to better allocate costs. Insurance companies use specialized credit scores to
make fairer underwriting decisions. Credit scores even provide benefits at the macroeconomic level
by helping small enterprises attain the funds they need and by facilitating the securitization and sale

45

of financial products in the secondary markets, substantially increasing the influx of capital into a
country.

Importance of credit score

Credit rating is an indicator that reflects how well or badly you manage your financial matters. By
having a look at your credit rating, one can get much information regarding your business
organization and particularly the payments made by your organization. There are several credit
bureaus that compile this kind of information and later on sale it to their clients. It's very important
to know your credit score and understand it completely, as it helps you to get loans, mortgage and
even a job. Credit report list personal information such as name, address, date of birth, social
security number, number of family member, your employer etc. Financial situations like
bankruptcies, tax liens, foreclosure, late payment of your bill etc, will also be listed in the report.
Your credit score list plenty of information about your financial actions. Your loan or credit account,
and how you pay them, your current debts, type of debts...etc. All these information are listed in the
report. The creditors, lending agencies and other companies will consider your credit score to
determine if they can finance you without a risk. Any doubtful record creates a negative impact and
can affect you in many ways. It's not only in case of sanctioning a loan but also determine the rate of
interest. Lower the score, higher will be the interest. According to the data of Jean Chatzky (the
financial editor for NBC's The Today Show), in May 2006, to qualify for the best rates on a
mortgage loan, home buyer needed a credit score of 620 or higher. Just 2 year later in May 2008, you
would have asked for a credit score of 750 to qualify for those same rates. So it's important to review
your report once in a year, so that you are aware of your report and know what the creditors say
about you and also can work on improving your score. Knowing your credit report will help you
make important financial decisions. In the competitive market, rating gives an edge to the company
when they place their bond/debenture or other debt instruments in the market for subscription. The
investor relies on the independent rating agency since he does not have the time, expertise, analytical
skills and the past data on the companys performance available with him. Comparison between 2
similar types of instruments is made easier if rating of the issues is available. The investor who
knows the risk he has bargained for when he decides to take a decision to invest vis-a-vis his own
risk appetite and the rewards he could expect. Rating helps the issuing companies to place their
issues at competitive rates of interest and reduce the cost of funds to a reasonable level keeping with
their credit standing, reputation and ability to repay the debts in time.

46

It should be noted that when a rating is attached to an issue, it by no means, reflects the total
financial capacity of the company. In other words, rating agencies carryout the rating exercise for an
issue of debt instrument and not a company as a whole. A company may get highest rating for a
particular size of an issue where as if size is increased beyond a particular level, same issue may be
allotted a lower rating if the companys financial capacity is unable to sustain the servicing of the
issue. Also if after the issue is launched with a higher credit rating and company undertakes
operations which are likely to put their financial capacity under strain, the credit rating may be
lowered by the rating agency anytime during the maturity of the instrument before it becomes due
for payment

By adopting a universally accepted measure of credit risk, issuers of any nationality can gain access
to global capital markets. In addition, since the issuer's credit risk is publicly announced, the issuer
can obtain financing at an appropriate interest rate and avoid unnecessary credit spreads that may
arise from misinformation or lack of recognition. Often, issues are raised as to the creditability of
credit rating agencies on account of the fact that different credit rating agencies often come up with
different ratings for the same organization. Ratings are determined through a comprehensive
evaluation including quantitative factors (financial indicators such as operating profit ratio, equity
ratio, etc.), qualitative factors (business foundation including industry trends, company
characteristics, etc.), and factors specific to the bond (issue conditions, bond type, etc.). Thus the
differences in ratings emerge due to the different stances of agencies toward each of these factors.
Investment decisions can change considerably depending on which credit rating data is used.
Usually, investors use the lowest rating in their analysis. However, this valuable source of
information will be rendered useless unless applied with the appropriate investment stance and
investment criteria.

Importance of credit rating in India

Establish a link between risk and return to investors in making investment decisions

47

Credit rating shows the exact worth of the organization In the Indian context its a sudden down
gradation of ratings of an organization, by three or more notches within a few months in spite of no
visible fluctuations in the market. The rating agencies justify it on the ground that they suffer from a
lack of adequate information, different agencies give different weightage to different factors on
account of there being no market regulatory body as such to lay down yardsticks or monitor their
ratings. Thus, it is evident that the system is still in its nascent stage in India and the SEBI guidelines
indicate a step forward in institutionalizing the process. The merit of the guidelines per se is of
course, a different issue that will be dealt with in a different chapter. As of now the issue is merely
concerned with ascertaining whether CRAs are here to stay and the answer quite definitely seems to
be in the affirmative.

PRACTICAL PROBLEMS WITH CREDIT RATING

The widespread of branch net work of the rating agency may limit skills in rating.
Inexperienced, unskilled or overloaded staff may not do justice to their job &the resulting ratings
may not be perfect.
48

The rating is not permanent but subject to changes & moreover the agencies can not give any

guarantee for the investors.

The time factor greatly affects rating & gives misleading conclusions. A company which adverse

conditions temporarily will be given a low rating judged on the basis of temporary phenomenon.
Since the rating agencies receive a sizable fee from the companies for

awarding ratings, a tendency to inflate the ratings may develop.

Investment which have the same rating may not have identical investment
quality

However, the problems with the credit rating system are several, and it would be unfair to say that
these problems are to be found only in the Indian CRAs as they plague CRAs all over the world.
Some of them are listed below:

There is often a possibility of biased ratings and misrepresentation on account of the lack of
accountability in the process and the close nexus between the agency and the issuer (at least in the

Indian context).
Rating only represents the past and present performances of the company and therefore future

events may alter the nature of the rating.

Rating is based on the material provided by the company and therefore, there is always a risk of

concealment of information on the part of the latter.

Rating of a debt instrument is not a guarantee as to the soundness of the company.
Ratings often on the debt instruments of different agencies.
Small differences in degrees of risk are usually not indicated by CRAs. Thus issues with the same

rating may actually be of differing quality.

