What Are the Functions of Credit Rating Agencies? What Are the Functions of Credit Rating Agencies?

thumbnail Credit agencies measure credit worthiness

Credit rating agencies are a broad category of agencies that analyze the finances of various parties to determine how credit worthy they are. This information is used by companies and individuals who offer loans, invest in securities or offer other lines of credit to determine which clients to accept and what interest rates to charge. The three main types of credit agencies each focuses on rating a certain set of entities.

Rating Public Entities The purpose of one type of credit rating agencies is to evaluate public entities for credit worthiness. They evaluate the history of corporations and other businesses to determine the likelihood they will pay off a loan or other line of credit. These ratings are based on the company's financial ratios, prior earnings and current debts. Financial ratios help interpret information found on a company's financial statements. For example, the ratio of a company's current cash and accounts receivable to its current liabilities helps determine whether the company can pay debts and expenses when they are due . The credit rating established from this information affects whether the corporation will secure a loan and the interest it will pay.

Investment Advice

Credit rating agencies may evaluate the financial instruments offered by different groups. These instruments include bonds and money markets. This rating evaluates how likely these investments are to pay off for investors. These ratings are used by investors in debt securities to determine which bonds or money markets to invest in. Consumer Credit Agency

A major function of credit agencies is to create consumer credit ratings. These are the credit scores for individuals. The consumer credit rating is based on the individual's past history of debt repayment, current debt-to-income ratio and financial assets. Scores range from 300 to 850, with scores above 700 being considered excellent and scores below 600 indicating high risk for lenders. A high credit score enables individuals to more easily obtain low-interest lines of credit while a low credit score can prevent

an individual from obtaining a loan or result in him being offered only a high interest-rate loan. Your credit score will impact whether you are accepted for a credit card, car loan, mortgage, home-equity loan and perhaps whether an application for apartment rental will be accepted. It also affects the interest rate. Those with lower scores receive higher interest-rate offers.

National Credit Rating Agencies

Credit rating agencies are responsible for providing investors with information regarding corporation and organization creditworthiness. Credit rating agencies are different from the more widely known credit reporting agencies. While credit reporting agencies are responsible for compiling a wide variety of financial data necessary for loan decisions for individuals, credit rating agencies do the mathematical and statistical math involved in placing a number (rating) on an organization or corporation's credit history. Standard & Poor

Standard and Poor's credit rating service was founded by Henry Varnum Poor in the late 1800s, after writing a book about the future of securities analysis and financial reporting. Over time, the company released corporate bond, municipal bond, and sovereign debt ratings. By 1966, Standard and Poor's became well-known through the S&P 500 for investor analysis and U.S. economic indicators. Moody's Investor Service

John Moody was the founder of Moody's Investor Service. In 1900, he published a manual that contained statistics and other information regarding industrial stocks and bonds. In 1914, Moody's Investors Service began providing ratings for government bond markets. In the 1960s to present time, Moody's rates both paper and bank deposits, resulting in a highly-successful full-scale rating agency. Fitch Ratings

The Fitch Publishing Company was founded by John Knowles Fitch in 1913. Using financial statistics in the investment industry, he produced a manual that outlined the AAA to D rating system that all the

credit rating agencies use as their standard today. Fitch now operates subsidiaries that specialize in enterprise risk management as well as data services and industry training from the financial factor.

Corporate Credit Rating Agencies

Corporate credit, or bond credit, rating agencies are used in the investing sector. This credit rating reveals whether a company is able to meet its debt obligations, and is often used by investors as a way to choose what debt security to invest in. Like personal credit rating, corporate credit ratings are offered by several different agencies. National Credit Rating Agencies Corporate Credit Reporting Agencies

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Moody's Corporation

Moody's Corporation rates corporations and government agencies in terms of credit worthiness, as well as publishing a number of investment and financial reports. Moody's corporate credit ratings scale differs from the other two large corporate credit rating agencies, Standard & Poor's and Fitch Ratings. Its ratings start off with AAA being the highest rating, and go down to C. Moody's has separate ratings for short and long term investments, as well as the financial security of banks.

Moody's Corporation 7 World Trade Center at 250 Greenwich Street New York, NY 10007 212-553-1658 moodys.com

Standard & Poor's

Standard & Poor's is part of the McGraw-Hill Companies, publishing its financial research. One of its most well known publications is the S&P 500 stock market index. Standard & Poor's corporate credit rating scale ranges between D, for the poorest rating, and AAA for the best rating. These ratings are accessed for short and long term investment outlooks. Standard & Poor's also provides financial projections for certain companies. Standard & Poor's offers its corporate credit ratings by industrial category.

Standard & Poor's 55 Water Street New York, NY 10041 212-438-1000 standardandpoors.com

Fitch Ratings

Fitch Ratings is based in New York and London, with headquarters in each city. This corporate credit rating agency started out as a publishing agency in 1913. Fitch provides long and short term credit ratings, using the same system as Moody's. Fitch also publishes financial reports on several different segments of the financial market.

Fitch Ratings One State Street Plaza New York, NY 10004 212-908-0500 fitchratings.com

The Importance of Credit Rating Agencies Credit rating agencies help you assess the risks you take

Credit rating agencies provide investors and debtors with important information regarding the creditworthiness of an individual, corporation, agency or even a sovereign government. The credit rating agencies help measure the quantitative and qualitative risks of these entities and allow investors to make wiser decisions by benefiting from the skills of professional risk assessment carried out by these agencies. The quantitative risk analysis carried out by credit rating agencies include comparison of certain financial ratios with chosen benchmarks and the qualitative analysis focuses on the management character, legal, political and economic environment in a jurisdiction. Development of Financial Markets

Credit rating agencies help provide risk measures for various entities and make it easier for financial market participants to assess and understand the credit risk of the parties involved in the investing process. Individuals can get a credit score in order to be eligible for easy access to credit cards and other loans. Institutions can borrow money easily from banks without having to go through lengthy evaluations from each individual lender separately. Also corporations and governments can issue debt in the form of corporate bonds and treasuries to attract investors based on the credit ratings.

Credit Rating Agencies Help Regulate Financial Markets

The credit ratings provided by popular rating agencies including Moodys, Standard & Poors and Fitch, have become a benchmark for regulation of financial markets. Legal policies require certain institutions to hold investment graded bonds. Bonds are classified to be investment graded based on their ratings by these agencies, any corporate bond with a rating higher than BBB is considered to be investment graded bond.

Estimation of Risk Premiums

The credit ratings provided by these agencies are used by various banks and financial institutions in determining the risk premium they will charge on loans and corporate bonds. A poor credit rating implies a higher risk premium with an increase in the interest rate charged to corporations and

individuals with a poor credit rating. Issuers with a good credit rating are able to raise funds at a lower interest rate.

Enhanced Transparency in the Credit Markets

The credit rating agencies provide improved efficiency in the credit markets and allow for more transparency in dealings. The ratings help monitor the credit soundness of various borrowers through a set of well-defined rules.

Standardization of the Evaluation Process

Most credit agencies use their own methodology for determining credit ratings, but since only a handful of popular credit rating providers exist, this adds a great deal of standardization in the rating process. The credit ratings of different borrowers can be easily compared using ratings provided by a credit rating company and the applications can be easily sorted.

A credit rating agency (CRA) is a company that assigns credit ratings for issuers of certain types of debt obligations as well as the debt instruments themselves. In some cases, the servicers of the underlying debt are also given ratings.

In most cases, the issuers of securities are companies, special purpose entities, state and local governments, non-profit organizations, or national governments issuing debt-like securities (i.e., bonds) that can be traded on a secondary market. A credit rating for an issuer takes into consideration the issuer's credit worthiness (i.e., its ability to pay back a loan), and affects the interest rate applied to the particular security being issued.

The value of such security ratings has been widely questioned after the 2007-09 financial crisis. In 2003 the U.S. Securities and Exchange Commission submitted a report to Congress detailing plans to launch an investigation into the anti-competitive practices of credit rating agencies and issues including conflicts of interest.[1] More recently, ratings downgrades during the European sovereign debt crisis of 2010-11 have drawn criticism from the EU and individual countries.

A company that issues credit scores for individual credit-worthiness is generally called a credit bureau (US) or consumer credit reporting agency (UK). 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. List of credit rating agencies

For more information, see Bond credit rating.

Agencies that assign credit ratings for corporations include:

A. M. Best (U.S.) Baycorp Advantage (Australia) Bulgarian Credit Rating Agency (Bulgaria, European Union) Capital Intelligence (Cyprus)[33] Capital Standards Rating (Kuwait)[34] Credo line (Ukraine) CreditSiren [35](European Union) Credit Rating Information and Services Limited(CRISL),[36](Bangladesh) Dagong Global (People's Republic of China) Dominion Bond Rating Service (Canada) Egan-Jones Rating Company (U.S.)

Fitch Ratings (Dual-headquartered U.S./UK), 80% of which is owned by FIMALAC, a French firm. Global Credit Ratings Co. (Africa) CRISIL (India) CARE (India) Japan Credit Rating Agency, Ltd. (Japan)[37] Moody's Investors Service (U.S.) Muros Ratings[38] (Russia alternative rating agency) Rapid Ratings International (U.S.) Standard & Poor's (U.S.) Weiss Ratings (U.S.)

