e

A PROJECT REPORT ON

CREDIT RATING

SUBMITTED BY:-

AASTHA. V. JAGAD

T.Y.B.M.S. [SEMESTER V]

MITHIBAI COLLEGE OF MANAGEMENT

VILE PARLE (W), MUMBAI - 400 056

SUBMITTED TO

UNIVERSITY OF MUMBAI

ACADEMIC YEAR

2012-2013

PROJECT GUIDE

MR. NAVEEN ROHATGI

DATE OF SUBMISSION

25TH JULY, 2012

ACKNOWLEDGMENT

At the outset I would like to take the privilege to convey my gratitude to all those who co-operated, supported, helped and suggested me as to how the project could be completed. This project bears imprint of advices, from many people who were either directly or indirectly involved in it

The Internet has been a veritable treasure throve of information .The websites and the information they contained helped me to do the project in a much easier and better manner.

I am also desirous of placing on record profound indebtness to my guide Prof. Naveen Rohatgi for his valuable advices, guidance, precious time and support that he lent to me.

DECLARATION

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

of TYBMS [Semester VI] hereby declare that I have completed my project, titled

‘CREDIT RATING’ in the Academic Year 2012-2013. The information

submitted herein is true and original to the best of my knowledge.

__________________________

Signature of Student

[Aastha.V.Jagad]

CERTIFICATE

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

Mithibai College of TYBMS [Semester VI] has completed her project, titled

‘CREDIT RATING’ in the academic year 2012-2013. The information submitted

herein is true and original to the best of my knowledge.

_______________________________ ______________________

Signature Of The Principal Signature Of The Project Guide

[Dr. Kiran V. Mangaonkar] [Mr. NAVEEN ROHATGI]

______________________

Signature of External Examiner

TABLE OF CONTENTS

INTRODUCTION....................................................................................................................................................................... 1

CREDIT RATING- MEANING............................................................................................................................................2

FEATURES.....................................................................................................................................................................................5

IMPETUS........................................................................................................................................................................................ 6

ORIGIN............................................................................................................................................................................................ 7

THE CREDIT RATING SYSTEM......................................................................................................................................9

CREDIT RATING AGENCY..............................................................................................................................................12

CREDIT RATING SYMBOLS...........................................................................................................................................17

CORPORATE CREDIT RATING....................................................................................................................................21

IPO GRADING/RATING..................................................................................................................................................... 23

SOVEREIGN CREDIT RATINGS...................................................................................................................................27

INDIVIDUAL CREDIT RATING IN INDIA..............................................................................................................30

USES OF RATINGS................................................................................................................................................................ 35

FUTURE OF CREDIT RATING IN INDIA................................................................................................................43

BENEFITS OF CREDIT RATING...................................................................................................................................43

NEED AND IMPORTANCE OF CREDIT RATING..............................................................................................46

PRACTICAL PROBLEMS WITH CREDIT RATING..........................................................................................49

REGUALTORY FRAMEWORK......................................................................................................................................51

SEBI GUIDELINES.................................................................................................................................................................53

REGISTRATION OF CREDIT RATING AGENCY..............................................................................................53

CODE OF CONDUCT............................................................................................................................................................58

COMPARISON OF REGULATIONS RELATED TO CREDIT RATING AGENCIES IN INDIA AND OTHER COUNTRIES................................................................................................................................................61

STANDARD & POOR'S........................................................................................................................................................64

CRISIL SME RATINGS:......................................................................................................................................................68

RECENT CREDIT RATING ARTICLES AND ACTIVITIES IN INDIA....................................................76

CONCLUSION...........................................................................................................................................................................79

BIBLIOGRAPHY..................................................................................................................................................................... 80

EXECUTIVE SUMMARY

A credit rating is an opinion from a credit rating agency about the creditworthiness of an issuer or

the credit quality of a particular debt instrument. Primarily, the rating opinion considers how likely

the issuer of the debt instrument is to meet its stated obligations, and whether investors will receive

the payments they were promised. A failure to meet such payments may be considered a default.

Credit rating agencies are placed as intermediate between investors and issuers of fixed income

securities. Their most important role is to minimize the existence of asymmetric information in the

marketplace. The role is central in operating the financial products has provided the credit rating

agencies with a tremendous power.

Despite the powerful position, is the credit rating industry subject to very weak regulation? The

credit rating agencies are by them self supposed to manage potential pitfalls in the rating process and

rating system. They are said to be self-controlled as no authority control how the agencies manage to

avoid potential pitfalls. The weak regulation and self-control provides the agencies with a high level

of freedom.

The mixture of power and freedom is a dangerous combination, if not managed well. The agencies

need to be fully aware of the responsibilities that naturally follow power and freedom. If they don’t

act as a responsible intermediate and perform trustworthy, the market will loose its faith to the

system.

CREDIT RATING

INTRODUCTION

The removal of strict regulatory framework in recent years has led to a spurt in the number of

companies borrowing directly from the capital markets. There have been several instances in the

recent past where the "fly-by-night operators have cheated unwary investors. In such a situation, it

has become increasingly difficult for an ordinary investor to distinguish between 'safe and good

investment opportunities' and 'unsafe and bad investments'. Investors find that a borrower's size or

names are no longer a sufficient guarantee of timely payment of interest and principal. Investors

perceive the need of an independent and credible agency, which judges impartially and in a

professional manner, the credit quality of different companies and assist investors in making their

investment decisions. Credit Rating Agencies, by providing a simple system of gradation of

corporate debt instruments, assist lenders to form an opinion on -the relative capacities of the

borrowers to meet their obligations. These Credit Rating Agencies, thus, assist and form an integral

part of a broader programme of financial disintermediation and broadening and deepening of the

debt market.

Credit rating is used' extensively for evaluating debt instruments. These include long-term

instruments, like bonds and debentures as well as short-term obligations, like Commercial Paper. In

addition, certificates of deposits, inter-corporate deposits, structured obligations including non-

convertible portion of partly Convertible Debentures (PCDs) and preferences shares are also rated.

The Securities and Exchange Board of India (SEBI), the regulator of Indian Capital Market, has now

decided to enforce mandatory rating of all debt instruments irrespective of their maturity.

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CREDIT RATING- MEANING

A credit rating estimates the credit worthiness of an individual, corporation, or even a country. It

is an evaluation made by credit bureaus of a borrower's overall credit history. A credit rating is

also known as an evaluation of a potential borrower's ability to repay debt, prepared by a credit

bureau at the request of the lender. Credit ratings are calculated from financial history and current

assets and liabilities. Typically, a credit rating tells a lender or investor the probability of the

subject being able to pay back a loan.

Definition

According to the Moody’s, “A credit rating is an opinion on the future ability and legal obligation

of the issuer to make timely payments of principal and interest on a specific fixed income security.

The rating measures the probability that the issuer will default on the security over its life, which

depending on the instrument, may be a matter of days to 30 days or more. In addition, long term

ratings incorporate an assessment of the expected monetary loss, should a default occur.

According to Standard & Poor’s, “Credit rating help investors by providing an easily

recognizable, simple tool that couples a possibly unknown issuer with an informative and

meaningful symbol of credit quality”

A poor credit rating indicates a high risk of defaulting on a loan, and thus leads to high interest rates

or the refusal of a loan by the creditor.

The following are few factors that contribute to an individuals credit score.

These are conditions that you have to avoid starting from getting your credit card application

approved.

1. When you make late payments, this affects 35% of your credit score negatively. Your creditor

informs your credit bureau and this affects your credit score. Make regular pays to avoid this.

It’s the only way to keep that 35%.

2. Worst of the factors that determine your credit score is when you don’t pay at all.

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3. When you make a loan default. This is when you were not able to comply with the terms and

conditions.

4. When you have a longer credit history, it is better. 15% of your credit score is from the duration

of your credit history. You might not be so much in control of this factor that contributes to your

credit score because your history depends on the number of years you have been with a social

security number.

5. Another factor that determines credit score is that when you are charged off your account because

your creditors know that you really don’t want to pay, you will watch your credit score

backslide.

6. Lenders can send an account charged off to collection agencies. These agencies do the work of

getting you pay your bills. Yes, they could harass you just so you go with what your lenders

wanted and what you are supposed to do in the first place. Be careful with charge offs because

they are minor factors that contribute to your credit score yet they are significant.

7. Of the many factors that contribute to your credit score, when the court intervenes because you

cannot pay your bills, your credit history and score is affected negatively because you will be

considered bankrupt.

8. When you file for bankruptcy yourself, this becomes a factor that contributes to your credit

score. This is not the best last option to get out of debt. These three following, better, few solutions

are more favorable ways:

· Credit counseling

· Debt settlement

· Debt management program

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

contributing to credit score negatively.

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10. Higher credit card balances will lead to credit card utilization. Remember that you should not

exceed your credit limits. Exceeded credit card limits is said to be a major factor contributing to

credit score negatively for over 90% of Americans with bad credit.

11. Connected to the previous factor contributing to bad credit is when you maxed out your credit

limit.

12. If you close your credit when it still contains balances, lenders will get the impression that the

limit is maxed out.

13. 10% of your credit score is from your credit inquiries or when you apply for multiple loans or

credit cards. In a short period of time, when you do credit card application several times, is not a

good thing for your score. It ruins it more.

All these are activities reported in your credit bureaus and are all recorded in your credit history.

These are crucial and must not be taken for granted. Each step you make in your credit deserves

proper thinking; otherwise, it will be a factor that contributes to your credit score negatively

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FEATURES

Following are the characteristic features of credit rating

Specificity

The rating is specific to a debt instrument. It is intended as a grade and an analysis of the credit risk

associated with that particular instrument. Rating is neither a general purpose evaluation of the

issuer, nor an overall assessment of the credit risk to be involved in all the debts contracted by such

an entity.

Relativity

The rating is based on relative capability and willingness of the issuer of the instrument to service

debt obligations (both principal and interest), in accordance with the terms of the contract.

Guidance

The rating primarily aims at furnishing guidance to the investors/creditors in determining a credit

risk associated with a debt instrument/credit obligation.

Not a recommendation

The rating does not provide any sort of recommendation to buy, hold or sell an instrument, since it

does not take into consideration, factors such as market prices, personal risk preferences and other

considerations which may influence an investment decision.

Broad parameters

The rating process is based on certain broad parameters of information supplies by the issuer, and

also collected from various other sources, including personal interactions with various entities.

No guarantee

The rating furnished by the agency does not provide any guarantee for the completeness or accuracy

of the information on which the rating is based.

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Qualitative and quantitative

While determining the rating grade, both quantitative as well as qualitative factors are employed.