Similarly, default probability need not be specifically predicted. Calculations are usually done in

relative terms.
CRAs cannot be used as recommendations to buy, sell or hold securities as they do not comment
on the adequacy of market price, suitability of any security for an investor or the taxability of the

payments.
The information is obtained from issuers, underwriters, etc. and is usually not checked for
accuracy or truth. Thus ratings may change on account of non-availability of information or

unavailability of adequate information.

Changes in market considerations may result in loss that will not be reflected in CRAs.

49

In India the chief problems in the context of CRAs arises on account of the fact that they are not the
independent and autonomous entities that their international counterparts are. The three primary
CRAs in India, viz., ICRA promoted by IFCI and other financial institutions and banks, CRISIL,
promoted by ICICI, Asian Development bank and others, and CARE promoted by IDBI are all
promoted by lending institutions. Further most corporate borrowers are clients of these institutions in
terms of borrowing. Further, institutions like ICICI, IDBI also have stakes in such client companies.
Thus it is very important for these agencies to distance themselves from their promoters if they want
to gain credibility. Thus, needless to say, the system of CRAs needs some amount of relooking and
overhauling in order to make it effective and viable in the future. A positive step has been taken in
this regard by the SEBI (Credit rating Agencies) Regulations,1999, which has attempted to resolve
some of the aforesaid problems, but much still remains to be done.

REGUALTORY FRAMEWORK
Credit rating has been made mandatory in India for issuance of instruments. Following are some of
the important regulatory agencies connected with credit rating.
SEBI:
50

As per the regulations of SEBI, a public issue of debentures and bonds convertible/redeemable
beyond a period of 18 months needs credit rating.
RBI:
According to the guidelines of RBI, one of the conditions for issuance of commercial paper in India
is that the issue must have a rating not below the P2grade from CRISIL/A2 grade from ICRA/PR2
from CARE.
Rating Framework
Credit rating at providing an opinion on the relative credit risk associated with an instrument. While
assigning ratings, all the factors that have a bearing on future cash generation, and claims that
require servicing, are considered. The major factors that determine the rating profile of a security
issue are discussed below:
Business Factors

Nature of industry
Market position
Efficiency of operation.
Project risk
Protective factors
Quality of management.
Financial Factors

Financing Policies.
Flexibility of financial structure.
Past track record.
Quality of accounting policy.
Financial performance indicators.
Profitability.
Gearing.
Coverage ratios.
Liquidity
Cash flow

Advantages
To investors
51

Information service.
Systematic risk evaluation.
Professional competency.
Easy to understand.
Low cost.
Efficient portfolio management.
Other benefits.

To Issuers
Index of faith.
Bench mark
Wider investor base

To Intermediaries
Efficient practice.
Effective monitoring
Drawbacks

Guidance, not recommendation.

Based on assumptions.
Competitive ratings.

SEBI GUIDELINES

No credit rating agencies shall rate a security issued by its promoters.

Dual rating is compulsory for public & rights issue of debt instrument of

Rs100 crore or more.

The net worth of rating agencies has been fixed at Rs 5cr.

Rating agencies can choose their methodology of operation but self

regulatory mechanism will give a better maturity status for agencies.

Period of validity of registration shall be 3 years.

52

Sebi has decided to incorporate a clause in the listing agreement of stock

exchanges requiring companies to corporate with agencies by providing correct
information. Refusal to do so many lead to breach of contract between rating

agency & client.

It is also suggested that a penal clause be

REGISTRATION OF CREDIT RATING AGENCY

Application for grant of certificate

1. Any person proposing to commence any activity as a credit rating agency on or after the date
of commencement of these regulations shall make an application to the Board for the grant of
a certificate of registration for the purpose.
2. Any person, who was immediately before the said date carrying on any activity as a credit
rating agency, shall make an application to the Board for the grant of a certificate within a
period of three months from such date: Provided that the Board may, where it is of the opinion
that it is necessary to do so, for reasons to be recorded in writing, extend the said period up to
a maximum of six months form such date.
3. An application for the grant of a certificate under sub-regulation or sub-regulation shall be
made to the Board in Form A of the First Schedule and shall be accompanied by a non
refundable application fee, as specified in Form A of the second Schedule, to be paid in the
manner specified in Part B thereof.
4. Any person referred to in sub-regulation who fails to make an application for the grant of a
certificate within the period specified in that sub-regulation shall cease to carry on rating
activity.

Promoter of credit rating agency

The Board shall not consider an application under regulation (3) unless the applicant is promoted
by a person belonging to any of the following categories, namely:
(a) A public financial institution, as defined in section 4 A of the Companies Act,1956 (1 of 1956);
53

(b) a scheduled commercial bank included for the time being in the second schedule to the Reserve
Bank of India Act, 1934 (2 of 1934);
(c) a foreign bank operating in India with the approval of the Reserve Bank of India;
(d) a foreign credit rating agency recognized by or under any law for the time being in force in the
country of its incorporation, having at least five years experience in rating securities;
(e) any company or a body corporate, having continuous net worth of minimum rupees one
hundred crores as per its audited annual accounts for the previous five years prior to filing of the
application with the Board for the grant of certificate under these regulations.

Eligibility criteria
The Board shall not consider an application for the grant of a certificate under regulation 3, unless
the applicant satisfies the following conditions, namely:
a. the applicant is set up and registered as a company under the Companies Act,1956;
b. the applicant has, in its Memorandum of Association, specified rating activity as one of its
c.

main objects;
The applicant has a minimum net worth of rupees five crores. Provided that a credit rating
agency existing at the commencement of these regulations, with a net worth of less than
rupees five crores, shall be deemed to have satisfied this condition, if it increases its net worth

d.

to the said minimum within a period of three years of such commencement.

the applicant has adequate infrastructure, to enable it to provide rating services in accordance

with the provisions of the Act and these regulations;

e. the applicant and the promoters of the applicant, referred to in regulation 4 have professional
competence, financial soundness and general reputation of fairness and integrity in business
transactions, to the satisfaction of the Board;
f. neither the applicant, nor its promoter, nor any director of the applicant or its promoter, is
involved in any legal proceeding connected with the securities market, which may have an
g.

adverse impact on the interests of the investors;

neither the applicant, nor its promoters, nor any director, of its promoter has at any time in the

h.

past been convicted of any offence involving moral turpitude or any economic offence;
the applicant has, in its employment, persons having adequate professional and other relevant

experience to the satisfaction of the Board;

i. neither the applicant, nor any person directly or indirectly connected with the applicant has in
the past been (I) refused by the Board a certificate under these regulations or (II) subjected
to any proceedings for a contravention of the Act or of any rules or regulations made under the
Act.