[edit] The Big Three Main article: Big Three (credit rating agencies)

The Big Three credit rating agencies are Standard & Poor's, Moody's Investor Service, and Fitch Ratings.[39] 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.[40] [edit] CRA business models

Most credit rating agencies follow one of two business models. Originally, all CRAs relied on a "subscriber-based" business model where the CRA would not distribute the ratings for free but would instead only provide the ratings to subscribers to the CRA's publications. Subscription fees would provide the bulk of the CRA's income. Today, most smaller CRAs still rely on this business model, which proponents believe allows the CRA to publish ratings that are less likely to be tinged by certain types of conflicts of interest. By contrast, most large and medium-sized CRAs (including Moody's, S&P, Fitch, Japan Credit Ratings, R&I, A.M. Best and others) today rely on an "issuer-pays" business model in which most of the CRA's revenue comes from fees paid by the issuers themselves. Under this business model, while subscribers to the CRA's services are still provided with more detailed reports analyzing an issuer, these services are a minor source of income and most ratings are provided to the public for free. Proponents of this model argue that if the CRA relied only on subscriptions for income, the vast majority

of bonds would go unrated since subscriber interest is low for all but the largest issuances. These proponents also argue that while they face a clear conflict of interest vis-a-vis the issuers they rate (as described above), the subscriber-based model also presents conflicts of interest, since a single subscriber may provide a large portion of a CRA's revenue and the CRA may feel obligated to publish ratings that support that subscriber's investment decisions.

Open Source model

In October 2011, a new collaboration based business model called Wikirating was developed by Austrian mathematician Dorian Cred. The online community credit rating platform aims to provide a transparent source of credit rating information, reviewed by a worldwide commnunity. S&p 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 its 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. The company is one of the Big Three creditrating agencies, which also include Moody's Investor Service and Fitch Ratings.[2] Its head office is located on 55 Water Street in Lower Manhattan, New York City. History

The company 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 annually updated versions of this book.[4][5]

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 Statistics would use 5" x 7" cards, allowing for more frequent updates.[4]

In 1941, Poor and Standard Statistics merged to become Standard & Poor's Corp. In 1966, the company was acquired by The McGraw-Hill Companies, and now encompasses the Financial Services division.[4] Credit ratings

Countries with a AAA credit rating as of January 2012.

As a credit-rating agency (CRA), the company 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. Long-term credit ratings World countries by Standard & Poor's Foreign Rating:[6][7] Green - AAA Turquoise - AA Lighter blue - A Dark blue - BBB Purple - BB Red - B Grey - not rated

The company 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-). For some borrowers, the company may also offer guidance (termed a "credit watch") as to whether it is likely to be upgraded (positive), downgraded (negative) or uncertain (neutral).

Investment Grade

AAA: An obligor rated 'AAA' has extremely strong capacity to meet its financial commitments. 'AAA' is the highest issuer credit rating assigned by Standard & Poor's. AA: An obligor rated 'AA' has very strong capacity to meet its financial commitments. It differs from the highest-rated obligors only to a small degree. Includes: AA+: equivalent to Moody's Aa1 (high quality, with very low credit risk, but susceptibility to longterm risks appears somewhat greater)

AA: equivalent to Aa2 AA-: equivalent to Aa3 A: An obligor rated 'A' has strong capacity to meet its financial commitments but is somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions than obligors in higher-rated categories. A+: equivalent to A1 A: equivalent to A2 BBB: An obligor rated 'BBB' has adequate capacity to meet its financial commitments. However, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity of the obligor to meet its financial commitments.

Non-Investment Grade (also known as junk bonds)

BB: An obligor rated 'BB' is less vulnerable in the near term than other lower-rated obligors. However, it faces major ongoing uncertainties and exposure to adverse business, financial, or economic conditions, which could lead to the obligor's inadequate capacity to meet its financial commitments. B: An obligor rated 'B' is more vulnerable than the obligors rated 'BB', but the obligor currently has the capacity to meet its financial commitments. Adverse business, financial, or economic conditions will likely impair the obligor's capacity or willingness to meet its financial commitments. CCC: An obligor rated 'CCC' is currently vulnerable, and is dependent upon favorable business, financial, and economic conditions to meet its financial commitments. CC: An obligor rated 'CC' is currently highly vulnerable. C: highly vulnerable, perhaps in bankruptcy or in arrears but still continuing to pay out on obligations CI: past due on interest R: An obligor rated 'R' is under regulatory supervision owing to its financial condition. During the pendency of the regulatory supervision, the regulators may have the power to favor one class of obligations over others or pay some obligations and not others. 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

Short-term issue credit ratings

The company rates specific issues on a scale from A-1 to D. Within the A-1 category it can be designated with a plus sign (+). This indicates that the issuer's commitment to meet its obligation is very strong. Country risk and currency of repayment of the obligor to meet the issue obligation are factored into the credit analysis and reflected in the issue rating.

A-1: obligor's capacity to meet its financial commitment on the obligation is strong A-2: is susceptible to adverse economic conditions however the obligor's capacity to meet its financial commitment on the obligation is satisfactory A-3: adverse economic conditions are likely to weaken the obligor's capacity to meet its financial commitment on the obligation B: has significant speculative characteristics. The obligor currently has the capacity to meet its financial obligation but faces major ongoing uncertainties that could impact its financial commitment on the obligation C: currently vulnerable to nonpayment and is dependent upon favorable business, financial and economic conditions for the obligor to meet its financial commitment on the obligation D: is in payment default. Obligation not made on due date and grace period may not have expired. The rating is also used upon the filing of a bankruptcy petition.

Stock market indices

It publishes a large number of stock market indices, covering every region of the world, market capitalization level and type of investment (e.g., indices for REITs and preferred stocks)

These indices include:

S&P 500 free-float capitalization-weighted index of the prices of 500 large-capitalization common stocks actively traded in the US. S&P 400 MidCap Index S&P 600 SmallCap Index[8]

Governance scores (GAMMA)

A GAMMA score reflects S&P's opinion of the relative strength of a company's corporate-governance practices as an investor protection against potential governance-related losses of value or failure to create value. GAMMA is designed for equity investors in emerging markets and is focused on nonfinancial-risk assessment, and in particular, assessment of corporate- governance risk. History of CGS and GAMMA scores

S&P has developed criteria and methodology for assessing corporate governance since 1998 and has been actively assessing companies' corporate-governance practices since 2000.

In 2007, the methodology of stand-alone governance analysis underwent a major overhaul to strengthen the risk focus of the analysis based on the group's experience assigning governance scores. GAMMA analysis focuses on a number of risks that vary in probability and expected impact on shareholder value. Accordingly, S&P's analysis seeks to determine the most vulnerable areas prompt to potential losses in value attributable to governance deficiencies. Recent developments in the international financial markets emphasize the relevance of enterprise risk management and the strategic process to governance quality. GAMMA methodology incorporates two new elements, addressing these areas of investor concern. It also promotes the culture of risk management and longterm strategic thinking among companies. GAMMA methodology components

Shareholder influence Shareholder rights Transparency, audit, and enterprise risk management Board effectiveness, strategic process and incentives

GAMMA scale

For the GAMMA score, the S&P uses a numeric scale from one to ten (with ten being the best possible score). At the S&P's discretion, a GAMMA score can be publicly disseminated or used privately.

GAMMA-10 and GAMMA-9 in S&P's opinion, the corporate-governance processes and practices at the company provide a very strong protection against potential governance related losses in value. A company in these scoring categories has, in S&P's opinion, few weaknesses in any of the major areas of governance analysis.

GAMMA-8 and GAMMA-7 in S&P's opinion, the corporate-governance processes and practices at the company provide strong protection against potential governance related losses in value. A company in these scoring categories has, in S&P's opinion, some weaknesses in certain of the major areas of governance analysis.

GAMMA-6 and GAMMA-5 in S&P's opinion, the corporate-governance processes and practices at the company provide moderate protection against potential governance related losses in value. A company in these scoring categories has, in S&P's opinion, weaknesses in several of the major areas of governance analysis.

GAMMA-4 and GAMMA-3 in S&P's opinion, the corporate-governance processes and practices provide weak protection against potential governance related losses in value. A company in these scoring categories has, in S&P's opinion, significant weaknesses in a number of the major areas of governance analysis.

GAMMA-2 and GAMMA-1 in S&P's opinion, the corporate-governance processes and practices provide very weak protection against potential governance related losses in value. A company in these scoring categories has, in S&P's opinion, significant weaknesses in most of the major areas of analysis.

Downgrade of U.S. long-term credit rating Main article: United States federal government credit rating downgrade, 2011

On August 5, 2011, following enactment of the Budget Control Act of 2011, S&P lowered the US's sovereign long-term credit rating from AAA to AA+.[9] The press release sent with the decision said, in part:

" The downgrade reflects our opinion that the fiscal consolidation plan that Congress and the Administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government's medium-term debt dynamics. " More broadly, the downgrade reflects our view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges to a degree more than we envisioned when we assigned a negative outlook to the rating on April 18, 2011. " Since then, we have changed our view of the difficulties in bridging the gulf between the political parties over fiscal policy, which makes us pessimistic about the capacity of Congress and the Administration to be able to leverage their agreement this week into a broader fiscal consolidation plan that stabilizes the government's debt dynamics any time soon."[9]

The United States Department of the Treasury, which had first called S&P's attention to its $2 trillion error in calculating the ten-year deficit reduction under the Budget Control Act, commented, "The magnitude of this mistake and the haste with which S&P changed its principal rationale for action when presented with this error raise fundamental questions about the credibility and integrity of S&Ps ratings action."*10+ The following day, S&P acknowledged in writing the US$2 trillion error in its calculations, saying the error "had no impact on the rating decision" and adding:[11]

In taking a longer term horizon of 10 years, the U.S. net general government debt level with the current assumptions would be $20.1 trillion (85% of 2021 GDP). With the original assumptions, the debt level was projected to be $22.1 trillion (93% of 2021 GDP).[11]

[edit] Downgrade of France's long-term credit rating

On November 11, 2011 S&P erroneously announced the cut of France's triple-A rating (AAA). French leaders said that the error was inexcusable and called for even more regulation of private credit rating agencies (CRA's).[12][13][14][15] On January 13, 2012 S&P truly cut France's AAA rating, lowering it to AA+. This was the first time since 1975 that Europe's second-biggest economy, France, had been downgraded to AA+.[16] The same day S&P downgraded the rating of eight other European countries: Austria, Spain, Italy, Portugal, Malta, Slovenia, Slovakia and Cyprus.