The judgment is qualitative in nature, and the role of quantitative analysis is limited to assist in the

making of the best possible overall judgment

IMPETUS

The credit rating system originated in the United States in the seventies. The high levels of default,

which occurred after the Great Depression in the U.S Capital markets, gave the impetus for the

growth of credit rating. The default of $82 million of commercial paper by Penn Central in the year

1970, and the consequent panic of investors in commercial paper, resulted in massive defaults and

liquidity crisis. This prompted the capital issuers to get their commercial paper programs rated by

independent credit agencies. This according to them would give the required degree of comfort and

reassurance to their investors. Moreover, the real impetus for growth came when regulatory agencies

in the U.S made rating mandatory for institutions such as Government Pension Funds and Insurance

Companies, who could not buy securities rated below a particular grade. In addition, investors

themselves became aware of the rating mechanism, and started using ratings as extensively as a tool

for risk assessment. Merchant bankers, underwriters and other intermediaries involved in the debt

market also found the rating useful for planning and pricing the debt instruments.

Over the last two decades there have been many other factors that have contributed to the growth

and importance of the credit rating system in many parts of the world. They are:

The increasing role of capital and the money markets consequent to disintermediation.

Increased securitization of borrowing and lending consequent to disintermediation

Globalization of the credit market

The continuing growth of information technology

The growth of confidence in the efficiency of the market mechanism

The withdrawal of government safety nets and the trend towards privatization

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ORIGIN

Credit rating has its origin in the financial crisis of the U.S. in 1837. Louis Tappan established the

first mercantile credit agency in New York in1841. The agency was used to assess the ability of

merchants to pay their financial obligations. Later on, it was acquired by Robert Dun, and its

first rating guide was published in 1859. In 1849, John Bradstreet set up similar agency, and it

published ratings book in 1857. In 1933, these two agencies were merged together to form Dun and

Bradstreet, which finally acquired the ‘Moody's Investors services’ in 1962.it is interesting to note

that Moody’s have a long history in the rating business, spanning over a period of more than a

hundred years.. In1900, John Moody laid stone of Moody’s Investors Services and in 1909 published

his ‘Manual of Railroad Securities’. The rating of utility and industrial bonds in 1904 followed this,

along with the rating of bonds issued by .S. cities and other municipalities in the early 1920’s.

Early 1920’s saw the expansion of credit rating industry when the POOR Publishing Company

published his first rating guide in 1916. Subsequently Fitch Publishing Company and Standard

Statistics Company were set up in 1924 and 1922 respectively. Poor Publishing Company and

Standard Statistics Company merged together in 1941 to form Standard and Poor’s which was

subsequently taken over by McGraw Hill in 1966. For almost 50 years after setting up of Fitch

Publishing in 1924, there were no major entrants in the field of credit rating. But since1970’s, a

number of credit rating agencies have been set up all over the world. These included the Canadian

Bond rating Service (1972), Thomson Bankwatch (1974) Japanese Bond Rating Institute (1975),

McCarthy Crisanti & Maffei (1975) (acquired by Duff & Phelps in 1991), Dominican Bond Rating

Service (1977), IBCA Limited(1978) and Duff & Phelps Credit Rating Company (1980). There are

other credit rating agencies too in operation in many other countries such as Malaysia, Philippines,

Mexico, Indonesia, Israel, Pakistan, Cyprus, Korea, Thailand, and Australia

In India, CRISIL (Credit Rating and Information Services of India Ltd.) was set up in 1987 as the

first rating agency followed by ICRA (formerly known as Investment Information & Credit Rating

Agency of India Ltd.) in 1991, and Credit Analysis and Research Ltd. (CARE) in 1994. All the three

agencies have been promoted by the All-India Financial Institutions. The rating agencies have

established their credit ability through their independence, professionalism, continuous research,

consistent efforts and confidentiality of information. Duff and Phelps has tied up with two Indian

NBFC’S to set up Duff and Phelps Credit Rating India (P) Ltd. in 1996

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

Year Credit Rating Agency

1841 Mercantile credit agency

1900 Moody’s Investors Service

1916 Poor Publishing Company (USA)

1922 Standard Publishing Company (USA)

1924 Fitch Publishing Company (USA)

1933 Dun & Bradstreet

1941 Standard & Poor (USA)

1966 McGraw Hill

1972 Canadian Bond rating Services

1974 Thomson Bankwatch (USA)

1975 Japanese Bond rating Service (JAPAN)

1975 McCarthy Crisanti & Maffie

1977 Dominican Bond rating Company

1978 I BCA Limited

1980 Duff & Phelps Credit Rating Company

1987 CRISIL (INDIA)

1991 ICRA (INDIA)

1994 CARE (INDIA)

1996 Duff and Phelps Credit Rating India (P) Limited

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THE CREDIT RATING SYSTEM

Credit rating has facilitated authorities around the world to issue mandatory rating requirements.

For instance, specific rules restrict the entry of new issues that are rated  below a

particular grade. Moreover they also stipulate different margin requirements for the mortgage of

rated and unrated instruments, and hence prohibit institutional investors from purchasing or holding

instruments that are rated below a particular level.

Growth Factors

Credibility and Independence

Ratings are considered valuable only as long as they are credible. Credibility arises primarily from

objectivity, which results from the rating agency being independent of the issuers business. The

investor is willing to accept the judgment only where such credibility exists. When increasing

number of investors are willing to accept the judgment of a particular rater, that rater than gaining

recognition as reputed rating agency. As expressed by Moody’s “The Rating Agency must do all it

can to reserve its credibility and integrity in the market place. As primary ingredient of credibility,

the agency must, maintain independence from all interested market forces, including issuers, security

underwriters, government.”

The credibility of a rating agency is also enhanced by other factors such as objectivity of

opinions, analytical integrity and consistency, professionalism, relevant expertise, strict rules of

confidentiality, timeliness of the rating review, announcement of changes, ability to reach a wide

range of investors through press reports, print or electronic publications, an investor friendly

research services.

Capital Market Mechanism.

A strong demand for investment related information is generated due to the reliance on the capital

market for resource allocation. Rating agencies provide this information. Investors consider rating an

important input for their investment decisions only when there is a perceived default risk.

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Disclosure requirements.

Rating agencies have assumed importance on account of their task of assigning grades to securities

issued by companies. Moreover, it is becoming incumbent for companies, due to regulatory

guidelines, to have adequate corporate disclosure and to publish all the essential information

required by the investors. These guidelines require a mandatory disclosure of ratings.

Credit Education.

Credit rating serves as an effective educator on the modalities of arriving at valid judgments about

investing in securities. It is to be noted that the information should not only reach the investor, but it

must also enable them to make meaningful interpretations. The investor should also be aware of the

limitations of credit rating and should realize that the rating is not an insurance or guarantee against

default risk.

Creation of Debt Market

Credit rating is considered as an essential input for guiding investments in bonds. This assumes

significance in the context of substantial risks involved in their subscription. In fact, the continued

growth and evolution of the credit rating business depends on the size and growth of the debt market.

An active primary and secondary debt market is crucial for rating agencies to provide their services.

MAJOR ISSUES

Investment Vs speculative Grades.

Investment and speculative grades are two terms popularized by regulators. For instance, securities

that are rated below ‘BBB’ (S&P) or ‘Baa’ (Moody’s) are called non investment grade, or

speculative grade, or ‘junk bonds’. Rating agencies, however, do not recommend or indicate the

rating levels of instruments up to which one should or should not invest

Continuous Monitoring.

Credit rating agencies keep a constant surveillance during the life of the instrument for any

developments, until it is fully serviced by the company. In the absence of any specific developments,

such reviews are taken up periodically, either quarterly or annually. In addition, a formal and

extensive written review is taken up at least once a year. However there are some specific concerns

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about the issuing entity, the review is taken up immediately. The grading is altered on the basis of

the changing debt servicing capability of the issuer.

Grade Surveillance

Where any major deviation from the expected trends of the issuers business occurs, or where any

event has taken place which may have an impact on the debt servicing capability of the issuer,

which could warrant a change in the rating, the rating agency put such ratings under grade

surveillance. This is done till such time the exact impact of the unanticipated developments is

analyzed and a decision is taken regarding the rating change. The grade surveillance listing may also

specify ‘positive’ or ‘negative’ outlooks.

Rating Ceiling

While rating an issue outside the issuer outside the issuer’s country of domicile, the international

credit rating agencies impose ceiling which is equal to the sovereign rating assigned to the country of

domicile. Accordingly rating of an instrument of any issuer domiciled in that country would be

placed above the sovereign rating of the country of domicile. This concept of sovereign rating

ceiling may not, however be applicable when domicile of the issuer in a country is wholly incidental

to an otherwise internationally dispersed business operation.

Evaluation of Line.

Evaluation of bank line policy is an important component of rating a commercial paper. However, it

is not a part of the rating criteria and the rating decision itself is not predicted on the strength of the

amount of bank lines.

Ownership Consideration.

It is invariably happens that ownership by a strong enterprise enhances the credit rating of an entity,

unless there exists a barrier separating the activities of the patent and subsidiary. The important

issues that are involved in deciding the relationship are mutual dependence, legal relationships, the

entity’s ability to influence the business of the other, and the importance of the operation of the

subsidiary to the owner.

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CREDIT RATING AGENCY

A credit ratings agency is a company that assigns credit ratings to institutions that issue debt

obligations (i.e. assets backed by receivables on loans, such as mortgage-backed securities. These

institutions can be companies, cities, non-profit organizations, or national governments, and the

securities they issue can be traded on a secondary market.

A credit rating measures credit worthiness, or the ability to pay back a loan. It affects the interest rate

applied to loans - interest rates vary depending on the risk of the investment. A low-rated security

has a high interest rate, in order to attract buyers to this high-risk investment. Conversely, a highly-

rated security (carrying a AAA rating, like a municipal bond which is backed by stable government

agencies) has a lower interest rate, because it is a low-risk investment. These low-risk bonds are

available to a wide range of investors, whereas high-risk bonds cater to a narrow investing

demographic.

Companies that issue credit scores for individuals are usually called credit bureaus and are distinct

from corporate ratings agencies.

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Definition:

"Credit Rating Agency" means any commercial concern engaged in the business of credit rating of

any debt obligation or of any project or programme requiring finance, whether in the form of debt or

otherwise, and includes credit rating of any financial obligation, instrument or security, which has

the purpose of providing a potential investor or any other person any information pertaining to the

relative safety of timely payment of interest or principal; [Section 65 (34)]

GLOBAL CREDIT RATING AGENCIES

John moody, with the publication of the first debt ratings as a a part of his Manual of Railroad

Securities, introduced the rating system in the US bond/securities market in 1909.the ratings were

associated with reports on the financial quality of 250-odd railroad companies operating in the US at

that time. Ratings began to play a more important role in the US capital markets after the Great

Depression, when high levels of default underscored the perception of risk in the fixed income

securities. To help assure the major institutional investors, who were critical to the economy, that

they were not further exposed to high defaults, government regulators stipulated that the big

institutions could not buy securities rated below a certain below a certain level. With the investors

exposing themselves to greater risk, it has become important to use the ratings extensively in bond

purchase and pricing decision. This resulted in a system, which served as a set of self regulatory

functions for the market participants.