54

Explanation: For the purpose of this clause, the expression "directly or indirectly connected
person" means any person who is an associate, subsidiary, inter-connected or group company of
the applicant or a company under the same management as the applicant.
j. the applicant, in all other respects, is a fit and proper person for the grant of a certificate; k.
k. Grant of certificate to the applicant is in the interest of investors and the securities market.

Application to conform to the requirements

a. Any application for a certificate, which is not complete in all respects or does
not conform to the requirement of regulation 5 or instructions specified in Form
A shall be rejected by the Board.
b. Provided that, before rejecting any such application, the applicant shall be
given an opportunity to remove, within thirty days of the date of receipt of
relevant communication, from the Board such objections as may be indicated
by the Board.

c. Provided further, that the Board may, on sufficient reason being shown, extend
the time for removal of objections by such further time, not exceeding thirty
days, as the Board may consider fit to enable the applicant to remove such
objections.

Furnishing of information, clarification and personal representation

a. The Board may require the applicant to furnish such further information or clarification as
the Board may consider necessary, for the purpose of processing of the application. 1 Inserted
by SEBI (Criteria for Fit and Proper Person) Regulations, 2004, w.e.f.10.3.2004.
b. The Board, if it so desires, may ask the applicant or its authorized representative to appear
before the Board, for personal representation in connection with the grant of a certificate.
Grant of Certificate
(1) The Board, on being satisfied that the applicant is eligible for the grant of a certificate of
registration, shall grant a certificate in Form B.
(2) The grant of certificate of registration shall be subject to the payment of the registration fee
specified in Part A of the Second Schedule, , in the manner prescribed in Part B thereof
Conditions of certificate and validity period
(1) The certificate granted under regulation 8 shall be, subject to the following conditions,
namely:
a) The credit rating agency shall comply with the provisions of the Act, the regulations made
there under and the guidelines, directives, circulars and instructions issued by the Board
from time to time on the subject of credit rating.
b) where any information or particulars furnished to the Board by a credit rating agency:
i.
is found to be false or misleading in any material particular ; or
55

ii.

has undergone change subsequently to its furnishing at the time of the application
for a certificate; the credit rating agency shall forthwith inform the Board in

writing.
(2) The period of validity of certificate of registration shall be three years.

Renewal of certificate
(1) A credit rating agency, if it desires renewal of the certificate granted to it, shall make to the
Board an application for the renewal of the certificate of registration.1(1A) An application for
renewal of certificate of registration made under sub-regulation(1) shall be accompanied by a non
refundable application fee as specified in the Second Schedule
(2) Such application shall be made not less than three months before expiry of the period of
validity of the certificate, specified in sub-regulation(2) of regulation 9..
(3) The application for renewal made under sub-regulation (1)-
a. shall be accompanied by a renewal fee as specified in the second schedule and 1 Inserted
by SEBI (Credit Rating Agencies)(Amendment) Regulations, 2006,w.e.f. 7-9-2006
b. as far as may be, shall be dealt with in the same manner as if it were an application for the
grant of a fresh certificate under regulation 3.

Procedure where certificate is not granted

If, after considering an application made under regulation 3 or regulation 10 as the case may be,
the Board is of the opinion that a certificate should not be granted or renewed, as the case may be,

it may, after giving the applicant a reasonable opportunity of being heard, reject the application.
The decision of the Board, not to grant or not to renew the certificate under sub-regulation (1)
shall be communicated by the Board to the applicant within a period of thirty days of such

decision, stating the grounds of the decision.

Any applicant aggrieved by the decision of the Board rejecting his application under subregulation
(1) may, within a period of thirty days from the date of receipt by him of the communication

referred to in sub-regulation
(2) apply to the Board in writing for reconsideration of such decision.
o Where an application for re-consideration is made under sub-regulation (3) the Board shall
consider the application and communicate to the applicant its decision in writing, as soon as may
be

Effect of refusal to grant certificate

56

l.

An applicant referred to in sub-regulation (1) of regulation 11 whose application for the grant of a

certificate has been rejected under regulation 11, shall not undertake any rating activity.
m. An applicant referred to in sub-regulation (2) of regulation 3, whose application for the grant of a
certificate has been rejected by the Board under regulation 11, shall, on and from the date of the
receipt of the communication under sub-regulation (2) of regulation 11, cease to carry on any
rating activity.
n. If the Board is satisfied that it is in the interest of the investors, it may permit the credit rating
agency referred to under sub-regulation (1) or (2) to complete the rating assignments already
entered into by it, during the pendency of the application or period of validity of the certificate.
o. The Board may, in order to protect the interests of investors, issue directions with regard to the
transfer of records, documents or reports relating to the activities of a credit rating agency, whose
p.

application for the grant or renewal of a certificate has been rejected.

The Board may, in order to protect the interests of investors, appoint any person to take charge of
the records, documents or reports relating to the rating activities of a credit rating agency referred
to in sub-regulation (4) and for this purpose also determine the terms and conditions of such
appointment.