While S&P's has retained their rating outlook at 'Stable' for Indian banks, there are worries about rate of credit growth and asset quality. Speaking to CNBC-TV18, Geeta Chugh of S&P's says that corporate India could face pressure in margins in FY13. She expects India's GDP growth to come down to 6.5% for FY13.

"While the overall rating of Indian banks remains stable, the standalone credit profile of some banks could come under pressure," she says. According to her, credit growth may decline to 16-17% in FY13 and asset quality may remain weak. "We expect a sharp rise in restructured loans in FY12 and FY13," she says.

"There is also stress seen coming in high risk construction and real estate sectors," she says.

Below is the edited transcript of the interview. Also watch the accompanying video.

Q: In your analysis are there any factors that might bring this stable outlook into question, what are your worries with respect to the current rating outlook on Indian banks?

A: S&P rates ten Indian banks at this point in time and our outlook for all the ten ratings is stable. In our base case scenario, we do not expect any of these ratings to change. Having said that, we do see some pressure points building up in the Indian banking sector, these are around asset quality and earnings deterioration, which we have seen in 2012. To an extent, we expect them to continue in 2013.

If the asset quality earnings deterioration is more than our expectation then the standalone credit profile of few banks could move down. However, we expect that the standalone credit profile, the duration could be more for the government owned banks in our rated portfolio. S&P expects that these banks will be supported by the government, there is high likelihood of that, so the impact on the overall rating may not be there even if there is a standalone deterioration in the credit profiles of these banks.

Q: With respect to weakening asset qualities have you all highlighted a few banks where perhaps the NPA in FY13 could come into question or worsen more than your expectations, any particular banks?

A: We have said that the pressure would be more on the government owned banks. The private sector banks have actually seen stable to improving asset quality in fiscal 2012. Though there could be some pockets of deterioration in the next year, but we see the government sector banks being more subject to asset quality deterioration.

Q: What would be the number that you will watch out for from the Budget itself, the bank recap number, is there a number that you have in mind?

A: We are expecting that the asset quality of the Indian banks will remain weak. However, if the deterioration is more than our expectations for the banks then the risk position and the stand alone credit profile of these banks could come under pressure.

Outlook on Indian banks is negative for 2012: Ritesh Maheshwari, Standard & Poors ET Now: You have recently put out an assessment of Indian banks saying that they are in for a tough year in FY13, especially in terms of asset quality. What are the main reasons for such a dim outlook on the sector?

Ritesh Maheshwari: Indian economy is facing a little bit of a challenge on the growth aspects, which has been clearly indicated by the lowering of GDP forecast for the fiscal year 2012 and even the fiscal year 2013. And that coupled with the high inflation as well as consistently strong interest rates means challenges for capital-intensive industries as well as consumers and then of course they have an implication on banks' margins. So, we think that this will have an impact on asset quality as well as earnings of the banks and we are turning a little negative on Indian banks for this fiscal year.

ET Now: Apart from asset quality concerns, do you think that Indian banks will face pressure on their margins going forward as well?

Ritesh Maheshwari: Yes, it is a bit of a double whammy. So, while the lowering of credit growth will occur alongside the increase in NPL, which is coming in from a few sectors, the margins of the banks are also likely to be impacted negatively because the strong interest rates are having an impact on their margins. But they cannot pass it onto the customers who are already reeling under the high inflation and high interest rates. And the fact that credit growth is lower means from a fixed base of cost point of view, banks are not able to really meet it so much with the total interest income that they will get with the increased base of loans. So, the combined impact on the banks' earnings will be relatively lower this year we believe.

ET Now: The Reserve of India cut the CRR some days ago, but decided to hold onto key policy rates in its statement last week. In fact, many believe the RBI may not still be convinced that inflation threats have left the system. What is your assessment of the situation?

Ritesh Maheshwari: Yes, RBI does look at the whole banking system deposit base as a factor which could have an inflationary impact. So, it has to balance between the liquidity available for credit in the environment as well as it not being in excess to cause inflationary pressures.

So it has been fine-tuning it. It eased out CRR by 75 basis points, but did not do anything to interest rates. I would believe that it is partly because it does not want to ease pressure on the inflationary conditions. While the inflation is not really because of demand side factors, but it cannot afford to let go on that aspect. So that is why it is keeping it on the tighter side.

ET Now: The budget also set aside about Rs 15000 for recapitalising PSU banks. Do you think that this sum would be enough? Ritesh Maheshwari: Given the fact that the growth is expected to be lower on the loan portfolios of the banks, it does seem like this increase in capital which will come in for public sector banks should have improved their capital ratios and because the growth on the loan portfolios is lower, on the whole the capital profile for some banks might even come to the adequate level.

I should point out that for most of the government-owned Indian banks, our capital assessment comes to be at a moderate level, below adequate. So, such a capital infusion of the order of 15000 crore, as it is denominated, would considerably relieve that pressure and probably for some of them, it might even be adequate because the credit growth is expected to be a little lower this year and hence the pressure on capital replenishment will be relatively lower as compared to last year.

ET Now: Now the government has also spoken about plans of setting up a holding company to recapitalise public sector banks. Would you see this as a positive in terms of the government's ability to raise money more efficiently and deploy it into these banks and also, are there any other countries where such a practice has been followed?

Ritesh Maheshwari: There are not too many countries where anyway the government continues to hold banks' shareholding. A few of them that come to my mind are of course China and Vietnam, but generally this holding is done directly through the government. But China of late has been thinking of using CIC to infuse capital. So, to that extent using of a holding company to own banks or at least infuse additional capital that way will provide an additional flexibility to the government because they could probably afford a little bit of leverage and hence increase the impact of capital infusion.

S&P warns Indian banks on asset quality Indian banks will have a tougher time in the next financial year with credit growth getting slower and asset quality worsening. Though over all credit outlook of the Indian banks remain stable, the stand alone profile of some Indian banks could worsen due to the challenges they face. The warning came clear today in a Standard and Poors report India Banking Outlook: Economic Headwinds Are Likely To Lower Asset Quality And Earnings In 2012. S&P said government owned banks were more exposed to the headwinds than the private banks when it came to strength of capital and credit profile. S&Ps estimate is credit growth will slow down to around 16-17 percent in financial year 2013, down from the 23 percent growth seen in this financial year. The over all slowing down of the economy, high interest rates and stubborn inflation are the likely reasons for the drop in credit disbursal.

S&P has already lowered Indias GDP growth forecast from 6.8 percent in 2012 to 6.5 percent in 2013. A worsening Europe and global recession might just add to the peril by bringing down foreign investments and exports. Their guess is that even wholesale price inflation will decline marginally in the second half

from 9 percent in previous half of this year But the factors behind inflation will continue to remain the same. In such a situation pressure on asset quality of banks will remain significant mainly to be reflected in restructured assets of banks which will go up strongly this fiscal year and the next. The pressure will be particularly visible in small and mid sized companies and also bigger companies with high debt. The sectors that have shown more vulnerability are road, telecom, textiles and iron and steel. Though not restructured as yet, state electricity distributors and airline companies undoubtedly face immense pressure and are likely to default.

Indian banks have already been reporting higher bad loans due to shift to introduction of system based recognition of bad assets. If the economys condition worsens, the risks could multiply. Profit margins for banks are unlikely to improve as high funding costs cannot be passed on to the customers. The ability to absorb high interest rates has also gone down for corporates.

However, the new Basel III norms introduced for Indian banks would lead them to better credit profile and stronger capital base which will be positive for the industry in the longer term. The Reserve Banks guidelines on capital structure are more stringent than the international Basel committee norms. Many banks would need fresh capital to meet the requirements and the government owned banks could perhaps get capital from the government. But given the governments own deficit restrictions, PSU banks would need to do much on their own like their private peers.

The fact that Indian banks have extensive branch networks and Indians have a habit to save in savings accounts is an inherent positive for the banking system as they do not depend much on external capital.

Outlook bleak for Indian banks Mumbai: The operating performance of some Indian banks is likely to remain weak in the fiscal year ending March 31, 2013, a report by Standard & Poor's has noted, citing a slowing economy, a dip in credit growth, rising delinquencies and tighter margins.

The asset quality of Indian banks is likely to remain weak, or even deteriorate, due to the moderation in economic activity, high inflation, and high interest rates," the report stated.

We expect restructured loans to rise in fiscal years 2012 and 2013. Small and mid-size companies are particularly vulnerable, it added. According to the report, credit growth in India is likely to weaken to 16-17% in 2012 and 2013, from about 23% in 2011. The agency expects net interest margins of Indian banks to remain tight in 2013 due to intensifying competition amid low credit growth, and borrowers' limited ability to absorb higher interest rates.

The report noted that the stand-alone credit profiles of a few Indian banks could weaken due to a decline in asset quality and earnings.

The ratings on government-owned banks, which face greater exposure to asset quality deterioration, could

benefit from a very high likelihood of government support.

Such support underpins the stable outlook on the ratings on Indian banks, said the report. Proposed guidelines of the Reserve Bank of India (RBI) on implementing Basel-III norms in India could strengthen the capitalisation of banks in the country.

We expect all the banks that we rate in India to meet the RBI's Basel- III capital adequacy requirements on time. Post implementation of Basel-III, Indian banks' risk-adjusted capital could move up by at least 100-200 basis points. This could strengthen the credit profiles of domestic banks over the next 3-5 years."

The report pointed out that Indian banks also benefit from the good long-term economic growth prospects of the economy. Over a longer period, the growth in business should enable banks to maintain sound financial health. Fitch: Stable outlook for Indian banks despite challenges Agencies Fitch Ratings says that the outlook for Indian banks remains stable in 2012, premised on domestic economy recovery in 2012, together with the government's continued commitment to maintain a minimum Tier 1 ratio of 8% for its banks (73% of system assets). While this is a base-case scenario, a build-up in credit concentration and weakening asset quality reflect mounting downside pressures.