In a developed economy, almost all the market participants are familiar with the rating process

and possess the experience to deal with new market developments. The market also helps to support

the value of the rating system to the market participants with factors such as high debt volume

unsupported by the government guarantee, and a liquid secondary market where the rating can be

useful in purchase decisions. The credit rating system is well established in the U.S debt markets.

Euro debt markets and international bank deposit markets are fairly well accepted in countries such

as UK, Canada and Australia, with a number of rating agencies operating in these markets.

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A brief note on the background of the major international rating agencies is as follows

Duff and Phelps Credit Rating Co (DCR)

DCR is a major international source of credit information. It has been in existence for over sixty

years. It rates all major types of fixed-income securities, long term and short term debt of

corporations, sovereign nations and financial institutions. It also rate4s structured financing,

mortgage backed securities and insurance companies. It has established joint ventures, largely in

Latin American countries and since 1992, also in Asian countries such as India and Pakistan.

Japan Credit Rating agency (JCR)

It was established in 1985 and was promoted by financial institutions, banks and insurance

companies in Japan. It provides ratings to foreign and domestic debt issuers.

Thomson BankWatch

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This rating agency is based in Toronto, Canada. It is a subsidiary of the Thomson Corporation. It is a

rating agency exclusively offering grades of rating to financial institutions including banks,

securities firms and finance companies.

Big Three Rating Agencies in U.S are:

Moody’s investors service (Moody’s)

Standard & Poor’s corporation (S & P)

Fitch ratings

The Big Three credit rating agencies are Standard & Poor's, Moody's Investor Service, and Fitch

Ratings. Moody's and S&P each control about 40 percent of the market. Third-ranked Fitch

Ratings, which has about a 14 percent market share, sometimes is used as an alternative to one

of the other majors. In the wake of recent credit-market turmoil, some niche agencies are picking

up market share or at least additional visibility. Among the niche agencies are DBRS and Egan-

Jones.

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There are 5 credit rating agencies in India. Namely

Credit Rating Information Services of India Limited (CRISIL)

Investment Information and Credit Rating Agency of India (ICRA)

Credit Analysis & Research Limited (CARE)

Duff & Phelps Credit Rating India Private Ltd. (DCR India)

ONICRA Credit Rating Agency of India Ltd.

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CREDIT RATING SYMBOLS

Meaning

Credit Rating Agencies rate an instrument by assigning a definite symbol. Each symbol has a

definite meaning. These symbols have been explained in descending order of safety or in ascending

order of risk of non-payment.

For example, CRISIL has prescribed the following system for debenture issues:

CRISIL AAA

(Highest Safety)

Instruments with this rating are considered to have the highest

degree of safety regarding timely servicing of financial obligations.

Such instruments carry lowest credit risk.

CRISIL AA

(High Safety)

Instruments with this rating are considered to have high degree of safety

regarding timely servicing of financial obligations. Such instruments carry

very low credit risk.

CRISIL A

(Adequate Safety)

Instruments with this rating are considered to have adequate degree of

safety regarding timely servicing of financial obligations. Such instruments

carry low credit risk.

CRISIL BBB

(Moderate Safety)

Instruments with this rating are considered to have moderate degree of

safety regarding timely servicing of financial obligations. Such instruments

carry moderate credit risk.

CRISIL BB

(Moderate Risk)

Instruments with this rating are considered to have moderate risk of default

regarding timely servicing of financial obligations.

CRISIL B

(High Risk)

Instruments with this rating are considered to have high risk of default

regarding timely servicing of financial obligations.

CRISIL C

(Very High Risk)

Instruments with this rating are considered to have very high risk of default

regarding timely servicing of financial obligations.

CRISIL D

Default

Instruments with this rating are in default or are expected to be in default

soon.

Note: 1) CRISIL may apply '+' (plus) or '-' (minus) signs for ratings from FAA to FC to indicate the

relative position within the rating category.

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You will note that as the value of symbol is reduced say from AAA to AA, the safety of timely

payment of interest and principal is decreased. While AAA indicates highest safety of timely

repayment, D indicates actual default or expected default on maturity. Different symbols indicate

different degrees of risk of repayment of principal and interest.

CRISIL Rating Symbols for Fixed Deposits

FAAA

("F Triple A") Highest

Safety

This rating indicates that the degree of safety regarding

timely payment of interest and principal is very strong.

FAA

("F Double A") High Safety

This rating indicates that the degree of safety regarding timely

payment of interest and principal is strong. However, the relative

degree of safety is not as high as for fixed deposits with 'FAAA'

ratings.

FA

Adequate Safety

This rating indicates that the degree of safety regarding timely

payment of interest and principal is satisfactory. Changes in

circumstances can affect such issues more than those in the

higher rated categories.

FB

Inadequate Safety

This rating indicates inadequate safety of timely payment of

interest and principal. Such issues are less susceptible to default

than fixed deposits rated below this category, but the

uncertainties that the issuer faces could lead to inadequate

capacity to make timely interest and principal payments.

FC

High Risk

This rating indicates that the degree of safety regarding timely

payment of interest and principal is doubtful. Such issues have

factors at present that make them vulnerable to default; adverse

business or economic conditions would lead to lack of ability or

willingness to pay interest or principal.

FD

Default

This rating indicates that the fixed deposits are either in default or

are expected to be in default upon maturity.

NM Instruments rated 'NM' have factors present in them, which

render the outstanding rating meaningless. These include

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Not Meaningful reorganization or liquidation of the issuer, the obligation being

under dispute in a court of law or before a statutory authority etc.

Note: 1) CRISIL may apply '+' (plus) or '-' (minus) signs for ratings from FAA to FC to indicate the

relative position within the rating category.

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CORPORATE CREDIT RATING

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The credit rating of a corporation is a financial indicator to potential investors of debt securities

such as bonds. Credit rating is usually of a financial instrument such as a bond, rather than the

whole corporation. These are assigned by credit rating agencies such as A. M. Best, Dun &

Bradstreet, Standard & Poor's, Moody's or Fitch Ratings and have letter designations such as

A, B, C.

The Standard & Poor's rating scale is as follows, from excellent to poor: AAA, AA+, AA, AA-,

A+, A, A-, BBB+, BBB, BBB-, BB+, BB, BB-, B+, B, B-, CCC+, CCC, CCC-, CC, C, D. Anything

lower than a BBB- rating is considered a speculative or junk bond.

The Moody's rating system is similar in concept but the naming is a little different. It is as follows,

from excellent to poor: Aaa, Aa1, Aa2, Aa3, A1, A2, A3, Baa1, Baa2, Baa3, Ba1, Ba2, Ba3, B1, B2, B3, Caa1,

Caa2, Caa3, Ca, C.

A.M. Best rates from excellent to poor in the following manner: A++, A+, A, A-, B++, B+, B, B-,

C++, C+, C, C-, D, E, F, and S. The CTRISKS rating system is as follows: CT3A, CT2A, CT1A,

CT3B, CT2B, CT1B, CT3C, CT2C and CT1C. All these CTRISKS grades are mapped to one-year

probability of default.

21

A.

22

IPO GRADING/RATING

When the Securities and Exchange Board of India (SEBI) decided to scrap discretionary allotment

for qualified institutional buyers (QIBs) and switch to the more transparent proportionate allotment

system, it became the first regulator to stand up to the powerful investment banking community

anywhere in the world. Once the decision was taken, it was evident that the exaggerated outrage and

predictions that large institutional investors would shun IPOs were completely baseless.

That decision recognized the specific needs of the Indian capital market and was the result of

pressure from investor groups. The path to mandatory grading of IPOs has been rocky, with

enormous opposition from companies, investment bankers, fund managers, market experts and SEBI

board members. We learn that the final decision came about in the face of strong opposition by

certain board members (apparently not full-time) and that too only, with a twist in the tail, which

dilutes the original proposal. The alleged opposition of the regulator’s board members raises an

interesting question. All board-level discussions must, indeed, remain confidential in order to ensure

free and frank expression, but what is the fiduciary responsibility of board members of a watchdog

organization, who have no knowledge, training or expertise about capital markets, when they choose

to oppose recommendations of the Primary Market Advisory Committee that are endorsed by the

regulator? It is also important to remember that investor groups have been pressing for IPO grading

for several years; first with the Investor Education and Protection Fund(attached to the ministry of

23

company affairs), which developed cold feet and dropped even its plans for a pilot project and later

with the capital market regulator.

Over the years, those opposed to IPO grading have constructed several elegant arguments to rubbish

its utility, but from an investor standpoint, the logic is simple. The disclosure-based model adopted

by the regulator, leads to a bulky, jargon-filled prospectus that can neither be read nor understood by

the average investor; consequently, a simple, one-page evaluation of disclosures by an expert

agency, which also helpfully condenses its findings into a single numerical grade on a scale of five,

is clearly a blessing. The offer price of the IPO will remain an important factor in the final

investment decision—after all, even the best companies can be bad investments at the wrong price.

But that is a reasonable decision to leave to the investor.

Introduction

IPO grading is the grade assigned by a Credit Rating Agency registered with SEBI, to the initial

public offering (IPO) of equity shares or any other security which may be converted into or

exchanged with equity shares at a later date. The grade represents a relative assessment of the

fundamentals of that issue in relation to the other listed equity securities in India. Such grading is

generally assigned on a five-point point scale with a higher score indicating stronger fundamentals

and vice versa as below.

IPO grade1: Poor fundamentals

IPO grade2: Below-average fundamentals

IPO grade3: Average fundamentals

IPO grade4: Above-average fundamentals

IPO grade5: Strong fundamentals

IPO grading has been introduced as an endeavor to make additional information available for the

investors in order to facilitate their assessment of equity issues offered through an IPO.

IPO grading can be done either before filing the draft offer documents with SEBI or thereafter.

However, the Prospectus/Red Herring Prospectus, as the case may be, must contain the grade/s given

to the IPO by all CRAs approached by the company for grading such IPO.

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

grading such IPO.

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

IPO.

IPO grading is not optional. A company which has filed the draft offer document for its IPO with

SEBI, on or after 1st May, 2007, is required to obtain a grade for the IPO from at least one CRA.

IPO grade/s cannot be rejected. Irrespective of whether the issuer finds the grade given by the rating

agency acceptable or not, the grade has to be disclosed as required under the DIP Guidelines.

However the issuer has the option of opting for another grading by a different agency. In such an

event all grades obtained for the IPO will have to be disclosed in the offer documents,

advertisements

IPO grading is intended to run parallel to the filing of offer document with SEBI and the consequent

issuance of observations. Since issuance of observation by SEBI and the grading process, function

independently, IPO grading is not expected to delay the issue process.