CODE OF CONDUCT
1. A credit rating agency shall make all efforts to protect the interests of investors.
2. A credit rating agency, in the conduct of its business, shall observe high standards of integrity,
dignity and fairness in the conduct of its Business.
3. A credit rating agency shall fulfill its obligations in a prompt, ethical and professional manner.
4. A credit rating agency shall at all times exercise due diligence, ensure proper care and exercise
independent professional judgment in order to achieve and maintain objectivity and independence
in the rating process.
5. A credit rating agency shall have a reasonable and adequate basis for performing rating
evaluations, with the support of appropriate and in depth rating researches. It shall also maintain
records to support its decisions.
6. A credit rating agency shall have in place a rating process that reflects consistent and
international rating standards

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7. A credit rating agency shall not indulge in any unfair competition nor shall it wean away the
clients of any other rating agency on assurance of higher rating.
8. A credit rating agency shall keep track of all important changes relating to the client companies
and shall develop efficient and responsive systems to yield timely and accurate ratings. Further a
credit rating agency shall also monitor closely all relevant factors that might affect the
creditworthiness of the issuers.
9. A credit rating agency shall disclose its rating methodology to clients, users and the public.
10. A credit rating agency shall, wherever necessary, disclose to the clients, possible sources of
conflict of duties and interests, which could impair its ability to make fair, objective and
unbiased ratings. Rating committee participating in the rating analysis, and that of its client.
11. A credit rating agency shall not make any exaggerated statement, whether oral or written, to the
client either about its qualification or its capability to render certain services or its achievements
with regard to the services rendered to other clients.
12. .A credit rating agency shall not make any untrue statement, suppress any material fact or make
any misrepresentation in any documents, reports, papers or information furnished to the board,
stock exchange or public at large.
13. A credit rating agency shall ensure that the Board is promptly informed about any action, legal
proceedings etc., initiated against it alleging any material breach or non-compliance by it, of any
law, rules, regulations and directions of the Boarder of any other regulatory body.(b) In case an
employee of the credit rating agency is rendering such advice, he shall also disclose the interest
of is dependent family members and the employer including their long or short position in the
said security, while rendering such advice.
14. A credit rating agency shall maintain an appropriate level of knowledge and competence and
abide by the provisions of the Act, regulations and circulars, which may be applicable and
relevant to the activities carried on by the credit rating agency. The credit rating agency shall
also comply with award of the Ombudsman passed under the Securities and Exchange Board of
India (Ombudsman) Regulations, 2003.
15. A credit rating agency shall ensure that there is no misuse of any privileged information
including prior knowledge of rating decisions or changes.
16. a) A credit rating agency or any of his employees shall not render, directly or indirectly any
investment advice about any security in the publicly accessible media.
b) A credit rating agency shall not offer fee-based services to the rated entities, beyond credit
ratings and research.
17. A credit rating agency shall ensure that any change in registration status/any penal action taken
by board or any material change in financials which may adversely affect the interests of
clients/investors is promptly informed to the clients and any business remaining outstanding is
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transferred to registered person in accordance with any instructions of the affected

clients/investors.
18. A credit rating agency shall maintain an arms length relationship between its credit rating
activity and any other activity.
19. . A credit rating agency shall develop its own internal code of conduct for governing its internal
operations and laying down its standards of appropriate conduct for its employees and officers
in the carrying out of their duties within the credit rating agency and as a part of the industry.
20. A credit rating agency shall provide adequate freedom and powers to its compliance officer for
the effective discharge of his duties.
21. A credit rating agency shall ensure that the senior management, particularly decision makers
have access to all relevant information about the business on a timely basis.
22. A credit rating agency shall ensure that good corporate policies and corporate governance are in
place
23. A credit rating agency shall not, generally and particularly in respect of issue of securities rated
by it, be party to or instrumental for
(a) Creation of false market;
(b) Price rigging or manipulation
(c)Dissemination of any unpublished price sensitive information in respect of securities which
are listed and proposed to be listed in any stock exchange, unless required, as part of rationale
for the rating accorded.

COMPARISON OF REGULATIONS RELATED TO CREDIT

RATING AGENCIES IN INDIA AND OTHER COUNTRIES

1. INDIA
The RBI prescribes a number of regulatory uses of ratings. The RBI requires that a NBFC must
have minimum investment grade credit rating if it intends to accept public deposits. Furthermore,
unrated or underrated NBFCs in the category of equipment leasing and hire purchase finance
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companies are required to disclose the fact of their being unrated, to the public, if they intend
raising deposits. Finally, as per money-market regulations of RBI, a corporate must get an issue of
CP rated and can issue such paper subject to a minimum rating. In the area of investments, SEBI
stipulated that ratings are compulsory on all public issues of debentures with maturity exceeding
18 months. SEBI has also made ratings mandatory for acceptance of public deposits by Collective
Investment Schemes. If the size of the issue is larger than Rs.100 crore, two ratings are required.
Pension funds can only invest in debt-securities that have two ratings, as per the stipulations of
Government of India.
In India, in 1998, SEBI constituted a Committee to look into draft regulation for Credit rating
agencies that were prepared internally by SEBI. The Committee held the view that in keeping
with international practice, SEBI Act 1992 should be amended to bring Credit rating agencies
outside the purview of SEBI for a variety of reasons. According to the Committee, a regulator will
not be in a position to objectively judge the appropriateness of one rating over another. The
competency and the credibility of a rating and CREDIT
RATING AGENCY should be judged by the market, based on historical record, and not by a
regulator. The Committee suggested that instead of regulation, SEBI could just recognise certain
agencies for particular purposes only, such as allowing ratings by Credit rating agencies
recognised by it for inclusion in the public/rights issue offer documents. In consultation with
Government, in July 1999, SEBI issued a notification bringing the Credit rating agencies under its
regulatory ambit in exercise of powers conferred on it by Section 30 read with Section 11 of the
SEBI Act 1992. The Act now requires all Credit rating agencies to be registered with SEBI. Since
then, all the four Credit rating agencies in India have been registered with SEBI. SEBI Act now
defines credit rating agency, rating, and securities. Details of who could promote a
CREDIT RATING AGENCY and their eligibility criteria are specified. The Act also mentions
about agreement with clients, method of monitoring of ratings, procedures for review of ratings,
disclosure of ratings and submission of