Part of the credit problem is cyclical and may ease with a lag if GDP growth picks up from mid-2012 on the back of lower interest rates to stimulate demand, as the Reserve Bank of India may look to loosen monetary policy if core inflation eases. However, should the Indian economy continue to slowdown through most of 2012, the resulting problems relating to asset quality could hurt banks' stand-alone credit profile and their Viability Ratings (VR).

The structural part of the problem relates to the growing concentration risk that has resulted in Indian banks having a greater proportion of stressed assets than in 2008. Exposures to the struggling sectors of aviation and state power utilities may be restructured in 2012, together with growing exposures to infrastructure projects that face teething trouble. As a result, Indian banks may see the share of loans restructured in 2011 and 2012 rising to 7%-8% of loans, significantly higher than the 4.4% seen in the aftermath of the 2008 crisis.

Credit losses may however remain contained. While the immediate outlook on Indian infrastructure is negative, the long-term viability of the projects - which is still intact - may help limit credit losses. Since these exposures to stressed assets are very thinly reserved, government banks' profits may be impacted by 15%-20% due to higher loan loss provisions. Nevertheless, pre-provision operating profits of banks are seen as being adequate to absorb the rising costs, leaving equity intact.

Infrastructure growth will remain a thrust area for the government, and cash-rich state-owned companies were recently advised to step-up investments in new projects. Till now, government banks were the largest source of long-term loans for infrastructure projects, but have become cautious as stresses increase. Though unlikely, any significant increase in the share of infrastructure loans leading to further weaknesses in asset quality and funding could impact the standalone credit profile of banks and lead to a downward pressure on their VR.

The government is expected to play a key role in maintaining stability of the banking system through periodic injections of core equity. Fitch understands that a 10-year capitalisation plan is under consideration, which includes maintaining majority shareholding and targeting a core Tier 1 ratio of at least 8% - possibly more for the larger, systemically important banks. The timeliness of such injection, which cannot always be predicted with certainty by management, may come under pressure as the government struggles with containing the fiscal deficit. If delays in equity injection turn chronic, it may impact the Issuer Default Ratings of government banks.

Funding has been the traditional strength of Indian banks, being largely driven by customer deposits with a loan / deposit ratio of around 75%. The share of short-term deposits has, however, been increasing for government banks, reflecting the funding strains of above-average loan growth, leading to rising funding gaps. The latter increase the risk of volatility in net interest margins, particularly during the current period of high interest rates and tight liquidity. S&P threatens negative rating for India New Delhi: Global rating agency S&P today warned that "the balance of risk factors" for India's sovereign credit rating could tilt towards 'negative' zone this year, given the headwinds being faced by the country on domestic and global fronts.

However, Standard and Poor's (S&P) maintained that it does not expect to downgrade or revise its 'stable' outlook on the investment grade 'BBB-' long-term sovereign credit rating on India in the near future.

At the same time, S&P said, India is battling with high inflation, a weak government fiscal position, and slower economic growth on domestic front, while European sovereign debt problems could add to the pressures for the country.

"Like many countries, India is facing some challenges on a few fronts, and the balance of risk factors for the sovereign credit rating may be shifting slightly toward the negative," S&P Ratings Services said today in a report.

"Standard & Poor's doesn't expect to downgrade or revise the outlook on the long-term rating in the near future. However, the negative factors, combined with the government's weak policy formulation and implementation, may lead us to a tipping point," S&P credit analyst Takahira Ogawa said.

"India has been grappling with a political gridlock and the government's ability to implement measures to improve economic growth and fiscal prudence will be vital to boosting confidence," Ogawa said.

As per the report titled "Several Factors Could Weigh On India's Current Stable Sovereign Rating In 2012", high inflation, a weak government fiscal position, and slower economic growth have hurt investor confidence in the rupee, triggered a capital outflow, and weighed on the stable sovereign outlook on India in 2012.

"Our stable outlook on the 'BBB-' long-term rating on India currently reflects our expectation of strong economic growth in the medium term and gradually improving fiscal performances," Ogawa said.

He further noted that S&P has "factored in inflation and political uncertainty, which may lead to higher government subsidies and stalled reform efforts."

At the recently held World Economic Forum (WEF) Annual Meeting in Davos, S&P President Douglas Peterson had said they have an investment grade rating with a stable outlook on India and the country is more likely to improve further on this.

Brushing aside the concerns of slow reforms and the perceived notion of 'policy-paralysis', Douglas had said, "In a democracy, the policies are made after a prolonged dialogue and that is indeed a healthy practise."

Apparently, impressed with the positive discussions about India, Peterson went on to say that it was quite a refreshing change that the talks have moved away from the European crisis to India at Davos.

India may face rating downgrade: S&P New Delhi: Standard & Poor's, whose rating downgrade of the US has created mayhem in markets worldwide, warned that Asia-Pacific economies, including India, might face a deeper and prolonged impact if the global economy suffers a renewed slowdown.

Without specifically naming India, S&P said the implications for sovereign creditworthiness in the AsiaPacific would likely be more negative than previously experienced and a larger number of negative ratings actions would follow.

Lowering of credit ratings generally make borrowings costlier and difficult for the country or company being downgraded.

"Fiscal capacities of Japan, India, Malaysia, Taiwan and New Zealand have shrunk relative to pre-2008 level," it said, adding that these countries continue to bear the scars of the downturn.

The governments, it said, would be required to use their own revenue streams to support their economies and financial sector once again.

It further said that if a renewed slowdown comes, it would create a deeper and more prolonged impact.

At the time of the global financial crisis in 2008, several countries, including India, had rolled out stimulus packages facilitating monetary expansion and lower taxes to mitigate the impact of the slowdown.

At that time, India had provided three fiscal stimulus packages totalling Rs 1.86 lakh crore, which helped the economy clock a growth of 8 per cent in 2009-10, as against 6.8 per cent in 2008-09. Prior to the crisis, the Indian economy had been expanding at a growth rate of over 9 per cent over a three-year period. S&P warns India of potential long-term consequences New Delhi: Standard & Poors, which lowered the US sovereign credit rating to AA+ on August 5, said on Monday that it did not see an immediate impact of the move on Indias sovereign rating, but warned that there could be potential longer-term consequences of weaker global growth pointing to negative factors for the country.

Giving its outlook for India, S&P has said that the country would have to make forward movement towards controlling inflation and fiscal deficit and cautioned that loose fiscal policies which impacted growth could downgrade the countrys sovereign rating. We do not see an immediate impact on Indias sovereign rating (BBB-/Stable) resulting from the lowering of the US sovereign rating to AA+. However, potential longer-term consequences may point to negative factors, S&Ps sovereign analyst Takahira Ogawa told FE in an e-mailed response.

Currently, Indias long-term rating stands at BBB-, the lowest investment grade, with a stable outlook.

Listing India among those Asia-Pacific countries that continue to bear the scars of the recent downturn in terms of reduction in fiscal capacities, the rating agency said a renewed slowdown (in the US and EU) would likely create a deeper and more prolonged impact on these countries than the last one. ...the fiscal capacities of Japan, India, Malaysia, Taiwan, and New Zealand have shrunk relative to pre-2008 levels, it said.

Although it is rather unclear as to how the present crisis would unfold, it has already alarmed the government and regulators. The Reserve Bank of India (RBI) is looking at revisiting its policy on foreign exchange investments while finance ministry is keen to ensure that the developments dont impact markets badly and lead to loss of investors confidence.

S&P has said that inflation remains Indias biggest challenge in the near term, as high inflation could push up credit costs and dampen the countrys economic growth trajectory. Although the pace of overall inflation has slowed down, food prices continue to spiral negating the trend.

Ballooning fiscal deficits also constrain the sovereign ratings on India, S&P has said, adding that continuing its fiscal consolidation policies into fiscal 2012 (ending March 31, 2012) would be a key challenge for the government, Ogawa said. We could raise the ratings on India if the government continues to reduce the public sectors deficits materially. For example, future government initiatives to significantly reduce subsidies for fertilisers, foods, and fuels would be a positive factor in improving the expenditure structure of the budget and reducing the negative influence of potential external shocks on Indias fiscal position, he said.

Strong commitment of the central and state governments to the medium-term fiscal consolidation plan set out by the 13th Finance Commission is key to India. Early implementation of the GST could help stabilise and potentially increase government revenues in the medium term and become a further positive factor for the sovereign ratings,: he said. Conversely, continued loose fiscal policy or policy setbacks on monetary, financial, and economic reform fronts that lower Indias medium-term growth prospects could result in a downgrade. .

Meanwhile, S&Ps Indian arm Crisil also said that India would be impacted if global growth weakened further.

The primary impact will be on the availability and cost of funding, both domestic and international, Crisil managing director and CEO Roopa Kudva said. She added that an increase in risk aversion globally will reduce appetite for emerging market risk and could affect the ability of Indian companies to raise money externally. Access to equity markets too, is likely to be muted.

The second impact will be on demand: export growth is likely to slow down and domestic private consumption, which has been strong so far, could moderate as consumers become more cautious, Kudva added.

Volatility in exchange rates are also expected to increase.

However, the rating agency said, Indian corporates are likely to be cushioned by a primarily domesticfocused economy and strong balance sheets. While we will continue to see upgrades, we can expect a higher number of downgrades and higher defaults, it said.

Standard & Poors Applies Revised Bank Criteria To Indian Banks Publication date: 01-Dec-2011 05:58:17 EST View Analyst Contact Information

MUMBAI (Standard & Poor's) Dec. 1, 2011--Standard & Poor's Ratings Services said today that it has affirmed its issuer credit ratings on 10 Indian banks, after applying new ratings criteria for banks, which was published on Nov. 9, 2011.