The IPO grading process is expected to take into account the prospects of the industry in which the

company operates, the competitive strengths of the company that would allow it to address the risks

inherent in the business(es) and capitalize on the opportunities available, as well as the company’s

financial position.

While the actual factors considered for grading may not be identical or limited to the following, the

areas listed below are generally looked into by the rating agencies, while arriving at an IPO grade

Business Prospects and Competitive Position

i. Industry Prospects etc.

ii. Company Prospects

Financial Position

Management Quality

Corporate Governance Practices

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Compliance and Litigation History

New Projects—Risks and Prospects

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

process and may vary on a case to case basis.

IPO grading is done without taking into account the price at which the security is offered in the IPO.

Since IPO grading does not consider the issue price, the investor needs to make an independent

judgment regarding the price at which to bid for/subscribe to the shares offered through the IPO.

IPO Grading is intended to provide the investor with an informed and objective opinion

expressed by a professional rating agency after analyzing factors like business and financial

prospects, management quality and corporate governance practices etc. However, irrespective

of the grade obtained by the issuer, the investor needs to make his/her own independent

decision regarding investing in any issue after studying the contents of the prospectus

including risk factors carefully.

As on date the following four credit rating agencies are registered with SEBI.

a) Credit Analysis & Research Ltd (CARE)

b) ICRA Limited

c) CRISIL

d) FITCH Ratings

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SOVEREIGN CREDIT RATINGS

A sovereign credit rating is the credit rating of a sovereign entity, i.e., a national government. The

sovereign credit rating indicates the risk level of the investing environment of a country and is used

by investors looking to invest abroad. It takes political risk into account

The table shows the ten least-risky countries for investment as of June 2012. Ratings are further

broken down into components including political risk, economic risk. Euro money’s bi-annual

country risk index monitors the political and economic stability of 185 sovereign countries. Results

focus foremost on economics, specifically sovereign default risk and/or payment default risk for

exporters (a.k.a. "trade credit" risk).

A. M. Best defines "country risk" as the risk that country-specific factors could adversely affect an

insurer's ability to meet its financial obligations.

COUNTRY RISK RANKINGS (JUNE 2012)

Least risky countries, Score out of 100

Rank Previous

Country Overall score

1 1 Norway 90.37

2 2 Switzerland 88.83

3 3 Singapore 88.03

4 4 Luxembourg 87.90

5 4 Sweden 86.79

6 5 Finland 84.30

7 7 Canada 84.26

8 8 Denmark 83.52

9 9 Netherlands 83.07

10 7 Germany 82.24

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WORLD COUNTRIES STANDARD & POOR'S RATINGS

28

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

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

29

INDIVIDUAL CREDIT RATING IN INDIA

Primer for Individuals

When it comes to risk management in Banks, the risk that takes the priority is "the credit risk".

The credit risk by definition means, risk of loans disbursed to various corporate and retail clients

will be paid back or not. For layman's understanding, a bank broadly has two main functions viz.

Assets and Liabilities. The main job of the liabilities side of a bank is to channelize savings in the

economy, designs various instruments, by which; money can be collected from the economy. This

could be in the form of saving bank accounts, current accounts, FDs etc. The money so collected,

is a liability on the bank as it has to repay the same to its customers with certain prevailing rate of

interest and hence the function is called Liability. Once money is collected from various sources,

the same has to be deployed at a profitable rate of return. The deployment could be in the form of

corporate lending, investing in projects or simply retail lending in the form of Personal Loans,

Vehicle loans, home loans, SME lending etc.

The basic principle of managing Credit Risk is diversification of portfolio. This means, that

lending to corporate borrowers is diversified in terms of different industries and within an

industry to different corporate. Lending is based on as per the underwriting standards of the bank

e.g. the repute of the company, past financials of the company including profitability over last

several years, shareholding pattern, qualitative study of management, project feasibility of the

project to be funded, future cash lows etc. Although all banks into corporate lending develop their

own individual underwriting policies, they also depend on the credit rating of a corporate by

accredited Credit Rating Agencies like CRISIL, ICRA and CARE. Even the Basel Committee on

Banking Regulation has accentuated on the importance of use of external credit ratings.

The retail segment in India, however, has been devoid of external agencies, which are into credit

rating of individuals i.e. retail customers. The lending to retail customers is done basis purely on

the lending policy of the bank, which vary from bank to bank, depending on the banks risk

appetite. In the United States, there are government funded repositories like Equifax, Trans-world,

Trans Union, Dun &Bradstreet etc, which act as credit rating agencies for retail borrowers. They

provide member banks/NBFCs with credit history of an individual in terms of loans that he has

paid in the past, loans that he is currently running, Credit Cards that he has held or currently

active with repayment history of the same. There are other vital information that the agency report

provide viz., if the borrower has ever filed for bankruptcy or if there is any litigation, court case

etc. pending against him. Based on the overall credit history of the customer, he/she is given a 30

credit rating, more popularly called, FICO score. This may vary from agency to agency but the

variation may not be more than 10%.However, the US system of credit rating individual could not

be replicated in India because of some practical difficulties. The most important being, absence of

a mechanism for identifying an individual. In the United States, each individual is issued a Social

Security Number or the SSN, when he/she is born. This SSN is a unique number and all

information related an individual, including social history, financial history, criminal history etc is

linked to ones SSN and therefore, collecting information about individual becomes much easier.

This is further facilitated by the presence of a system, which ensures that the information flows

freely between well coordinated government and public departments. Hence, information related

to individual can be stored at a common place and retrieved when required. Also, there are proper

laws in place, which requires all the public/private entities like banks, NBFCs etc. to share their

customer related data with the credit rating agencies. In India, the scenario has been different. The

is no concept of Social Security Number to identify an individual. The only way to identify a

customer is through name, address, Date of Birth (DoB) etc. However, with no sanctity of DoB

proofs or address proofs, it is very easy to fool the system. Till sometime bank, the only way for a

bank to know the credit history of a prospective customer was through its collection or field

verification agencies, which may or may not had information about the customer. Besides, banks

also did not pay any strict attention to the data sanctity of the customer at their end. This is,

particularly true to banks issuing Credit Cards.

With rising competition in the retail sector, there was a sharp rise in delinquency level of banks.

The need for Credit Rating Agency which could work like a repository for credit information of

individual was widely felt. As a first attempt in this direction, The Credit Information Bureau of

India Ltd or the CIBIL was incorporated in 2000. CIBIL was an effort of The Government of

India and the Reserve Bank of India. The first promoters and the member banks were the State

Bank of India (SBI) and HDFC. Necessary logistics and technology was provided by

internationally reputed credit rating agencies like Dun & Bradstreet and Trans-union. However,

the attempt was not efficacious initially, since most banks were reluctant about sharing their

customer data with other banks. This was further aggravated by the fact that the banks were not

under any legal obligation to share their data. However, with RBI's efforts, more and more banks

and NBFCs have joined hand in providing customer data to CIBIL and in return get data on the

customers on payment of some fees from CIBIL. This initiative called CIBIL has really been

helpful in curbing delinquency and banks have starting weaving their credit lending policy around

CIBIL.

31

The quality of CIBIL reports have further been helped by certain government measures like

introduction of PAN numbers and making the same mandatory for availing most banking

services. The PAN number may be considered as a very crude form of a Social Security Number,

since only taxpaying individuals apply for it i.e. people not falling in tax bracket or not wanting to

pay tax, may or may not have PAN no. But with regulators like RBI, Tax Departments etc making

PAN no. mandatory for availing banking and investment services, more and more percentage of

population (at least those wanting to avail credit) are now having a valid PAN no., which to a

large extent has done the same job what SSN does in the United States. Any technological

advancement in future, which may lead to better networking between banks, government agencies

like judiciary, RBI and CIBIL will only further improve the quality of CIBIL reporting. As of

now, CIBIL has not introduced any system of assigning any Credit Rating to individuals like the

FICO scoring as mentioned above. But this may be just round the corner. Also, a competition in

the credit rating field i.e. more set ups like CIBIL will not only see a further improvement in

quality in terms of services being provided to the banks and NBFCs but will also see cost

rationalization. Prior to CIBIL and along with CIBIL, there was information available in the

market but it was more scattered and specific. For example, Satyam Database, more popularly

known as MCNF database (Master Card Negative Feedback), is available in the market. The

MCNF database is the data of database of all delinquent customers who have defaulted in their

Master Card Credit Card. The customer could belong to any bank which issues Master Card

Credit Card. Besides this, most of the verification agencies in any particular area, are a rich source

of credit information, specially derogatory. Since most of these verification agencies are also

invariably collection agencies for multiple banks, they have their own database for derogatory

customers. There is a basic limitation to both MCNF database and data available with verification

agencies. One the data is very limited and does not cover sizable proportion of the credit seeking

population. MCNF covers only Master Card Credit Card while verification agencies have data of

their client banks only. Most of these verification agencies have their area of operation limited to

only one city or couple of cities in the same state but not beyond that. Second, the MCNF and

Verification Agencies have only derogatory data. So, if a match is found, then, the customer is a

bad credit or risky to lend, but if there is no match, it will not be prudent to assume that the

customer is a good credit or not risky to lend. CIBIL is however, a balanced approach, as it

contains all the credit history available for the customer, both good and bad.

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How Does It Impacts Individuals

With set ups like CIBIL, there is a free flow of credit information between banks. All members

have access to the CIBIL database. Hence, it is becoming, increasingly difficult for chronic

defaulters to obtain credit from the banks. As mentioned before, most bank are weaving their

credit policy around CIBIL, MCNF and Verification Agency records, it is very important for

individuals to be aware and sensitive to their credit history.

It is a common observation with the people of younger age group, that, they carry multiple credit

cards, more as a matter of style statement, than, having an actual requirement of the same. This is

coupled with over spending and in their juvenile spirit, not paying. What they do not realize is

that this derogatory information is actually being stored against their name, add or PAN no.

somewhere, and when, later in their life, they are in actual need for credit, they do not get it. The

above given example is of a willful customer, but there are also common instances service related

issues with the banks, specially, credit card issuing banks e.g. annual fee levied when free credit

card promised or insurance premium charged without customer's knowledge. Instances could be

numerous, but unfortunately, itis the individual, who is impacted negatively in such a situation.

Often, after charging multiple late fees, interests etc, the default amount reported to CIBIL or

Satyam database, is quite high. Lending institution, prima facie, do not investigate in the

derogatory information and decline a loan or a credit card application upfront. Since, all banks are

free to make their own credit policy, a bank with low risk appetite and hence strict credit policy is

not likely to reconsider credit application, even if, in reality, it was not customer's fault.