2. OTHER COUNTRIES
Regulators of both developed and emerging markets rely on credit ratings for a variety of
purposes. USA introduced the concept of regulatory use of ratings in 1931. The Office of the
Comptroller of Currency used ratings as a means to determine the basis of valuation of bonds.
The use of ratings spread to other activities such as determination of capital prescription or
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margin money for brokers/dealers, disclosure requirements under Securities and Exchange
Commission norms, exemption from registration and regulation for certain issuers of asset-backed
securities, etc. The National Association of Insurance Commissioners (NAIC), which determines
insurance companys regulatory capital charges, also relies on ratings. Japan promoted credit
ratings in 1974 and regulators used the ratings of Japan Bond Research Institute (a rating agency)
as one of the eligibility criteria for bond issues in the 1980s. The Ministry of Finance relies on
ratings in a variety of ways, including regulation of money reserve funds. In 1993, the European
Community stipulated capital requirements for market risk for banks and security houses based on
ratings. UK adopted rating based Capital Adequacy Directives in 1996. Favoured treatment is also
accorded to firms engaged in securities business based on rating. France, Italy, Australia,
Switzerland, Canada, Argentina, Chile, Mexico, Indonesia, Korea, Malaysia, Philippines, Taiwan
Province of China and Thailand are other countries that have regulatory uses for ratings. In fact,
the adoption of rating based regulations was the main force leading to the creation of rating
agencies in emerging markets in Latin America and Asia. An important issue is the criteria for
recognising a credit rating agency for use of its ratings in regulation. It is now commonly
accepted that criteria are : assured continuous objectivity in methodology; independence from
outside influences; credibility, though this should not be an entry barrier; access to all parties with
legitimate interest; and adequacy of resources. Most regulators stipulate a list of recognised
agencies whose ratings can be used to satisfy rating requirements. Broadly, there are three areas
where extensive use is made of ratings in the regulatory process, viz., investment restrictions on
regulated institutions; establishing capital requirements for financial and disclosure as well as
issuance requirements. The issues faced by regulators in use of ratings include reconciling
divergent ratings by different Credit rating agencies and deciding cut-off of level of ratings. In the
aftermath of the Asian crisis and the scathing criticism on the failure of Credit rating agencies to
predict the crisis and later on its role in precipitating it through downgrades, the role of credit
rating agencies has been placed under microscopic scrutiny. The merits and demerits of regulating
credit rating agencies and the issue of rating the rating agencies have been discussed in many
international forums. There is no international regulatory authority overseeing rating agencies.
Whether they are regulated or not depends on specific country circumstances. In general,
however, countries impose a modest regulation over Credit rating agencies. In USA, Securities
and Exchange Commission gives recognition to Credit rating agencies as Nationally Recognised
Statistical Rating Organisations (NRSO) for specific purposes. The main form of regulation is
USA is in officially recognising a credit rating agency. Thereafter, there is hardly any regulation.
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Similarly in UK, recognition as a rating agency is required from the Financial Services Authority
(FSA). So is the case in Japan, Australia, France and Spain.

STANDARD & POOR'S

62

Introduction
Standard & Poor's (S&P) is a United States-based financial services company. It is a division of
the McGraw-Hill Companies that publishes financial research and analysis on stocks and bonds.
It is well known for the stock market indices, the US-based S&P 500, the Australian S&P/ASX
200, the Canadian S&P/TSX, the Italian S&P/MIB and India's S&P CNX Nifty. It is one of the
Big Three (credit rating agencies) (Standard& Poor's, Moody's Investor Service and Fitch
Ratings) Standard & Poor's, as a credit rating agency (CRA), issues credit ratings for the debt of
public and private corporations. It is one of several CRAs that have been designated a Nationally
Recognized Statistical Rating Organization by the U.S. Securities and Exchange Commission. It
issues both short-term and long-term credit ratings.

History of Standard and Poors

Standard & Poor's traces its history back to 1860, with the publication by Henry Varnum Poor of
History of Railroads and Canals in the United States .This book was an attempt to compile
comprehensive information about the financial and operational state of U.S. railroad companies.
Henry Varnum went on to establish H.V. and H.W. Poor Co with his son, Henry William, and
published updated versions of this book on an annual basis.
In 1906 Luther Lee Blake founded the Standard Statistics Bureau, with the view to providing
financial information on non-railroad companies. Instead of an annually published book Standard

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Statistics would use 5" x 7" cards, allowing for more frequent updates. In 1941, Poor and
Standard Statistics merged to become Standard& Poor's Corp. Then in 1966 S&P was acquired by
The McGraw- Hill Companies, and now encompasses the Financial Services division

From this source, it shows that Standard & Poors expects a brief earnings dip in the fourth
quarter of 2007 with the earnings trend returning to the prior growth pattern by the second quarter
of 2008.Remember that much of the growth in earnings was driven by the growth in revenues
which was fueled by the rapid expansion of credit that is now contracting significantly. The
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problem is this earnings forecast doesnt do not seem very logical nor does it follow history.
According to McKinsey & Company, the strategic consulting firm, in order for overall S&P 500
earnings to reach the long-run average proportion of GDP, profits would have to fall 20 percent
from their 2007 levels. This excludes the financial and energy sectors, so we get a better focus on
the underlying economy.