We will publish individual research updates on the banks reviewed under the new criteria as per the banks identified below including a list of ratings on affiliated rated entities, as well as the ratings by debt type--senior,

subordinated, junior subordinated, and preferred stock. The research updates will be available at www.standardandpoors.com/AI4FI and on RatingsDirect on the Global Credit Portal. Ratings on specific issues will be available on RatingsDirect on the Global Credit Portal and www.standardandpoors.com following release.

RELATED CRITERIA AND RESEARCH All articles listed below are available on RatingsDirect on the Global Credit Portal, unless otherwise stated.

Banks: Rating Methodology And Assumptions, Nov. 9, 2011 Banking Industry Country Risk Assessment Methodology And Assumptions, Nov. 9, 2011 Group Rating Methodology And Assumptions, Nov. 9, 2011 Bank Hybrid Capital Methodology And Assumptions, Nov. 1, 2011 Rating Government-Related Entities: Methodology And Assumptions, Dec. 9, 2010

RATINGS LIST

Issuer credit rating

To

From

Axis Bank Ltd.

BBB-/Stable/A-3

BBB-/Stable/A-3

Bank of India

BBB-/Stable/A-3

BBB-/Stable/A-3

Bank of India (New Zealand) Ltd. BBB-/Stable/A-3 HDFC Bank Ltd. ICICI Bank Ltd. IDBI Bank Ltd. Indian Bank BBB-/Stable/A-3 BBB-/Stable/A-3 BBB-/Stable/A-3 BBB-/Stable/A-3 BBB-/Stable/A-3 BBB-/Stable/A-3 BBB-/Stable/A-3 BBB-/Stable/A-3 BBB-/Stable/A-3

BBB-/Stable/A-3 BBB-/Stable/A-3 BBB-/Stable/A-3 BBB-/Stable/A-3

Indian Overseas Bank BBB-/Stable/A-3 State Bank of India Syndicate Bank Union Bank of India BBB-/Stable/A-3 BBB-/Stable/A-3 BBB-/Stable/A-3

Watch the related CreditMatters TV segment titled, "How Standard & Poor's Updated Ratings Criteria Affects Asia-Pacific Banks," dated Dec. 6, 2011.

Standard & Poor's, a part of The McGraw-Hill Companies (NYSE:MHP), is the world's foremost provider of credit ratings. With offices in 23 countries, Standard & Poor's is an important part of the world's financial infrastructure and has played a leading role for 150 years in providing investors with information and independent benchmarks for their investment and financial decisions. For more information, visit http://www.standardandpoors.com.

Primary Credit Analysts: Geeta Chugh, Mumbai (91)22-3342-1910; geeta_chugh@standardandpoors.com

Ryan Tsang, Hong Kong (852) 2533-3532; ryan_tsang@standardandpoors.com Secondary Contacts: Ritesh Maheshwari, Singapore (65) 6239-6308;

ritesh_maheshwari@standardandpoors.com Deepali Seth, Mumbai (91) 22-3342-4186; deepali_seth@standardandpoors.com

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BIS Quarterly Review, June 2011 39 Frank Packer frank.packer@bis.org Nikola Tarashev nikola.tarashev@bis.org Rating methodologies for banks1 The three major rating agencies are reassessing banks credit risk in the light of the recent crisis. So far, this has resulted in material downgrades, especially of European and US institutions, and increased agreement about banks overall level of creditworthiness and their greater dependence on public support than in the past. The agencies are also making efforts to enhance the transparency of bank ratings and the role of official support. Agency assessments of regulatory initiatives may affect policymakers communication with financial markets. JEL classification: G21, G24, G28. In the wake of the global financial crisis, the role of the major credit rating agencies and the ratings they assign to financial institutions have come under increased scrutiny. The crisis highlighted risks that had been underestimated, brought into greater relief the value of government assistance and led public authorities to commit to an overhaul of banks regulatory and support frameworks. In response, one agency has recently proposed significant changes to its bank rating methodology, seeking public comment. Another has recalibrated the relative importance attached to rating factors. A close look at data on bank credit ratings and agency publications leads to three key findings. First, all three major rating agencies (Fitch Ratings, Moodys Investors Service and Standard & Poors) consider the

creditworthiness of large European and US banks to have worsened materially since the onset of the crisis. Second, rating agencies are currently in greater agreement about banks creditworthiness than in mid-2007, reflecting shifts in estimates of government support. Third, ongoing revisions to agencies methodologies and assessments of the financial landscape seem likely to lead to further downgrades in the banking sector. Changes to ratings methodologies can be a double-edged sword for prudential authorities. By adopting a system-wide perspective on financial risk and paying closer attention to measures aimed at reducing official support to banks, agencies seem so far to be in sync with recent policy initiatives. But 1 We would like to thank Jimmy Shek for excellent research assistance, Claudio Borio, Stephen Cecchetti, Michael Davies, Dietrich Domanski, Stephen Shevoley and Christian Upper for useful comments on earlier drafts of the article, and Emir Emiray for help with the graphs and tables. The views expressed are our own and do not necessarily reflect those of the BIS. 40 BIS Quarterly Review, June 2011 policymakers may face credibility issues in future if ratings contradict official statements eg about the authorities own assessments of banks health or the design of bank resolution plans and markets focus on these ratings. In the rest of this article, we proceed as follows. In the first section, we discuss in general terms the information that ratings convey about creditworthiness. In the second, we examine the relationship of ratings and other credit risk indicators observed before the recent crisis to banks performance during the crisis. In the third, we put this relationship in context by discussing reasons why accurate assessments of banks creditworthiness may be inherently difficult to obtain. After outlining the bank rating methodology of

each of the three major agencies in the fourth section, in the fifth we examine how actual bank ratings differ across these agencies and how they have evolved since the beginning of the crisis. We discuss policy implications in the final section, paying particular attention to the agencies recent drive towards greater transparency. Credit ratings: general background Ratings are opinions about the creditworthiness of a rated entity, be it a sovereign, an institution or a financial instrument. They reflect both quantitative assessments of credit risk and the expert judgment of a ratings committee. Thus, no rating can be unequivocally explained by a particular set of data inputs and formal rules. Ratings convey information about the relative and absolute creditworthiness of the rated entities. Agencies often emphasise that a rating reflects the creditworthiness of the rated entity relative to that of others. That said, agencies regularly publish studies that convey the historical association of ratings and indicators of absolute creditworthiness, such as default rates and the magnitude of losses at default. Moreover, in the case of structured finance products, ratings are explicitly tied to estimates of default probabilities and credit losses.2 Ratings and other credit indicators prior to the recent crisis Ahead of the financial crisis, credit ratings were not particularly successful in spotting the build-up of widespread vulnerabilities in the financial system or in identifying which institutions were most exposed to them. In particular, pre-crisis ratings would have contained useful information had they been lower for banks that subsequently resorted to stronger emergency measures, such as

capital-raising and asset sales. However, for a sample of 60 large internationally active banks, the financial strength ratings assigned by two of the major agencies in mid-2007 had a weak and positive relationship with 2 Depending on the agency or type of rated entity, some ratings are intended to convey information about default probabilities while others refer to expected credit losses. This alone limits comparisons across sectors and agencies. More generally, Fender et al (2008) argue that ratings comparability is impaired by the fact that a single rating scale cannot rank the rated entities along multiple dimensions of credit risk simultaneously. Missed vulnerabilities ahead of the crisis ... reflecting relative creditworthiness Ratings are expert opinions BIS Quarterly Review, June 2011 41 banks subsequent reliance on emergency measures (Graph 1).3 To be sure, other credit market indicators faired similarly poorly. For instance, bank CDS spreads prior to the crisis are not informative about banks performance during the crisis (Graph 2, left-hand panel). Even though these CDS spreads might be expected to relate positively to the extent of banks subsequent reliance on emergency measures, the empirical relationship is weak and negative. Hindsight points to indicators that could have improved the accuracy of pre-crisis ratings. On a system level, there is a general agreement that features of the regulatory environment and financial culture in banks home and host

Pre-crisis characteristics and in-crisis performance of large banks Credit spreads and resilience Capital and resilience 0.0 0.3 0.6 0.9 1.2 2.0 2.5 3.0 3.5 4.0 4.5 5.0 CDS spread1 Emergency measures2 0.0 0.3 0.6 0.9 1.2 6 8 10 12 14 16 Tier 1 capital ratio3 Emergency measures2 1 On log scale. 2 Sum of the values of fixed income, capital and hybrid instruments issued and assets sold from mid-2007 to end2009, divided by total equity in 2006. 3 In per cent. Sources: Bankscope; Bloomberg; Markit. Graph 2 3 Likewise, mid-2007 financial strength ratings exhibit no relation to banks profitability in 2008 and 2009, scaled by banks equity in 2007. These results pertain only to the ratings of Moodys and Fitch. Standard & Poors had published financial strength ratings only for banks in the Asia-Pacific region, whereas our sample is composed mostly of US and European

banks. Pre-crisis ratings and in-crisis performance of large banks Moodys ratings and resilience Fitch ratings and resilience 0.0 0.3 0.6 0.9 1.2 BB BB+ BBB A A+ AA AAA Financial strength rating1 Emergency measures2 0.0 0.3 0.6 0.9 1.2 BB BB+ BBB A A+ AA AAA Financial strength rating1 Emergency measures2 1 Referred to as individual rating by Fitch and bank financial strength rating by Moodys. Translated into a standard scale on the basis of mapping tables in Fitch (2010) and Moodys (2007b). 2 Sum of the values of fixed income, capital and hybrid instruments issued and assets sold from mid-2007 to end-2009, divided by total equity in 2006. Sources: Bloomberg; Fitch Ratings; Moodys Investors Service. Graph 1 42 BIS Quarterly Review, June 2011