What to Do / What Not to Do

The importance of a clean credit history is understood when emergency credit is required, for

example, a personal loan in order to meet immediate medical expenses or a home loan and the

same is denied because one did not bother to repay his credit card debts or his auto loan EMI or

resolve the dispute with a financier in the past. Since, most of us, especially in the middle class,

salaried or businessmen, will require a credit at some point of time either for a personal need,

building a house or for business purpose or a credit card, there are a few precautions that an

individual must take in his financial dealings. One must be very diligent and disciplined in

repaying his debts, EMIs, Credit Card payments etc. In rarity, if there is a delay in payment, one

should make sure, that, the payment with late payment charges if any, should not cross 30 days

past due. If late payment charges or any other charges are waived off by the bank specifically in

written, then only, such charges are not to be paid. If there is a dispute in payment, especially in 33

credit card related payments, one should make sure that the dispute is resolved and he has a

written record of the same in his possession. Some people think that settling an account for

something less than what is actual due is an easy way out. The settlement will only give them a

settlement letter, which is an indicator that they did not pay the full amount. Neither is their name

or record taken off from the derogatory history of the bank and hence CIBIL/Satyam records. In

case, the bank is at a fault, which it agrees on also, it is very important to acquire an apology letter

from the bank, clearly stating the issue and bank's apology on the same.

Most of us, keep getting calls from various Credit Card issuing bank's DSA (Direct Selling

Associates), which would make loads of promises and would request us to at least keep the card

for a year and then destroy the same after informing the bank of your intention of not using the

same. Such offers should be avoided, if one is NOT in need of that credit card. Since, one does

not need that card; it will be lying dormant in his pocket for a year. He would even forget the date

as to when the card is to be blocked. Since the card is free for only the first year, next year

beginning, he would receive a statement with annual fees levied. He will dispute it, not pay it. The

bank will keep following up and levying late payment and other incidentals charges, and report it

as a derogatory card to the CIBIL. The bank cannot blamed for the same, since, as per its terms

and conditions, the card was free for first year only and the customer did not bother to cancel it at

the end of the year. So, why, unnecessarily, call for a problem, when it can be easily avoided by

politely declining to accept for the card in the first place. The principle is simple. Do NOT avail a

credit if you DON'T need it.

SHORT-TERM RATING

A short-term rating is a probability factor of an individual going into default within a year. This is in

contrast to long-term rating which is evaluated over a long timeframe. In the past institutional

investors preferred to consider long-term ratings. Nowadays, short-term ratings are commonly used.

First, the Basel II agreement requires banks to report their one-year probability if they applied

internal-ratings-based approach for capital requirements. Second, many institutional investors can

easily manage their credit/bond portfolios with derivatives on monthly or quarterly basis. Therefore,

some rating agencies simply report short-term ratings.

34

USES OF RATINGS

Credit ratings are used by investors, issuers, investment banks, broker-dealers, and governments. For

investors, credit rating agencies increase the range of investment alternatives and provide

independent, easy-to-use measurements of relative credit risk; this generally increases the efficiency

of the market, lowering costs for both borrowers and lenders. This in turn increases the total supply

of risk capital in the economy, leading to stronger growth. It also opens the capital markets to

categories of borrower who might otherwise be shut out altogether: small governments, startup

companies, hospitals, and universities.

Ratings use by bond issuers

Issuers rely on credit ratings as an independent verification of their own credit-worthiness and the

resultant value of the instruments they issue. In most cases, a significant bond issuance must have at

least one rating from a respected CRA for the issuance to be successful (without such a rating, the

issuance may be undersubscribed or the price offered by investors too low for the issuer's purposes).

Studies by the Bond Market Association note that many institutional investors now prefer that a debt

issuance have at least three ratings.

Issuers also use credit ratings in certain structured finance transactions. For example, a company

with a very high credit rating wishing to undertake a particularly risky research project could create a

legally separate entity with certain assets that would own and conduct the research work. This

"special purpose entity" would then assume all of the research risk and issue its own debt securities

to finance the research. The SPE's credit rating likely would be very low, and the issuer would have

to pay a high rate of return on the bonds issued.

However, this risk would not lower the parent company's overall credit rating because the SPE

would be a legally separate entity. Conversely, a company with a low credit rating might be able to

borrow on better terms if it were to form an SPE and transfer significant assets to that subsidiary and

issue secured debt securities. That way, if the venture were to fail, the lenders would have recourse

to the assets owned by the SPE. This would lower the interest rate the SPE would need to pay as part

of the debt offering.

The same issuer also may have different credit ratings for different bonds. This difference results

from the bond's structure, how it is secured, and the degree to which the bond is subordinated to

other debt. Many larger CRAs offer "credit rating advisory services" that essentially advise an issuer

on how to structure its bond offerings and SPEs so as to achieve a given credit rating for a certain 35

debt tranche. This creates a potential conflict of interest; of course, as the CRA may feel obligated to

provide the issuer with that given rating if the issuer followed its advice on structuring the offering.

Some CRAs avoid this conflict by refusing to rate debt offerings for which its advisory services were

sought.

Ratings use by government regulators

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

example, under the Basel II agreement of the Basel Committee on Banking Supervision, banking

regulators can allow banks to use credit ratings from certain approved CRAs (called "ECAIs", or

"External Credit Assessment Institutions") when calculating their net capital reserve requirements. In

the United States, the Securities and Exchange Commission (SEC) permits investment banks and

broker-dealers to use credit ratings from "Nationally Recognized Statistical Rating Organizations"

(NRSRO) for similar purposes. The idea is that banks and other financial institutions should not need

keep in reserve the same amount of capital to protect the institution against (for example) a run on

the bank, if the financial institution is heavily invested in highly liquid and very "safe" securities

(such as U.S. government bonds or short-term commercial paper from very stable companies).

CRA ratings are also used for other regulatory purposes as well. The US SEC, for example, permits

certain bond issuers to use a shortened prospectus form when issuing bonds if the issuer is older, has

issued bonds before, and has a credit rating above a certain level. SEC regulations also require that

money market funds (mutual funds that mimic the safety and liquidity of a bank savings deposit, but

without Federal Deposit Insurance Corporation insurance) comprise only securities with a very high

NRSRO rating. Likewise, insurance regulators use credit ratings to ascertain the strength of the

reserves held by insurance companies.

In 2008, the US SEC voted unanimously to propose amendments to its rules[2] that would remove

credit ratings as one of the conditions for companies seeking to use short-form registration when

registering securities for public sale.

This marks the first in a series of upcoming SEC proposals in accordance with Dodd-Frank to

remove references to credit ratings contained within existing Commission rules and replace them

with alternative criteria.

36

Under both Basel II and SEC regulations, not just any CRA's ratings can be used for regulatory

purposes. (If this were the case, it would present a moral hazard). Rather, there is a vetting process of

varying sorts. The Basel II guidelines for example, describe certain criteria that bank regulators

should look to when permitting the ratings from a particular CRA to be used. These include

"objectivity," "independence," "transparency," and others. Banking regulators from a number of

jurisdictions have since issued their own discussion papers on this subject, to further define how

these terms will be used in practice. (See The Committee of European Banking Supervisors

Discussion Paper, or the State Bank of Pakistan ECAI Criteria).

In the United States, since 1975, NRSRO recognition has been granted through a "No Action Letter"

sent by the SEC staff. Following this approach, if a CRA (or investment bank or broker-dealer) were

interested in using the ratings from a particular CRA for regulatory purposes, the SEC staff would

research the market to determine whether ratings from that particular CRA are widely used and

considered "reliable and credible." If the SEC staff determines that this is the case, it sends a letter to

the CRA indicating that if a regulated entity were to rely on the CRA's ratings, the SEC staff will not

recommend enforcement action against that entity. These "No Action" letters are made public and

can be relied upon by other regulated entities, not just the entity making the original request. The

SEC has since sought to further define the criteria it uses when making this assessment, and in

March 2005 published a proposed regulation to this effect.

On September 29, 2006, US President George W. Bush signed into law the Credit Rating Reform

Act of 2006.This law requires the US Securities and Exchange Commission to clarify how NRSRO

recognition is granted, eliminates the "No Action Letter" approach and makes NRSRO recognition a

Commission (rather than SEC staff) decision, and requires NRSROs to register with, and be

regulated by, the SEC. S & P protested the Act on the grounds that it is an unconstitutional violation

of freedom of speech. In the Summer of 2007 the SEC issued regulations implementing the act,

requiring rating agencies to have policies to prevent misuse of nonpublic information, disclosure of

conflicts of interest and prohibitions against "unfair practices".

Recognizing CRAs' role in capital formation, some governments have attempted to jump-start their

domestic rating-agency businesses with various kinds of regulatory relief or encouragement. This

may, however, be counterproductive, if it dulls the market mechanism by which agencies compete,

subsidizing less-capable agencies and penalizing agencies that devote resources to higher-quality

opinions.

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Ratings use in structured finance

Credit rating agencies may also play a key role in structured financial transactions. Unlike a

"typical" loan or bond issuance, where a borrower offers to pay a certain return on a loan, structured

financial transactions may be viewed as either a series of loans with different characteristics, or else

a number of small loans of a similar type packaged together into a series of "buckets" (with the

"buckets" or different loans called "tranches"). Credit ratings often determine the interest rate or

price ascribed to a particular tranche, based on the quality of loans or quality of assets contained

within that grouping.

Companies involved in structured financing arrangements often consult with credit rating agencies to

help them determine how to structure the individual tranches so that each receives a desired credit

rating. For example, a firm may wish to borrow a large sum of money by issuing debt securities.

However, the amount is so large that the return investors may demand on a single issuance would be

prohibitive. Instead, it decides to issue three separate bonds, with three separate credit ratings—A

(medium low risk), BBB (medium risk), and BB (speculative) (using Standard & Poor's rating

system).

The firm expects that the effective interest rate it pays on the A-rated bonds will be much less than

the rate it must pay on the BB-rated bonds, but that, overall, the amount it must pay for the total

capital it raises will be less than it would pay if the entire amount were raised from a single bond

offering. As this transaction is devised, the firm may consult with a credit rating agency to see how it

must structure each tranche—in other words, what types of assets must be used to secure the debt in

each tranche—in order for that tranche to receive the desired rating when it is issued.

There has been criticism in the wake of large losses in the collateralized debt obligation (CDO)

market that occurred despite being assigned top ratings by the CRAs. For instance, losses on $340.7

million worth of CDOs issued by Credit Suisse Group added up to about $125 million, despite being

rated AAA or Aaa by Standard & Poor's, Moody's Investors Service and Fitch Group.

The rating agencies respond that their advice constitutes only a "point in time" analysis, that they

make clear that they never promise or guarantee a certain rating to a tranche, and that they also make

clear that any change in circumstance regarding the risk factors of a particular tranche will invalidate

their analysis and result in a different credit rating. In addition, some CRAs do not rate bond

issuances upon which they have offered such advice.