Long-term credit ratings

S&P rates borrowers on a scale from AAA to D. Intermediate ratings are offered at each level
between AA and CCC (e.g., BBB+, BBB and BBB)

Investment Grade
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AAA: the best quality borrowers, reliable and stable (many of them governments)
AA: quality borrowers, a bit higher risk than AAA. Includes:
AA+: equivalent to Moody's and Fitch
AA: equivalent to Aa2
AA-: equivalent to Aa3
A: quality borrowers whose financial stability could be affected by certain economic situations
A+: equivalent to A1
A: equivalent to A2
BBB: medium class borrowers, which are satisfactory at the moment

Non-Investment Grade (also known as junk bonds)

BB: more prone to changes in the economy
B: financial situation varies noticeably
CCC: currently vulnerable and dependent on favorable economic conditions to meet its
commitments
CC: highly vulnerable, very speculative bonds
C: highly vulnerable, perhaps in bankruptcy or in arrears but still continuing to pay out on
obligations
CI: past due on interest
R: under regulatory supervision due to its financial situation
SD: has selectively defaulted on some obligations
D: has defaulted on obligations and S&P believes that it will generally default on most or all
obligations
NR: not rated

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CRISIL SME RATINGS:

BACKGROUND
Recent years have seen rapid growth in the Small and Medium Enterprises (SME) sector, and an
enhanced appreciation of this sector's critical role in driving economic growth. However, authentic
and independent credit research in this sector has so far been minimal. With many private and public
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sector banks directing resources and focus towards SME lending, the need has arisen for
independent credit opinions. CRISIL offers its rating services to SMEs to meet this need. SME
ratings are offered on an exclusive rating scale, distinct from regular ratings offered to large
corporations, banks and government entities.
Credit evaluation in the SME sector needs a specialized approach, as the issues and drivers of credit
quality are different from those applicable for large companies. The weightages assigned to various
parameters of evaluation therefore need to be different. There has to be a good understanding of the
particular cluster or area where the SME is operating.
When Lalchand Nathalal Gandhi was approached by Crisil three years ago to get a credit rating
exercise done for his companies, LN Chemicals and Modera Chemicals, he was skeptical but
decided to go ahead anyway. The experiment worked. While Gandhis businesses already had a good
relationship with Saraswat Bank for years, the rating helped them get an additional 0.5% interest rate
reduction on their bank borrowings. We were also noticed by other companies sand new enquiries
began to flow in, says Gandhi, whose firmswith a combined turnover of Rs 40 croremake
chemicals that are used in textile processing, and soap, paper and paint manufacture.
Now, as Gandhi looks to expand his business, hes already being approached by other banks to fund
his expansion plans. This could be due to the rating we got from Crisil over the past three years, he
says. Cultivating healthy relationships with banks may have helped small companies tide over credit
access issues to an extent.
However, banks reluctance to lend to MSMEs often stems from lack of information, and the fact
that evaluating risk in such firms is often a difficult and time consuming process. Credit rating could
be the solution. A rating report provided by an independent agency like Crisil, ICRA or CARE offers
deep insights into a companys operations.
It can reveal the creditworthiness of the company in relation to its peers in the sector, and an
assessment of its strengths and weaknesses based on its financial condition. Anyone who sees the
report is instantly appraised of the health of the company, says Yogesh Dixit, head-SME Ratings at
Crisil. Large corporates have been getting themselves rated for many years now, but in the world of
small business this is a relatively recent and emerging trend.
Four years ago, the National Small Industries Corporation (NSIC) launched a programme where a
micro or small enterprise (with a maximum investment of Rs 5crore in plant and machinery) would
receive a 75% subsidy on rating fees (around Rs 50,000) charged by any of the six empanelled rating
agencies Crisil, ICRA,D&B , SMERA, Fitch and CARE. This has had a positive effect with around
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5,000units getting rated last year, and NSIC expects that at least another 7,000 will follow suit this
year.
Under the new Basel II norms that came into effect from April 1 this year, rating is mandatory for
businesses with investments over Rs 10 crore. For those firms that are below the Rs 10-crore level,
rating is also beneficial, especially when it comes to dealing with customers. For a small business, a
rating by a recognized agency helps it command better terms with its buyers, says HP Kumar,
chairman and managing director of NSIC.
A robust rating process includes a visit to the factories and warehouses to authenticate information
provided by the company, verifying if the insurance of assets is in order and also taking feedback
from suppliers, customers and bankers of the firm, among other aspects.
The NSIC rating scale takes into account two factorsperformance capability and financial
strength. For example, a company with moderate performance capability and high financial strength
will be rated SE3A, while one with weak performance capability and moderate financial strength
will be rated SE4B.
On the basis of rating reports, banks are able to take faster decisions on project loans as well as on
renewing and increasing credit limits for those clients. Every bank has its own internal guidelines on
lending but Dixit says ratings are useful since information about small companies is not readily
available. It is an independent third party assessment of the overall condition of the SME, he
says.In that sense, ratings bring credibility and a better image to a sector thats fragmented and often
opaque about the financial health of its companies. Ratingscan be revealed to vendors and
customers without furnishing all financial data,says Rajesh Dubey, executive director, ICRA
Online.
Take the case of In marco Industries, which makes high-tech industrial sealing products. The Rs 25crore (turnover) firm has been getting rated by Crisil everyyear for the past four years and has
managed to obtain the highest level of SE1Aeach time. We have been able to establish JVs and
partnerships with the help of the rating, says Chetan Doshi, executive director, In marco, adding
that its a calibration tool for his business that could come handy when he decides to go for an IPO
later. It helps us in self-analysis as we expand. Many companies have been leveraging ratings to
enhance their brand image and acquire new clients.
For instance, Gandhi says his firms rating is displayed prominently on the company stationery and
website. It gives us an identity in new markets and with new customers, he says. Moreover some
supply tender notices insist the applying companies be rated. Rating is also bringing a shift in
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thinking among SMEs in terms of self-regulation. Rated companies today understand that good
corporate governance, transparency and a sound accounting policy are all important in this changing
world, says Dixit.
That doesnt mean ratings have become fully accepted among small companies and their bankers.
There have been cases reported where banks have not honoured ratings done by external agencies,
and have relied only on their own due diligence. Rajeev Karwal, CEO, Milagrow Business and
Knowledge Solutions, a small business advisory firm says, Banks should accept it. Only if they
give loans on the basis of the rating will it have any meaning. At Meerut-based Kanohar Electricals,
managing director Dinesh Singhal contends that mandatory rating due to Basel II adds to his cost
and provides no additional value. These rating agencies are not fully equipped to rate according to
Basel II.
They prepare reports after just looking at the balance sheets, he says. While the maximum benefit to
a company getting rated is an interest reduction of 0.5%, the cost of rating works out to be higher
than the savings, he says. There are other limitations to the ratings system as well, says Anil
Bhardwaj, secretary general of the Federation of Indian Micro and Small & Medium Enterprises
(FISME). Most banks have a tacit understanding with one or two rating agencies and they do not
accept ratings by other agencies. Therefore, a serious re-look is required in the models and the
mandatory nature of ratings. Secondly, the field must be opened up to more credit rating players to
bring in greater competition and customer service orientation, he says.