countries such as the degree to which exposure to complex financial products was encouraged or tolerated would have provided useful information. Macroprudential indicators, based on above-trend credit growth and asset price increases, may also have been effective in pointing to a buildup of vulnerabilities.4 And in terms of bank-level characteristics, both rating agencies and markets could have paid closer attention to the level of highquality capital. Banks with high Tier 1 capital ratios in 2006 had little or no need for emergency measures during the crisis, while the largest emergency measures were taken by banks with low ratios (Graph 2, right-hand panel). It is thus not surprising that rating agencies are reviewing their assessments of banks risk in the light of the crisis. Why assessing banks creditworthiness is difficult The difficulties rating agencies, credit markets and many financial analysts had in forecasting banks performance during the recent crisis are rooted in unique features of the banking industry.5 Banks role as financial intermediaries and their importance for financial stability determine the degree of external assistance they receive and shape the risk factors to which they are exposed. Assessments of bank creditworthiness thus need to account for the degree of external support, gauge the degree of systemic risk and address the inherent volatility of banks performance. Accounting for external support: stand-alone versus all-in ratings Since banks play a key role as financial intermediaries, they often benefit not just from the support of the parent institution as any other firm would but also from that of public authorities. The recent crisis illustrated that support can come in different forms: as capital injections, asset purchases or liquidity

provisions. When there is a commitment to support the creditworthiness of a bank, be it explicit or implicit, the rating agency has to evaluate not only the ability of the parent or sovereign to honour this commitment but also their willingness to do so. And even if support can be expected to be strong most of the time, what matters is its availability when the bank needs it. This suggests that the correlation between distress of the bank and its underlying source of support should also be examined. Given the importance of external support, rating agencies generally assign at least two different ratings to banks, which in the remainder of this feature we refer to as stand-alone and all-in ratings. A stand-alone rating reflects the intrinsic financial strength of the institution and, thus, its likelihood of default, assuming that no external support is forthcoming. In addition to accounting for stand-alone financial strength, an all-in rating factors in the likelihood and 4 See, for example, Borio and Drehmann (2009). 5 For evidence that uncertainties about banks creditworthiness lead agencies to disagree more about bank ratings than about the ratings of firms in other industries, see Cantor and Packer (1994) and Morgan (2002). ... external support to banks ... Bank ratings need to account for ... BIS Quarterly Review, June 2011 43 magnitude of extraordinary external support that the bank may receive if and when it is in distress. While all-in ratings matter to banks creditors and trading counterparties, stand-alone ratings provide useful information to a prudential

authority interested in the underlying strength of institutions.6 In addition, by comparing the stand-alone rating of a bank with its all-in rating, investors can infer the agencys assessment of external support and, possibly, make adjustments to this assessment for their own use. Accounting for systemic risk The recent crisis has underscored the need for a holistic approach to assessing bank risk. In particular, it has become clear that the creditworthiness of a bank depends on vulnerabilities that may build up in different parts of the financial system, as well as on interlinkages in this system. Thus, a banks rating should not be derived in isolation but should reflect the industrial, financial and economic context of the banks business. Adopting a system-wide perspective is not straightforward. First, there has to be an operational definition of the relevant system, which gives rise to a tension between the desire to be comprehensive and the need to be practical. Should the system comprise only banks or also other financial institutions to which the bank is linked, or should it be expanded even further? And should it be limited geographically to the home country or cover all the countries in which a given bank operates? What is the right approach to analysing internationally active banks that fund themselves in one part of the world while the liquidity of their investments depends on financial conditions in another? Second, even when the relevant system is defined, there is no agreed formal metric for assessing systemic risk. The literature has proposed a number of model-based measures that are either overly stylised or quite dataintensive and difficult to communicate to the general public. As an alternative to model-based measures, rating agencies often rely on leading indicators based

on empirical regularities that signal the build-up of vulnerabilities in the system, such as high credit growth and asset price increases.7 Accounting for earnings volatility Another reason banks creditworthiness is especially hard to assess is that their earnings performance is highly volatile, not least because of structurally high leverage. For instance, on the back of leverage roughly five times that of firms in other sectors, the volatility of returns on banks stocks over the past several decades has been consistently higher than that of non-financial stocks (BIS (2010), Chapter VI). Evaluating the outlook for banks earnings the key source of loss-absorbing capital is a critical component of bank credit analysis. It is important to evaluate not only the extent to which a banks 6 That said, when one bank has a credit exposure to another bank, it is common practice to use the all-in rating of the second in assessing the risk-weighted assets of the first for regulatory requirements. 7 See Drehmann and Tarashev (2011) and Borio and Drehmann (2009). ... and large uncertainties about banks performance ... banks financial and regulatory environment ... 44 BIS Quarterly Review, June 2011 earnings can absorb adverse shocks, but also how far investors would allow the bank to retain more earnings through reduced dividend payouts when raising fresh capital is difficult. Banks that wait too long to increase earnings

retention may be particularly unstable, as the speed at which distress unfolds can overwhelm banks concurrent earnings capacity. Agencies use this argument to explain why they consider banks that consistently retain a greater share of their earnings during tranquil times as more creditworthy. Agency methodologies This section discusses sequentially the rating methodologies of the three major rating agencies. The discussion is condensed in Table 1. Fitch Ratings8 The Fitch methodology provides stand-alone ratings (which the agency calls individual ratings) and, for ease of comparison, a mapping table for translating them into the scale of the more granular all-in ratings (issuer default ratings). To enhance the transparency of all-in ratings, Fitch also publishes separate ratings on a five-point scale designed to capture the likelihood and magnitude of external support either from the state or from an institutional owner (support ratings). In cases where these support ratings reflect potential assistance from the state, Fitch announces a support rating floor utilising the same scale as the all-in ratings scale. The all-in rating is then the higher of the stand-alone rating and the support rating floor. Fitch intends to make the link between its stand-alone and all-in bank ratings more transparent than in the past. In mid-2011, it will convert its ninepoint stand-alone ratings scale into a 19-point scale that corresponds exactly to that of all-in ratings. The new stand-alone scale will provide both more granularity on Fitchs financial strength assessments and clarity on the specific benefits of support. Even though Fitch was the first major rating agency to engage in explicit

assessments of systemic risk and to provide ratings for national banking systems, these assessments are used as input to its sovereign ratings rather than directly in the calibration of individual bank ratings. In 2005, Fitch introduced two systemic risk measures, each of which characterises the economic and financial stability of a country. The first incorporates a bottom-up approach, as it equals the system-wide average of individual banks standalone ratings. The second is based on macroprudential indicators designed to capture abnormal growth of bank credit to the private sector and unusually strong asset price increases, drawing explicitly on Borio and Lowe (2002). A combination of weak scores on both measures is viewed as most worrisome. 8 This subsection draws on Fitch Ratings (2005, 2010, 2011). Fitchs assessment of external support ... ... will become more transparent BIS Quarterly Review, June 2011 45 Moodys Investors Service9 In 2007, ahead of the financial crisis, Moodys introduced a new bank rating methodology, called joint default analysis (JDA). Motivated by studies showing that the default frequency of banks was consistently lower than that of non-bank corporates with similar ratings, JDA analysed more systematically the external support available to banks. The methodology takes stand-alone ratings (called bank financial strength ratings) as its starting point. Then, in order to arrive at all-in ratings (issuer ratings), it sequentially assesses four

types of support operating parent, cooperative group, regional government and national government and adjusts the stand-alone rating accordingly. For each type of support, the all-in rating reflects the guarantors capacity to provide support (as captured, for example, by its rating), its willingness to 9 This subsection draws on Moodys Investors Service (2007a, 2007b, 2009). Rating methodologies for banks Fitch Moodys Standard & Poors1 Stand-alone assessments (intrinsic financial strength) Focus on off-balance sheet commitments, funding and liquidity risk Emphasis on forwardlooking assessments of capital ratios, based on embedded expected losses Focus on risk-adjusted performance and ability to grow capital from profits All-in ratings (with external support) Distinct ratings of sovereign support

provide a floor Based on a joint default analysis of banks and providers of support Anticipated support increases with the banks systemic importance System-wide assessment Country rating Based on: - macro indicators - average bank rating None Based on: - macro indicators - industry and regulatory environment Does systemic risk affect banks ratings? Not explicitly; anticipated support increases with the banks systemic importance but falls in times of generalised distress Not explicitly; anticipated support increases with

the banks systemic importance Yes, through: - macro indicators for countries where the bank operates - assessments of the industry and regulatory environment in the home country Last major changes 2005: systemic risk analysis 2007: joint default analysis in support assessment 2011: overhaul of the rating methodology. Greater emphasis on: - system-wide risks - link from earnings to capital 1 Refers to the agencys proposed methodology for bank ratings, as outlined in Standard & Poors (2011). Table 1 Moodys ratings for banks have reflected ...