38

Complicating matters, particularly where structured finance transactions are concerned, the rating

agencies state that their ratings are opinions (and as such, are protected free speech, granted to them

by the "personhood" of corporations) regarding the likelihood that a given debt security will fail to

be serviced over a given period of time, and not an opinion on the volatility of that security and

certainly not the wisdom of investing in that security. In the past, most highly rated (AAA or Aaa)

debt securities were characterized by low volatility and high liquidity—in other words, the price of a

highly rated bond did not fluctuate greatly day-to-day, and sellers of such securities could easily find

buyers.

However, structured transactions that involve the bundling of hundreds or thousands of similar (and

similarly rated) securities tend to concentrate similar risk in such a way that even a slight change on

a chance of default can have an enormous effect on the price of the bundled security. This means

that even though a rating agency could be correct in its opinion that the chance of default of a

structured product is very low, even a slight change in the market's perception of the risk of that

product can have a disproportionate effect on the product's market price, with the result that an

ostensibly AAA or Aaa-rated security can collapse in price even without there being any default (or

significant chance of default). This possibility raises significant regulatory issues because the use of

ratings in securities and banking regulation (as noted above) assumes that high ratings correspond

with low volatility and high liquidity.

Credit rating agencies do not downgrade companies promptly enough. For example, Enron's rating

remained at investment grade four days before the company went bankrupt, despite the fact that credit

rating agencies had been aware of the company's problems for months. Some empirical studies have

documented that yield spreads of corporate bonds start to expand as credit quality deteriorates but

before a rating downgrade, implying that the market often leads a downgrade and questioning the

informational value of credit ratings. This has led to suggestions that, rather than rely on CRA ratings in

financial regulation, financial regulators should instead require banks, broker-dealers and insurance

firms (among others) to use credit spreads when calculating the risk in their portfolio.

Large corporate rating agencies have been criticized for having too familiar a relationship with

company management, possibly opening themselves to undue influence or the vulnerability of being

misled. These agencies meet frequently in person with the management of many companies, and advise

on actions the company should take to maintain a certain rating .Furthermore, because information

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about ratings changes from the larger CRAs can spread so quickly (by word of mouth, email, etc.), the

larger CRAs charge debt issuers, rather than investors, for their ratings. This has led to accusations that

these CRAs are plagued by conflicts of interest that might inhibit them from providing accurate and

honest ratings. At the same time, more generally, the largest agencies (Moody's and Standard &

Poor's)are often seen as agents of globalization and/or "Anglo-American" market forces, that drive

companies to consider how a proposed activity might affect their credit rating, possibly at the expense

of employees, the environment, or long-term research and development. These accusations are not

entirely consistent: on one hand, the larger CRAs are accused of being too cozy with the companies

they rate, and on the other hand they are accused of being too focused on a company's “bottom line"

and unwilling to listen to a company's explanations for its actions.

The lowering of a credit score by a CRA can create a vicious cycle, as not only interest rates for that

company would go up, but other contracts with financial institutions may be affected adversely, causing

an increase in expenses and ensuing decrease in credit worthiness. In some cases, large loans to

companies contain a clause that makes the loan due in full if the companies’ credit rating is lowered

beyond a certain point (usually a “speculative" or “junk bond" rating). The purpose of these "ratings

triggers “is to ensure that the bank is able to lay claim to a weak company's assets before the company

declares bankruptcy and a receiver is appointed to divide up the claims against the company. The effect

of such ratings triggers, however, can be devastating: under a worst-case scenario, once the company's

debt is downgraded by a CRA, the company's loans become due in full; since the troubled company

likely is incapable of paying all of these loans in full at once, it is forced into bankruptcy (a so-called

"death spiral").These rating triggers were instrumental in the collapse of Enron. Since that time, major

agencies have put extra effort into detecting these triggers and discouraging their use, and the U.S.

Securities and Exchange Commission requires that public companies in the United States disclose their

existence.

Agencies are sometimes accused of being oligopolists because barriers to market entry are high and

rating agency business is itself reputation-based (and the finance industry pays little attention to a rating

that is not widely recognized). Of the large agencies, only Moody's is a separate, publicly held

corporation that discloses its financial results without dilution by non-ratings businesses, and its high

profit margins (which at times have been greater than 50 percent of gross margin) can be construed as

consistent with the type of returns one might expect in an industry which has high barriers to entry.

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Credit Rating Agencies have made errors of judgment in rating structured products, particularly in

assigning AAA ratings to structured debt, which in a large number of cases has subsequently been

downgraded or defaulted. The actual method by which Moody's rates CDOs has also come under

scrutiny. If default models are biased to include arbitrary default data and "Ratings Factors are biased

low compared to the true level of expected defaults, the Moody’s [method] will not generate an

appropriate level of average defaults in its default distribution process. As a result, the perceived default

probability of rated tranches from a high yield CDO will be in correctly biased downward, providing a

false sense of confidence to rating agencies and investors." Little has been done by rating agencies to

address these shortcomings indicating a lack of incentive for quality ratings of credit in the modern

CRA industry. This has led to problems for several banks whose capital requirements depend on the

rating of the structured assets they hold, as well as large losses in the banking industry. AAA rated

mortgage securities trading at only 80 cents on the dollar, implying a greater than 20% chance of

default, and 8.9% of AAA rated structured CDOs are being considered for downgrade by Fitch, which

expects most to downgrade to an average of BBB to BB-. These levels of reassessment are surprising

for AAA rated bonds, which have the same rating class as US government bonds. Most rating agencies

do not draw a distinction between AAA on structured finance and AAA on corporate or government

bonds (though their ratings releases typically describe the type of security being rated). Many banks,

such as AIG, made the mistake of not holding enough capital in reserve in the event of downgrades to

their CDO portfolio. The structure of the Basel II agreements meant that CDOs capital requirement rose

'exponentially'. This made CDO portfolios vulnerable to multiple downgrades, essentially precipitating

a large margin call. For example under Basel II, a AAA rated securitization requires capital allocation

of only 0.6%, a BBB requires 4.8%, a BB requires 34%, whilst a BB (-) securitization requires a 52%

allocation. For a number of reasons(frequently having to do with inadequate staff expertise and the

costs that risk management programs entail), many institutional investors relied solely on the ratings

agencies rather than conducting their own analysis of the risks these instruments posed. (As an example

of the complexity involved in analyzing some CDOs, the Aquarius CDO structure has 51 issues behind

the cash CDO component of the structure and another 129 issues that serve as reference entities for

$1.4 billion in CDS contracts for a total of 180. In a sample of just 40 of these, they had on average

6500 loans at origination. Projecting that number to all 180 issues implies that the Aquarius CDO has

exposure to about 1.2 million loans.)

Ratings agencies, in particular Fitch, Moody's and Standard and Poor’s have been implicitly allowed by

the government to fill a quasi-regulatory role, but because they are for-profit entities their incentives

may be misaligned. Conflicts of interest often arise because the rating agencies are paid by the 41

companies issuing the securities — an arrangement that has come under fire as a disincentive for the

agencies to be vigilant on behalf of investors. Many market participants no longer rely on the credit

agencies ratings systems, even before the economic crisis of 2007-8, preferring instead to use credit

spreads to benchmarks like Treasuries or an index. However, since the Federal Reserve requires that

structured financial entities be rated by at least two of the three credit agencies, they have a continued

obligation.

Many of the structured financial products that were responsible for rating, consisted of lower quality

'BBB' rated loans, but were, when pooled together into CDOs, assigned an AAA rating. The strength

of the CDO was not wholly dependent on the strength of the underlying loans, but in fact the

structure assigned to the CDO in question. CDOs are usually paid out in a ‘waterfall' style fashion,

where income received gets paid out first to the highest tranches, with the remaining income flowing

down to the lower quality tranches i.e. <AAA. CDOs were typically structured such that AAA

tranches which were to receive first lien (claim) on the BBB rated loans cash flows, and losses

would trickle up from the lowest quality tranches first. Cash flow was well insulated even against

heavy levels of home owner defaults. Credit rating agencies only accounted for a ~5% decline in

national housing prices at worst, allowing for a confidence in rating the many of these CDOs that

had poor underlying loan qualities as AAA. It did not help that an incestuous relationship between

financial institutions and the credit agencies developed such that, banks began to leverage the credit

ratings off one another and 'shop' around amongst the three big credit agencies until they found the

best ratings for their CDOs. Often they would add and remove loans of various quality until they met

the minimum standards for a desired rating, usually, AAA rating. Often the fees on such ratings

were$300,000 - $500,000, but ran up to $1 million.

As part of the Sarbanes-Oxley Act of 2002, Congress ordered the U.S. SEC to develop a report,

titled Report on the Role and Function of Credit Rating Agencies in the Operation of the Securities

Markets detailing how credit ratings are used in U.S. regulation and the policy issues this use raises.

Partly as a result of this report, in June 2003, the SEC published a "concept release" called Rating

Agencies and the Use of Credit Ratings under the Federal Securities Laws hat sought public

comment on many of the issues raised in its report. Public comments on this concept release have

also been published on the SEC's website. In December 2004, the International Organization of

Securities Commissions (IOSCO) published a Code of Conduct for CRAs that, among other things,

is designed to address the types of conflicts of interest that CRAs face. All of the major CRAs have 42

agreed to sign on to this Code of Conduct and it has been praised by regulators ranging from the

European Commission to the U.S. Securities and Exchange Commission.

FUTURE OF CREDIT RATING IN INDIA

At present, commercial paper, k bonds and debentures with maturities exceeding18 months & fixed

deposits of large non-banking companies registered with RBI are required to be compulsorily rated.

These are moves to make rating compulsorily for other types of borrowings such as fixed deposit

programme of manufacturing companies. In addition, the rating agencies are expected to be called

upon to enlarge volumes of securitization of debt & structuring of customized instruments to meet

the needs of issuers or different class of investors. There are number of areas where rating agencies

will have to cover new grounds in the coming years. The rating of municipal bonds, state govt.

borrowings, commercial banks & public sector

BENEFITS OF CREDIT RATING

Low Cost Information

Quick Investment Decision

Independent Investment Decision

Investment Protection

Spending too much on credit risk research diminishes the return on investment. In addition, unlike

underwriters and main banks, credit rating agencies are valued for their neutral viewpoint and

expertise in credit risk analysis. For these reasons, investors rely heavily on credit rating data.

Benefits to Rated Companies

Sources of additional certification

Attracting higher number of investors

Forewarns risk

Encourages financial discipline amongst the corporate and better financial planning

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Merchant banker’s job made easy

Foreign collaboration made easy

Low cost of borrowing

Rating as a marketing tool

Competitive rates of interest

Added investors’ confidence

Ability to raise money from foreign markets at cheaper rates

Helps to build reputation in the market.