FINDINGS
Ratings are not a guarantee against loss.
Credit ratings are assigned to companies through Credit rating agency.
The rating given by the agency is very important for:

o
o
o
o
o

Investor
Issuer
Financial Intermediaries
Business Counter-parties
Regulators

These days people refer to 3 different credit ratings agencies in order

to make correct decision of investment.
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 Issuer can Appeal to the credit rating agency if they would not satisfy
with the ratings

Converting a Bad Credit Rating into Good Credit Rating

Even if past mistakes have brought your company to the despair and the credit rating is very poor,
you always have the chances to improve. However, to rebuild the credit rating, your financial
management team should have all the relevant information with it.There are several computer
software programs available in the market that help alot in this regard. Law also permits to
convert the bad credit rating in to good credit rating and repairing the damage done by poor credit
rating. According to latest regulations, credit bureaus have to wipe out negative remarks from
your organizations' credit report after a certain period of time. You can argue with them regarding
any information that you feel objectionable. They have to delete it if they cannot verify such
information.
Know the common myths related to your credit report
Today the consumers have been really informed and vast majority of them are also aware about
the credit report system or even their own credit scores. However it is astonishing to know that
the there are some myths that people believe in connection to their credit reports. Some of the
common ones are mentioned below:
Checking your credit report hurts your credit score
Often it has been believed that checking your own credit report and credit score will put a
negative impact on your credit score. However the fact is that a soft inquiry does not go against
your score. On the other hand, if anyone else like a lender or Credit Card Company is checking
your credit report, then this is considered as a hard inquiry and normally it take off about 5 credit
points from your score. Moreover one should know that multiple inquiries in a 14 days period are
just treated as just one inquiry in the credit score rating system. Also the system ignores all
inquiries made within 30 days before the day when the credit score is computed. Therefore if you
want to minimize the damage on your credit score through credit inquiries then try shopping for a
loan within 14 days period.
Closing old accounts and canceling credit cards improves your credit report score
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This is a very common myth because sometimes even your lenders tell you to close your old and
inactive accounts in order to improve your credit scores. But closing old accounts and canceling
credit cards may actually have an opposite effect with the current credit score rating system. It
may leave a negative impact as it will make your credit history appear shorter and thereby lower
your credit score.
Credit counseling causes harm to your score
Attending a debt management program will not cause any harm to credit score. The current FICO
credit score rating system take no notice of any reference to credit counseling that may be
mentioned in your file. The researchers have found that people who have opted for credit
counseling have not defaulted on their debts and therefore it is not taken into consideration while
tabulating credit score.
However late payments can hurt your credit report and credit counseling can hurt your ability to
avail a loan because you probably have had trouble paying creditors.
All credit reports are the same
Most people believe that credit reports from all the three credit rating agencies is same but it is not
so. These days, most creditors across the country do report their information to all three major
agencies Equifax, Experian, TransUnion and as they are separate firms, the method and the
pace in which they update records may not necessarily be the same. So make sure you get your
credit reports from all three major credit reporting bureaus before you apply for a big loan.

SOME MORE QUESTIONS

Which Companies Are Affected by Ratings?
Every company or country that has a rating will be affected in its borrowing costs, at least in
public markets. A higher ranking means lower interest rates for the borrower and vice versa. The
price of credit is set not only by relative credit ratings but also by the general supply of money
and the specifics of an individual borrowing. A low-rated borrower, for example, can sometimes
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borrow more cheaply by securing the bond with a claim on specific assets, or by paying a thirdparty to insure the bond. Conversely, a highly-rated borrower may choose a structure that attracts
a lower rating because of special characteristics of the issue, including its standing in the
borrower's capital structure or the jurisdiction in which it is issued.
How do I Improve the Credit Rating of My Organization?
To improve the credit rating of any corporation you need to increase the credit score. If the
persons who are managing your financial matters are cautious enough to pay all the bills on time,
they are doing the best thing to achieve higher credit rating. On the contrary, if they make
payments late, not only it adversely affects your company's credit rating but also the added
interest makes your organization in debted for a longer period for time. However, if they are
finding it difficult to pay according to present schedule, ask them to sit with the creditors and
reschedule payment dates. Whatever efforts you make to increase the credit rating of your
business organization will not go in the vain. Whenever you need extra money in the future, you
will be able to get it. Furthermore, you will get the money at lower interest rates as compared to
those organizations that have a bad credit rating. Similarly, getting mortgage loans or car loans
also become easier to the companies with good credit rating.
Is Service tax payable on Information and Advisory services rendered by Credit Rating
Agencies?
No, the information and advisory services, if any, rendered by credit rating agencies would not
attract service tax for the reason that taxable services in respect of credit rating agency means
service provided to a client only in relation to credit rating of any financial obligation, instrument
or security. Services of research and information such as analysis of industries in specific sectors
of financial and business aspects of a company, other customized services on say business houses
and capital markets, indexing services and information services such as privatization policy for
infrastructure projects, macro studies of infra-structure sector, implication of government policy
in respect of any sector, financial modeling, bid evaluation, power purchase agreement,
restructuring of state electricity boards, etc are not services 'in relation to' the credit rating of any
financial obligation, instrument or security and are hence outside the ambit of service.
Is the Service tax payable on money received by Credit rating Agency for the purpose of
Credit Rating assignment, but returned to the client due to any reason subsequently?