46 BIS Quarterly Review, June 2011 provide support and the probability that it is in default when the bank needs support (or the joint default probability). In contrast to the other two agencies discussed here, Moodys does not publish a specific summary measure of banking system risk. That said, publications of the rating agency implicitly acknowledge that background assessments of a banks role in, and exposure to, systemic risk are natural inputs when estimating the extent of support from national authorities. On the one hand, given the fiscal costs involved, the agency expects national authorities to be less able to provide support to a bank that shares common exposures with the rest of the system and thus is more likely to need support at a time of general distress. On the other hand, it expects them to be more willing to provide support when the institution is more systemically important, since its failure could have stronger adverse knock-on effects on other banks. Moodys reaction to the global financial crisis has been to recalibrate the relative importance attached to certain rating factors. A notable example is the weight on support from national authorities, which changed as the crisis evolved. During most of the crisis, the willingness of national authorities to provide all-encompassing support turned out to be stronger than Moodys had originally expected. This translated into a wider gap between all-in and standalone ratings. At the same time, the depth of the crisis has raised questions about the ability of some sovereigns to provide support and has prompted the international policy community to express clearly the intent to wean banks off extraordinary support. Thus, in recent publications, Moodys has forecast a

decline in the weight it will assign to government support in the future. In particular, in reviewing the level of systemic support available for banks in non-AAA sovereigns, it has described in detail the parameters that affect its assessment of governments ability to provide support. In many cases, the revisions are likely to worsen all-in ratings. Lessons from the crisis have also led Moodys to revise its assessment of stand-alone strength. The agency has indicated its intention to put a greater emphasis on forward-looking assessments of bank capital ratios, based on analyses of expected losses for risk assets in stress scenarios. Standard & Poors10 Standard & Poors is the agency that has proposed the most significant revisions to its methodology since the financial crisis, though they are not yet final. In addition, it plans to enhance the transparency of its bank ratings, broadening the set of banks for which it publishes stand-alone credit risk assessments (called stand-alone credit profiles). This will allow investors to gauge the role of support in determining Standard & Poors all-in ratings (issuer ratings). The stand-alone risk profiles that Standard & Poors intends to assign to banks will be based on so-called anchor profiles, which themselves draw on 10 This subsection draws on Standard & Poors (2010, 2011). The latter publication contains criteria proposals that are still being reviewed and are likely to be finalised in late 2011. S&P intends to overhaul its bank ratings methodology ... changing

perceptions of government support BIS Quarterly Review, June 2011 47 Banking Industry Country Risk Assessments (BICRA). First, the agency will assess the industry and economic/financial risks in a given country and combine them to form the BICRA. Then, focusing on a particular bank, it will obtain: (i) the industry risk component of the BICRA score of the banks home country; and (ii) a weighted average of the economic/financial risk components of the BICRA scores of all the countries in which the bank operates. Combining the two will lead to the banks anchor profile. Finally, bank-specific strengths and weaknesses will guide the mapping of the anchor profile into the banks own stand-alone risk profile. Standard & Poors has also signalled changes to its bank-specific analysis. Among other things, it intends to align stand-alone risk profiles better than in the past with the degree of uncertainty surrounding banks performance. The agency plans to accomplish this by placing less emphasis on diversification benefits and more on the risks related to off-balance sheet derivatives and structured finance instruments. Earnings analysis will focus on risk-adjusted performance and ability to use retained profits to increase the banks level of capital. In addition, in determining the role of extraordinary external support in all-in ratings (including both government and group support), Standard & Poors will pay particular attention to banks systemic importance and governments tendency to support banks. All else equal, greater systemic importance would lead to a better all-in rating. The proposed revisions to Standard & Poors methodology are likely to

change its bank ratings significantly. In a preliminary analysis of a sample of 138 banks, the agency found that 42% experienced no rating change, around 33% were downgraded by one notch or more, and 22% were upgraded by one notch or more. According to Standard & Poors, the greater emphasis on system-wide risk factors would affect the geographical distribution of potential rating actions. In particular, Asian (excluding Australian and New Zealand) banks would tend to be upgraded, while European banks would tend to be downgraded. Ratings differences We collected data on ratings that Moodys, Standard & Poors and Fitch assigned to 70 large banks before the recent financial crisis (mid-2007) and after it (April 2011), and examine these ratings from two perspectives. First, we look for indications that methodological differences across the rating agencies have resulted in different ratings of the same banks. (Given the two points in time we consider, we can only identify differences among the agencies that have manifested themselves after the most recent change in Moodys methodology and before Standard & Poors implementation of its recent proposal.) Second, we investigate how bank ratings have evolved since the crisis began. We pay special attention to differences across geographical regions and countries and to agencies assessments of external support. Differences among rating agencies Ratings differences across agencies are rather pronounced in our sample. In fact, cases where all three agencies assign the same all-in rating comprise only Disagreements among rating agencies ...

48 BIS Quarterly Review, June 2011 8% of the banks jointly rated by the agencies. At the same time, a full 33% of these banks have ratings that span a gap of two notches or more.11 Rating agencies have disagreed not only at the level of individual banks but also in systematic ways across banks. At least at the two points in time we consider, Moodys has consistently assigned higher all-in and stand-alone ratings than the other two major agencies (Table 2). The all-in ratings assigned by Moodys in mid-2007 were roughly 1.5 notches higher on average than those assigned by Standard & Poors and Fitch. This difference has recently declined, and stood at around one notch in April 2011. By contrast, the wedge between the stand-alone ratings assigned by Moodys and Fitch (the other agency publishing similar ratings) has remained quite stable since 2007, ranging between 1.3 and 1.4 notches. Taken together, these findings suggest that the convergence in all-in ratings is due to evolving views of external support, as opposed to banks inherent financial strength.12 Comparing pre- and post-crisis ratings The financial crisis has resulted in significant downgrades of many large banks by all major agencies, which is hardly a surprise. Over the last four years, the all-in ratings assigned by Standard & Poors to 62 banks in our sample have declined on average by six tenths of a notch, from an average rating of A+ to an average rating between A and A+ (Table 3). The declines have been similar on average in the case of Fitch. Moodys has moved even more sharply since the crisis began, lowering bank all-in ratings by twice as much as the other two agencies. 11 For the numerical examples, we convert ratings into numbers as follows: AAA = 20, AA+ = 19,

AA = 18, , C = 0. A notch is the difference between two adjacent ratings. 12 In the case of covered bonds, ratings differences in 2007 arose primarily from differences of opinion concerning the protection offered by the cover and its structure rather than from different assessments of bank default risk. See Packer et al (2007). Differences across rating agencies1 Averages of notch differences All-in ratings Stand-alone ratings Mid-2007 April 2011 Mid-2007 April 2011 Moodys vs Fitch 1.59 (54) 0.82 (56) 1.26 (64) 1.44 (62) Moodys vs S&P2 1.63 (57) 1.04 (57) Fitch vs S&P2 0.12

(60) 0.28 (60) A stand-alone (or financial strength) rating is referred to as an individual rating by Fitch and as a bank financial strength rating by Moodys. An all-in rating, which accounts for financial strength and external support, is referred to as a long term issuer default rating by Fitch and an issuer rating by Moodys and Standard & Poors. Stand-alone ratings are translated into the all-in ratings (standard) scale on the basis of mapping tables in Fitch (2010) and Moodys (2007). Then ratings are translated into numbers as follows: AAA = 20, AA+ = 19, AA = 18, , C = 0. A notch is the difference between two consecutive ratings. 1 The number of banks, for which a particular average is calculated, is reported in parentheses. 2 S&P stand-alone ratings not available. Sources: Fitch Ratings; Moodys Investors Service; Standard & Poors. Table 2 Downgrading of banks ... have diminished since the crisis BIS Quarterly Review, June 2011 49 The downgrading of the global financial system masks some striking differences across geographical regions. All three major agencies have substantially lowered the ratings of US and European banks, reflecting these

institutions position at the epicentre of the global financial crisis (Table 4). By contrast, the rating agencies lowered their assessments of the creditworthiness and financial strength of Asia-Pacific banks very little, if at all. The recent crisis also prompted the three agencies to reassess the external support available to banks. As the crisis unfolded, all-in ratings fell by less on average than stand-alone ratings. Thus, despite questions concerning the willingness and capacity of sovereigns to provide support to banks going forward, they currently contribute to a greater gap between stand-alone and all-in ratings than in mid-2007. Again, this is a phenomenon driven principally by banks in Europe and the United States, where external support has improved ratings by three notches on average most recently, from about two in 2007. At the country level, the percentage change in the ratings improvement due to external support has been largest for US and UK banks (Graph 3). Bank ratings before the crisis and now1 Averages across banks Mid-2007 April 2011 Change (number of notches) S&P2 Moodys Fitch S&P2 Moodys Fitch S&P2 Moodys Fitch All-in ratings A+ (65) AA (58) A+/AA (62) A/A+

(65) A+/AA (61) A+ (63) 0.6 (62) 1.28 (58) 0.54 (61) Stand-alone ratings A (70) A (64) BBB+/A (70) BBB (62)

1.54 (69) 1.75 (62) 1 See Table 2 for a definition of stand-alone and all-in ratings and an explanation of how they are mapped into numbers. The number of banks for which a particular average is calculated is reported in parentheses. 2 S&P stand-alone ratings not available. Sources: Fitch Ratings; Moodys Investors Service; Standard & Poors. Table 3 Rating changes, by region1 Averages across banks Europe2 United States Asia-Pacific3 S&P4 Moodys Fitch S&P4 Moodys Fitch S&P4 Moodys Fitch All-in ratings 1.06 (33) 1.69 (35) 0.83 (36) 1.83 (6) 1.71 (7) 1.33 (6) 0.40

(15) 0.33 (9) 0.36 (11) Stand-alone ratings 2.39 (36) 2.80 (32) 3.93 (7) 2.42 (6) 0.44 (18) 0.25 (16) 1 Between mid-2007 and April 2011. See Table 2 for a definition of stand-alone and all-in ratings and an explanation of how they are

mapped into numbers. The number of banks for which a particular average is calculated is reported in parentheses. 2 Refers to banks headquartered in 13 European countries. 3 Refers to banks headquartered in Australia, China, India and Japan. 4 S&P stand-alone ratings not available. Sources: Fitch Ratings; Moodys Investors Service; Standard & Poors. Table 4 Increased value of official support notably in Europe and the US 50 BIS Quarterly Review, June 2011 The future of bank ratings The downgrading of the banking sector, which started during the course of the recent financial crisis, is likely to continue. The key reasons for this are lessons learned from the recent crisis about systemic risk and the volatility of banks performance, weakened finances of some sovereign providers of support, and policy initiatives to wean banks off official support. Downgrading banks for such reasons could put strain on the sector in the short term, but would also place it on a long-term path towards a sustainable risk profile. In the short term, downgrades can reduce banks capital-raising capacity, just as they emerge from the crisis with weakened balance sheets and the need to meet stricter regulatory requirements. That said, ratings that reflect changes to regulatory and support frameworks and accurately capture banks vulnerabilities would help strengthen market discipline and align risk with funding costs. This would lead to a healthier banking sector in the long term.