Benefits for the investors

Saves the time and energy in studying company’s financials,

Strong indicator of company’s financial capacity,

Ratings represent the informed opinion of a neutral third party.

Identification of the risk involved in the debt instrument.

Guidance in making an investment decision by being presented with a wide variety of safe choices.

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

management strategies.

Periodical evaluation of company’s financial capacity by rating agency helps the investor to exit the

investment, in case rating is downgraded subsequently.

Benefits for the issuer

Expanded access to capital markets.

Lower financing cost.

Recognition to a first time and unknown issuer in order to establish his market credibility.

Enhancement of goodwill.

Motivation for better performance.

Economic Benefits of Credit Reporting and Scoring

Credit scoring offers multiple benefits at every level of the economy. Credit scores have enabled

lenders to extend into historically underserved market segments. In addition, decisions are now

faster and more objective with the majority of applicants receiving answers within minutes, rather

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than days. Finally, by using credit scores to predict risk more effectively, lenders have been able to

reduce the cost of such vital services as mortgages, personal loans and credit cards. Despite this

expansion into traditionally underserved markets, moral hazard rates are actually lower with credit

scores because lenders can more proactively monitor risk and maintain it at more appropriate levels.

Credit scoring plays a vital role in economic growth by helping expand access to credit markets,

lowering the price of credit and reducing delinquencies and defaults. In the United States, credit

scoring helps drive the American economy and makes credit affordable. For consumers, scoring is

the key to homeownership and consumer credit. It increases competition among lenders, which

drives down prices. Decisions can be made faster and cheaper and more consumers can be approved.

It helps spread risk more fairly so vital resources, such as insurance and mortgages, are priced more

fairly. For businesses, especially small and medium-sized enterprises, credit scoring increases access

to financial resources, reduce costs and helps manage risk. For the national economy, credit scoring

helps smooth consumption during cyclical periods of unemployment and reduces the swings of the

business cycle. By enabling loans and credit products to be bundled according to risk and sold as

securitized derivatives, credit scoring connects consumers to secondary capital markets and increases

the amount of capital that is available to be extended or invested in economic growth.

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NEED AND IMPORTANCE OF CREDIT RATING

A wide range of industries take advantage of credit scores to improve fairness, effectiveness and

efficiency. Financial companies use credit scores to predict the risk of delinquencies and losses,

which enables them to better allocate costs. Insurance companies use specialized credit scores to

make fairer underwriting decisions. Credit scores even provide benefits at the macroeconomic level

by helping small enterprises attain the funds they need and by facilitating the securitization and sale

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

country.

Importance of credit score

Credit rating is an indicator that reflects how well or badly you manage your financial matters. By

having a look at your credit rating, one can get much information regarding your business

organization and particularly the payments made by your organization. There are several credit

bureaus that compile this kind of information and later on sale it to their clients. It's very important

to know your credit score and understand it completely, as it helps you to get loans, mortgage and

even a job. Credit report list personal information such as name, address, date of birth, social

security number, number of family member, your employer etc. Financial situations like

bankruptcies, tax liens, foreclosure, late payment of your bill etc, will also be listed in the report.

Your credit score list plenty of information about your financial actions. Your loan or credit account,

and how you pay them, your current debts, type of debts...etc. All these information are listed in the

report. The creditors, lending agencies and other companies will consider your credit score to

determine if they can finance you without a risk. Any doubtful record creates a negative impact and

can affect you in many ways. It's not only in case of sanctioning a loan but also determine the rate of

interest. Lower the score, higher will be the interest. According to the data of Jean Chatzky (the

financial editor for NBC's The Today Show), in May 2006, to qualify for the best rates on a

mortgage loan, home buyer needed a credit score of 620 or higher. Just 2 year later in May 2008,

you would have asked for a credit score of 750 to qualify for those same rates. So it's important to

review your report once in a year, so that you are aware of your report and know what the creditors

say about you and also can work on improving your score. Knowing your credit report will help you

make important financial decisions. In the competitive market, rating gives an edge to the company

when they place their bond/debenture or other debt instruments in the market for subscription. The

investor relies on the independent rating agency since he does not have the time, expertise, analytical

skills and the past data on the company’s performance available with him. Comparison between 2

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similar types of instruments is made easier if rating of the issues is available. The investor who

knows the risk he has bargained for when he decides to take a decision to invest vis-a-vis his own

risk appetite and the rewards he could expect. Rating helps the issuing companies to place their

issues at competitive rates of interest and reduce the cost of funds to a reasonable level keeping with

their credit standing, reputation and ability to repay the debts in time.

It should be noted that when a rating is attached to an issue, it by no means, reflects the total

financial capacity of the company. In other words, rating agencies carryout the rating exercise for an

issue of debt instrument and not a company as a whole. A company may get highest rating for a

particular size of an issue where as if size is increased beyond a particular level, same issue may be

allotted a lower rating if the company’s financial capacity is unable to sustain the servicing of the

issue. Also if after the issue is launched with a higher credit rating and company undertakes

operations which are likely to put their financial capacity under strain, the credit rating may be

lowered by the rating agency anytime during the maturity of the instrument before it becomes due

for payment

By adopting a universally accepted measure of credit risk, issuers of any nationality can gain access

to global capital markets. In addition, since the issuer's credit risk is publicly announced, the issuer

can obtain financing at an appropriate interest rate and avoid unnecessary credit spreads that may

arise from misinformation or lack of recognition. Often, issues are raised as to the creditability of

credit rating agencies on account of the fact that different credit rating agencies often come up with

different ratings for the same organization. Ratings are determined through a comprehensive

evaluation including quantitative factors (financial indicators such as operating profit ratio, equity

ratio, etc.), qualitative factors (business foundation including industry trends, company

characteristics, etc.), and factors specific to the bond (issue conditions, bond type, etc.). Thus the

differences in ratings emerge due to the different stances of agencies toward each of these factors.

Investment decisions can change considerably depending on which credit rating data is used.

Usually, investors use the lowest rating in their analysis. However, this valuable source of

information will be rendered useless unless applied with the appropriate investment stance and

investment criteria.

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Importance of credit rating in India

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

Credit rating shows the exact worth of the organization In the Indian context it’s a sudden down

gradation of ratings of an organization, by three or more notches within a few months in spite of no

visible fluctuations in the market. The rating agencies justify it on the ground that they suffer from a

lack of adequate information, different agencies give different weightage to different factors on

account of there being no market regulatory body as such to lay down yardsticks or monitor their

ratings. Thus, it is evident that the system is still in its nascent stage in India and the SEBI guidelines

indicate a step forward in institutionalizing the process. The merit of the guidelines per se is of

course, a different issue that will be dealt with in a different chapter. As of now the issue is merely

concerned with ascertaining whether CRAs are here to stay and the answer quite definitely seems to

be in the affirmative.

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PRACTICAL PROBLEMS WITH CREDIT RATING

The widespread of branch net work of the rating agency may limit skills in rating.

Inexperienced, unskilled or overloaded staff may not do justice to their job &the resulting ratings

may not be perfect.

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

guarantee for the investors.

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

conditions temporarily will be given a low rating judged on the basis of temporary phenomenon.

Since the rating agencies receive a sizable fee from the companies for awarding ratings, a

tendency to inflate the ratings may develop.

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

However, the problems with the credit rating system are several, and it would be unfair to say that

these problems are to be found only in the Indian CRAs as they plague CRAs all over the world.

Some of them are listed below:

There is often a possibility of biased ratings and misrepresentation on account of the lack of

accountability in the process and the close nexus between the agency and the issuer (at least in the

Indian context).

Rating only represents the past and present performances of the company and therefore future events

may alter the nature of the rating.

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

concealment of information on the part of the latter.

Rating of a debt instrument is not a guarantee as to the soundness of the company.

Ratings often on the debt instruments of different agencies.

Small differences in degrees of risk are usually not indicated by CRAs. Thus issues with the same

rating may actually be of differing quality.

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

relative terms.

CRAs cannot be used as recommendations to buy, sell or hold securities as they do not comment on

the adequacy of market price, suitability of any security for an investor or the taxability of the

payments.

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The information is obtained from issuers, underwriters, etc. and is usually not checked for accuracy

or truth. Thus ratings may change on account of non-availability of information or unavailability of

adequate information.

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

In India the chief problems in the context of CRAs arises on account of the fact that they are not the

independent and autonomous entities that their international counterparts are. The three primary

CRAs in India, viz., ICRA promoted by IFCI and other financial institutions and banks, CRISIL,

promoted by ICICI, Asian Development bank and others, and CARE promoted by IDBI are all

promoted by lending institutions. Further most corporate borrowers are clients of these institutions in

terms of borrowing. Further, institutions like ICICI, IDBI also have stakes in such client companies.

Thus it is very important for these agencies to distance themselves from their promoters if they want

to gain credibility. Thus, needless to say, the system of CRAs needs some amount of relooking and

overhauling in order to make it effective and viable in the future. A positive step has been taken in

this regard by the SEBI (Credit rating Agencies) Regulations,1999, which has attempted to resolve

some of the aforesaid problems, but much still remains to be done.

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REGUALTORY FRAMEWORK

Credit rating has been made mandatory in India for issuance of instruments. Following are some of

the important regulatory agencies connected with credit rating.

SEBI:

As per the regulations of SEBI, a public issue of debentures and bonds convertible/redeemable

beyond a period of 18 months needs credit rating.

RBI:

According to the guidelines of RBI, one of the conditions for issuance of commercial paper in India

is that the issue must have a rating not below the P2grade from CRISIL/A2 grade from ICRA/PR2

from CARE.

Rating Framework

Credit rating at providing an opinion on the relative credit risk associated with an instrument. While

assigning ratings, all the factors that have a bearing on future cash generation, and claims that

require servicing, are considered. The major factors that determine the rating profile of a security

issue are discussed below:

Business Factors

Nature of industry

Market position

Efficiency of operation.

Project risk

Protective factors

Quality of management.

Financial Factors

Financing Policies.

Flexibility of financial structure.

Past track record.

Quality of accounting policy.

Financial performance indicators.

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Profitability.

Gearing.

Coverage ratios.

Liquidity

Cash flow

Advantages

To investors

Information service.

Systematic risk evaluation.

Professional competency.

Easy to understand.

Low cost.

Efficient portfolio management.

Other benefits.

To Issuers

Index of faith.

Bench mark

Wider investor base

To Intermediaries

Efficient practice.

Effective monitoring

Drawbacks

Guidance, not recommendation.

Based on assumptions.

Competitive ratings.

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SEBI GUIDELINES

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

Dual rating is compulsory for public & rights issue of debt instrument of Rs100 crore or more.

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

Rating agencies can choose their methodology of operation but self regulatory mechanism will

give a better maturity status for agencies.