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No. The amount received in advance for the service of rating to be provided to the client, is only
an advance and the services can be deemed to have been provided only when the rating exercise
has been completed and when such rating has been assigned. In case rating is not done, for any
reason and the entire amount is returned back to the client,. it cannot be said that services have
been rendered and hence service tax is not attracted.
What would be the relevant date for determining the liability for payment of Service Tax?
The relevant date for determining the service tax liability would be the date when rating has been
assigned to a particular instrument. In the case of ongoing projects, where rating has been
assigned after the notified date i.e. 16th October, 1998, the service tax would be payable

RECENT CREDIT RATING ARTICLES AND ACTIVITIES IN

INDIA

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THE HINDU

New Delhi, June 18, 2012

Fitch downgrades Indias credit rating outlook to negative

Within three months of Standard & Poors action in April and its follow-up threat last week,
global rating agency Fitch, on Monday, scaled down Indias sovereign credit outlook to negative
from stable while citing much the same reasons as S&P corruption and the absence of or
inadequate reforms.
However, unlike in the case of S&Ps strictures when the government appeared to go on the
defensive, Finance Minister Pranab Mukherjee junked the downgrade saying that the rating
agencies observations were based on old data and did not reflect the recent developments.
In a statement, pointing out that the revision in rating outlook by Fitch to the lowest investment
grade notch was because it had ignored the recent positive economic trends, Mr. Mukherjee said:
While the markets had already anticipated that Fitch would revise the outlook and so there is no
surprise in the announcement, it must be pointed out that Fitch has primarily relied on older data,
and has ignored the recent positive trends in the Indian economy. Chief Economic Advisor
Kaushik Basu, on the other hand, dubbed Fitchs action as herd mentality and expressed no
surprise over the outlook downgrade. There is a herd mentality among policymakers, herd
mentality among corporates. There is also little bit of herding among credit rating agencies. We
were pretty much expecting Fitch to do so, he said. He, however, admitted that even while there
was some deep strength in the country, there is lot to be done. I think that the next six months
will be crucial, he said.
Announcing the lowering of sovereign rating oulook, Fitch Ratings, in a statement, said that India
was faced with an awkward combination of slow growth and elevated inflation as well as
structural challenges surrounding its investment climate in the form of corruption and inadequate
economic reforms.

THE HINDU

New Delhi, June 25, 2012

Moodys reaffirms stable rating outlook for India

Ushering in positive sentiments in an otherwise despondent economic environment, global rating
agency Moodys, on Monday, retained Indias credit rating outlook at stable as it viewed that the
current slowdown was unlikely to be a permanent feature of the countrys economy.
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Unlike its peers such as Standard & Poors and Fitch, which lowered the outlook to negative and
threatened to downgrade the sovereign credit rating to speculative from investment grade on
account of deteriorating growth prospects and the governments inertia on the reforms front,
Moody's Investors Service chose to maintain its stable outlook on India's current Baa3 rating.
Giving reasons for the positive stance on India in its newly released Frequently asked questions
about India's sovereign rating, Moodys stated that various credit challenges such as weak
fiscal performance, tendency towards inflation and an uncertain investment policy environment
have characterized the Indian economy for decades, and are already incorporated into the
current Baa3 rating.
On the other hand, the rating agency noted that certain recent negative trends such as lower
growth, slowing investment and poor business sentiment were unlikely to become permanent or
even medium-term features of the Indian economy, although Moody's expects that global and
domestic factors, including potential shocks in agriculture, could keep Indias growth below trend
for the next few quarters.
Moreover, the agency statement pointed out that its ratings express a view on medium-term
sovereign creditworthiness and do not generally change with fluctuations in growth-related to the
direction of the business cycle at a particular point, if Moody's believes growth will recover and
sustain over time.
Besides, it viewed that the impact of lower growth and still-high inflation will deteriorate credit
metrics in the near term, but not to the extent that they will become incompatible with India's
current rating.
Commenting on Moodys rating outlook stance, Prime Minister's Economic Advisory Council
Chairman C. Ranagarajan said: Well, I think its good that Moody's has affirmed the stable
grade. It also shows that the Indian economy is right on the track.
In its assessment of India's budget deficits, Moodys has pointed out that the countrys
government debt and fiscal deficit ratios have always been worse than those of similarly-rated
peers while noting that its own assessment of low government financial strength is based not
merely on a comparison of ratios, but also on the underlying reasons for weak government
finances.

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These lie in the role fiscal policy plays in maintaining social stability in a highly diverse, poor
and unequal society, which limits government revenues and imposes demands on government
expenditure. This poverty constraint is effectively factored into the rating by assigning India a
'moderate' economic strength assessment, despite the well above global average size and growth
rates of its economy, it said.
On the more current issue of rupee depreciation, Moodys has maintained that as the
governments foreign currency debt comprises only 5.3 per cent of its total debt and is equivalent
to 3.8 per cent of the GDP (gross domestic product), the rupees decline does not raise the
governments own debt service burden significantly, especially since most of its foreign currency
debt is owed to multilateral and bilateral creditors with low annual repayment requirements.

CONCLUSION

The credit market turmoil that began in the U.S. in the summer of 2007 has been amplified in recent
months by dramatic slowing of broader economic activity. What began as a significant, but relatively
isolated, deterioration in the performance of sub-prime housing loans has led to a wave of negative
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events that have reverberated across a highly-leveraged, interconnected and, at times, opaque global
financial system. More importantly, a credit crisis has transformed into a much wider and deeper
crisis of confidence in the global markets. Credit rating agencies have an opportunity to help restore
confidence in markets by restoring confidence in our industry. Many necessary actions can and have
been undertaken at the individual firm and industry level and we are committed to continuing along
that path. Nonetheless, a few key actions and reforms as I have described above require help from
the broader market and oversight authorities. For 2009, the description of credit is identical to the
way forward for credit markets: confidence. The rebuilding process will be far more protracted
than the events that necessitated it which is all the more reason to get on with the task with energy,
tenacity and coordination.

BIBLIOGRAPHY

www.wikipedia.com
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www.standardandpoors.com
www.nsic.com
www.crisil.com
www.icra.in
www.sebi.com
www.thehindu.com

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