Of course, changes to bank ratings be they driven by a methodological overhaul or a simple recalibration of the ratings model will be consequential only to the extent to which they affect financial decisions. The financial crisis has given rise to policy initiatives that aim to weaken the reliance of regulators and investors on rating agencies.13 That said, it is not obvious that market players, especially those facing expertise constraints, will find viable alternatives to ratings provided by the major agencies. 13 See, for example, Dodd-Frank Act (2010) and Financial Stability Board (2010). Stand-alone ratings and the importance of external support1 Moodys Fitch BB BB+ BBB A A+ AA AAA DE FR CH GB IT ES US CA JP AU BB BB+ BBB A A+ AA AAA

DE FR CH GB IT ES US CA JP AU Stand-alone ratings External support DE = German banks (8; 8); FR = French banks (4; 2); CH = Swiss banks (2; 2); GB = UK banks (5; 5); IT = Italian banks (3; 3); ES = Spanish banks (4; 3); US = US banks (7; 6); CA = Canadian banks (5; 5); JP = Japanese banks (5; 3); AU = Australian banks (4; 4). The first figure in parentheses refers to the number of banks rated by Moodys, and the second to the number rated by Fitch. 1 For each country, the first bar plots average ratings in mid-2007, and the second those in April 2011. The stand-alone rating plus the rise due to external support equals the all-in rating. See Table 2 for a definition of stand-alone and all-in ratings and an explanation of how they are mapped into numbers for the calculation of averages. Sources: Fitch Ratings; Moodys Investors Service. Graph 3 BIS Quarterly Review, June 2011 51 To the extent that rating agencies maintain their pre-crisis role in the financial landscape, they will influence the effectiveness of prudential authorities communication with financial markets. More transparent ratings will convey more explicit assessments of the external support available to banks. Any doubts expressed about policy initiatives to restrict external support and to put in place effective resolution schemes could undermine official statements to the contrary. Conversely, convincing agencies of the irreversibility of these policy initiatives could contribute to a smooth transition to new regulatory and support frameworks for banks.

Pranabs deficit target unattainable, says S&P Standard & Poors Ratings Services is not happy with Pranab Mukherjees fiscal consolidation plan. On Friday, the credit rating agency said, Indias budget for the fiscal year ending March 31, 2013, would be mildly negative for the unsolicited sovereign credit rating on India (BBB-/Stable/A-3).

Though the finance minister had announced various fiscal measures to tackle the deficit, there was no clear path on when the direct tax code or goods and service tax could come into effect. There was no clarity even on the exact measures to contain subsidy disbursal which would be crucial to bring down subsidies.

In addition, Indias deficit in the next fiscal year is likely to remain high, and uncertainty surrounds the path to subsidy consolidation and to lowering fiscal vulnerability to volatile commodity prices, the note said. Basically crude oil prices are still high and the finance minister himself said the prices could be around $115 per barrel. High commodity prices will keep fuel subsidies high and unless there is a clear roadmap for curbing expenditure, fiscal deficit numbers will keep bothering the economy.

S&P believes Indias nominal GDP growth will most probably exceed the ratio of general government deficits to GDP in the coming fiscal year. Based on our calculations, we expect Indias debt-to-GDP ratio to fall to 74.7 percent in 2012-2013, from 74.9 percent in 2011-2012, it said in a note.

According to the budget, Indias fiscal deficit will be 5.1 percent of GDP in fiscal 2012-2013, compared with 5.9 percent of GDP in the current fiscal year. Both metrics fall short of the 13th financial commissions fiscal consolidation targets of 4.2 percent of GDP in the coming fiscal year and 4.8% of GDP in the current fiscal year. The ratios are also lower than the governments targets in its five-year plan of 4.1 percent in fiscal 2012-2013 and 4.6 percent in fiscal 2011-2012.

S&P adds that governments fiscal deficit targets seem unbelievable given the general elections in 2014. Clubbing the number along with that of the states, S&P says, the budget deficit could be 8 percent in the coming fiscal year, compared with about 8.5 percent in the current fiscal year.

Slowdown puts banks at risk, says S&P

NPAs of banks will be 2.9% of gross advances Banks in India are at risk due to deteriorating asset quality, falling margins, dull credit growth and a drop in profitability in a slowing economy. Credit rating and research agency Standard & Poors has warned that while ratings for Indian banks will remain stable due to capital support from the government, their operating performance will come under threat due to a rise in delinquencies and dip in return on assets (ROA).

The report did not provide any figure as to how much deterioration does it expect in asset quality over the next financial year, except for saying that it will rise. During this financial year, it said, gross NPAs of banks would be 2.9 per cent of gross advances.

High fiscal deficit and inflation are keeping interest rates high and the liquidity tight. Infrastructure loans that led credit growth for most banks are slowing down. Deteriorating asset quality and a high amount of restructured assets are a bane for most banks, said Geeta Chugh, a credit analyst with S&P.

The agency rates about 10 banks in India, three of which are in the private sector. It said ratings for all these banks are expected to remain stable, as recapitalisation by the government will be a big support for them.

However, the report said standalone credit profiles of a few banks could weaken due to a drop in asset quality and earnings. Ratings of public sector banks, which run a higher risk of asset quality deterioration, could benefit due to a very high likelihood of government support. Such support underpins the stable outlook on ratings of Indian banks, it said.

RK Bansal, executive director of IDBI Bank, said, Rising NPAs are the result of a slowing economy. When the economy is slowing, profitability for many companies are also under pressure, which results in their inability to service debt, forcing banks to report higher delinquencies.

S&Ps ratings services has lowered Indias GDP growth forecast to 6.8 per cent for FY12 and to 6.5 per cent for FY13. A potential recession in the euro zone would lower Indias exports and foreign investments. The European belt accounts for nearly 15 per cent of Indias merchandise exports.

Infrastructure funding, which was leading credit growth, has slacked, resulting in the weakening of credit growth to 16 per cent and 17 per cent (projected) in FY12 and FY13 from 23 per cent in FY11.

Standard & Poors expects net interest margins of banks to remain tight over the next financial year as well, due to intensifying competition, low credit growth and borrowers limited ability to absorb higher interest rates.

The proposed Reserve Bank of India (RBI) guidelines for the implementation of Basel III norms could strengthen capitalisation of banks, the report said. TEXT-S&P Says Operating Performance Of Indian Banks Will Stay Weak

(The following was released by the rating agency)

MUMBAI (Standard & Poor's) March 13, 2012--The operating performance of some Indian banks is likely to remain weak in the fiscal year ending March 31, 2013. The economy's slower growth than in recent years, a dip in credit growth, rising delinquencies, and tighter margins could cause a deterioration in performance. That's according to a report titled, "India Banking Outlook: Economic Headwinds Are Likely To Lower Asset Quality And Earnings In 2012," that Standard & Poor's Ratings Services published recently.

"The asset quality of Indian banks is likely to remain weak, or even deteriorate, due to the moderation in economic activity, high inflation, and high interest rates," said Standard & Poor's credit analyst Geeta Chugh. "We expect restructured loans to rise in fiscal years 2012 and 2013. Small and midsize companies are particularly vulnerable."

According to the report, credit growth in India is likely to weaken to 16%-17% in fiscal years 2012 and 2013, from about 23% in fiscal year 2011. Standard & Poor's expects net interest margins of Indian

banks to remain tight in fiscal year 2013 due to intensifying competition amid low credit growth, and borrowers' limited ability to absorb higher interest rates.

The report noted that the stand-alone credit profiles of a few Indian banks could weaken due to a decline in asset quality and earnings. The ratings on government-owned banks, which face greater exposure to asset quality deterioration, could benefit from a "very high" likelihood of government support.

Such support underpins the stable outlook on the ratings on Indian banks. Proposed guidelines of the central bank, Reserve Bank of India (RBI), for implementing Basel III in India could strengthen the capitalization of banks in the country, the report said.

"We expect all the banks that we rate in India to meet the RBI's Basel III capital adequacy requirements on time," said Ms. Chugh. "Post implementation of Basel III, Indian banks' risk-adjusted capital could move up by at least 100-200 basis points. This could strengthen the credit profiles of domestic banks over the next three to five years."

The report pointed out that Indian banks also benefit from the good long-term economic growth prospects of the economy. Over a longer period, the growth in business should enable banks to maintain sound financial health. SBI rating unaffected by weakening loan quality: S&P Global rating agency Standard & Poor's today said that its rating on SBI is not affected by the significant slippage in the bank's loan quality. "We anticipate that SBI's credit provisioning costs for the fiscal year ending March 31, 2012, will not be significantly higher than the projected credit losses based on our risk-adjusted capital framework," S&P said in a statement.

The bank's credit losses have been significantlyhigher than domestic peers' so far in fiscal 2012, it said. "We expect SBI's stand-alone credit profile (SACP) to underpin the rating. The jump in SBI's nonperforming assets and credit losses could pressure our current "adequate" assessment of its risk position. This could, in turn, strain the bank's SACP, which we assess at 'bbb'," it said.

"Nevertheless, SBI's SACP has adequate cushion to absorb some slippage in loan quality. We therefore believe it is unlikely that the SACP will fall to 'bb', which is our downward rating trigger," it said. On a standalone basis, it said, SBI's reported ratio of gross nonperforming assets to gross advances increased to 4.61 per cent at the end of December 2011, from 4.19 per cent at the end of September 2011. The ratio was 3.28 per cent at the end of March 2011, it said.