Period of validity of registration shall be 3 years.

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

companies to corporate with agencies by providing correct information. Refusal to do so many

lead to breach of contract between rating agency & client.

It is also suggested that a penal clause be

REGISTRATION OF CREDIT RATING AGENCY

Application for grant of certificate

1. Any person proposing to commence any activity as a credit rating agency on or after the date

of commencement of these regulations shall make an application to the Board for the grant of

a certificate of registration for the purpose.

2. Any person, who was immediately before the said date carrying on any activity as a credit

rating agency, shall make an application to the Board for the grant of a certificate within a

period of three months from such date: Provided that the Board may, where it is of the opinion

53

that it is necessary to do so, for reasons to be recorded in writing, extend the said period up to

a maximum of six months form such date.

3. An application for the grant of a certificate under sub-regulation or sub-regulation shall be

made to the Board in Form A of the First Schedule and shall be accompanied by a non–

refundable application fee, as specified in Form A of the second Schedule, to be paid in the

manner specified in Part B thereof.

4. Any person referred to in sub-regulation who fails to make an application for the grant of a

certificate within the period specified in that sub-regulation shall cease to carry on rating

activity.

Promoter of credit rating agency

The Board shall not consider an application under regulation (3) unless the applicant is promoted

by a person belonging to any of the following categories, namely:

(a) A public financial institution, as defined in section 4 A of the Companies Act,1956 (1 of 1956);

(b) a scheduled commercial bank included for the time being in the second schedule to the Reserve

Bank of India Act, 1934 (2 of 1934);

(c) a foreign bank operating in India with the approval of the Reserve Bank of India;

(d) a foreign credit rating agency recognized by or under any law for the time being in force in the

country of its incorporation, having at least five years experience in rating securities;

(e) any company or a body corporate, having continuous net worth of minimum rupees one

hundred crores as per its audited annual accounts for the previous five years prior to filing of the

application with the Board for the grant of certificate under these regulations.

Eligibility criteria

The Board shall not consider an application for the grant of a certificate under regulation 3, unless

the applicant satisfies the following conditions, namely:

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

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b. the applicant has, in its Memorandum of Association, specified rating activity as one of its

main objects;

c. The applicant has a minimum net worth of rupees five crores. Provided that a credit rating

agency existing at the commencement of these regulations, with a net worth of less than

rupees five crores, shall be deemed to have satisfied this condition, if it increases its net worth

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

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

with the provisions of the Act and these regulations;

e. the applicant and the promoters of the applicant, referred to in regulation 4 have professional

competence, financial soundness and general reputation of fairness and integrity in business

transactions, to the satisfaction of the Board;

f. neither the applicant, nor its promoter, nor any director of the applicant or its promoter, is

involved in any legal proceeding connected with the securities market, which may have an

adverse impact on the interests of the investors;

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

past been convicted of any offence involving moral turpitude or any economic offence;

h. the applicant has, in its employment, persons having adequate professional and other relevant

experience to the satisfaction of the Board;

i. neither the applicant, nor any person directly or indirectly connected with the applicant has in

the past been – (I) refused by the Board a certificate under these regulations or (II) subjected

to any proceedings for a contravention of the Act or of any rules or regulations made under

the Act.

Explanation: For the purpose of this clause, the expression "directly or indirectly connected

person" means any person who is an associate, subsidiary, inter-connected or group company of

the applicant or a company under the same management as the applicant.

j. the applicant, in all other respects, is a fit and proper person for the grant of a certificate; k.

k. Grant of certificate to the applicant is in the interest of investors and the securities market.

Application to conform to the requirements

a. Any application for a certificate, which is not complete in all respects or does not conform to

the requirement of regulation 5 or instructions specified in Form A shall be rejected by the

Board.

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b. Provided that, before rejecting any such application, the applicant shall be given an

opportunity to remove, within thirty days of the date of receipt of relevant communication,

from the Board such objections as may be indicated by the Board.

c. Provided further, that the Board may, on sufficient reason being shown, extend the time for

removal of objections by such further time, not exceeding thirty days, as the Board may

consider fit to enable the applicant to remove such objections.

Furnishing of information, clarification and personal representation

a. The Board may require the applicant to furnish such further information or clarification as

the Board may consider necessary, for the purpose of processing of the application. 1

Inserted by SEBI (Criteria for Fit and Proper Person) Regulations, 2004, w.e.f.10.3.2004.

b. The Board, if it so desires, may ask the applicant or its authorized representative to appear

before the Board, for personal representation in connection with the grant of a certificate.

Grant of Certificate

(1) The Board, on being satisfied that the applicant is eligible for the grant of a certificate of

registration, shall grant a certificate in Form ‘B’.

(2) The grant of certificate of registration shall be subject to the payment of the registration fee

specified in Part A of the Second Schedule, , in the manner prescribed in Part B thereof

Conditions of certificate and validity period

(1) The certificate granted under regulation 8 shall be, subject to the following conditions,

namely:

a) The credit rating agency shall comply with the provisions of the Act, the regulations made

there under and the guidelines, directives, circulars and instructions issued by the Board

from time to time on the subject of credit rating.

b) where any information or particulars furnished to the Board by a credit rating agency:

i. is found to be false or misleading in any material particular ; or

ii. has undergone change subsequently to its furnishing at the time of the application

for a certificate; the credit rating agency shall forthwith inform the Board in

writing.

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

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Renewal of certificate

(1) A credit rating agency, if it desires renewal of the certificate granted to it, shall make to the

Board an application for the renewal of the certificate of registration.1(1A) An application for

renewal of certificate of registration made under sub-regulation(1) shall be accompanied by a non

refundable application fee as specified in the Second Schedule

(2) Such application shall be made not less than three months before expiry of the period of

validity of the certificate, specified in sub-regulation(2) of regulation 9..

(3) The application for renewal made under sub-regulation (1)- –

a. shall be accompanied by a renewal fee as specified in the second schedule and 1 Inserted

by SEBI (Credit Rating Agencies)(Amendment) Regulations, 2006,w.e.f. 7-9-2006

b. as far as may be, shall be dealt with in the same manner as if it were an application for the

grant of a fresh certificate under regulation 3.

Procedure where certificate is not granted

o If, after considering an application made under regulation 3 or regulation 10 as the case may be,

the Board is of the opinion that a certificate should not be granted or renewed, as the case may be,

it may, after giving the applicant a reasonable opportunity of being heard, reject the application.

o The decision of the Board, not to grant or not to renew the certificate under sub-regulation (1) shall

be communicated by the Board to the applicant within a period of thirty days of such decision,

stating the grounds of the decision.

o Any applicant aggrieved by the decision of the Board rejecting his application under sub-

regulation

(1) may, within a period of thirty days from the date of receipt by him of the communication

referred to in sub-regulation

(2) apply to the Board in writing for reconsideration of such decision.

o Where an application for re-consideration is made under sub-regulation (3) the Board shall

consider the application and communicate to the applicant its decision in writing, as soon as may

be

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Effect of refusal to grant certificate

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

certificate has been rejected under regulation 11, shall not undertake any rating activity.

m. An applicant referred to in sub-regulation (2) of regulation 3, whose application for the grant of a

certificate has been rejected by the Board under regulation 11, shall, on and from the date of the

receipt of the communication under sub-regulation (2) of regulation 11, cease to carry on any

rating activity.

n. If the Board is satisfied that it is in the interest of the investors, it may permit the credit rating

agency referred to under sub-regulation (1) or (2) to complete the rating assignments already

entered into by it, during the pendency of the application or period of validity of the certificate.

o. The Board may, in order to protect the interests of investors, issue directions with regard to the

transfer of records, documents or reports relating to the activities of a credit rating agency, whose

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

p. The Board may, in order to protect the interests of investors, appoint any person to take charge of

the records, documents or reports relating to the rating activities of a credit rating agency referred

to in sub-regulation (4) and for this purpose also determine the terms and conditions of such

appointment.

CODE OF CONDUCT

1. A credit rating agency shall make all efforts to protect the interests of investors.

2. A credit rating agency, in the conduct of its business, shall observe high standards of integrity,

dignity and fairness in the conduct of its Business.

3. A credit rating agency shall fulfill its obligations in a prompt, ethical and professional manner.

4. A credit rating agency shall at all times exercise due diligence, ensure proper care and exercise

independent professional judgment in order to achieve and maintain objectivity and independence

in the rating process.

5. A credit rating agency shall have a reasonable and adequate basis for performing rating

evaluations, with the support of appropriate and in depth rating researches. It shall also maintain

records to support its decisions.

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6. A credit rating agency shall have in place a rating process that reflects consistent and

international rating standards

7. A credit rating agency shall not indulge in any unfair competition nor shall it wean away the

clients of any other rating agency on assurance of higher rating.

8. A credit rating agency shall keep track of all important changes relating to the client companies

and shall develop efficient and responsive systems to yield timely and accurate ratings. Further a

credit rating agency shall also monitor closely all relevant factors that might affect the

creditworthiness of the issuers.

9. A credit rating agency shall disclose its rating methodology to clients, users and the public.

10. A credit rating agency shall, wherever necessary, disclose to the clients, possible sources of

conflict of duties and interests, which could impair its ability to make fair, objective and

unbiased ratings. Rating committee participating in the rating analysis, and that of its client.

11. A credit rating agency shall not make any exaggerated statement, whether oral or written, to the

client either about its qualification or its capability to render certain services or its achievements

with regard to the services rendered to other clients.

12. .A credit rating agency shall not make any untrue statement, suppress any material fact or make

any misrepresentation in any documents, reports, papers or information furnished to the board,

stock exchange or public at large.

13. A credit rating agency shall ensure that the Board is promptly informed about any action, legal

proceedings etc., initiated against it alleging any material breach or non-compliance by it, of any

law, rules, regulations and directions of the Boarder of any other regulatory body.(b) In case an

employee of the credit rating agency is rendering such advice, he shall also disclose the interest

of is dependent family members and the employer including their long or short position in the

said security, while rendering such advice.

14. A credit rating agency shall maintain an appropriate level of knowledge and competence and

abide by the provisions of the Act, regulations and circulars, which may be applicable and

relevant to the activities carried on by the credit rating agency. The credit rating agency shall

also comply with award of the Ombudsman passed under the Securities and Exchange Board of

India (Ombudsman) Regulations, 2003.

15. A credit rating agency shall ensure that there is no misuse of any privileged information

including prior knowledge of rating decisions or changes.

16. a) A credit rating agency or any of his employees shall not render, directly or indirectly any

investment advice about any security in the publicly accessible media.59

b) A credit rating agency shall not offer fee-based services to the rated entities, beyond credit

ratings and research.

17. A credit rating agency shall ensure that any change in registration status/any penal action taken

by board or any material change in financials which may adversely affect the interests of

clients/investors is promptly informed to the clients and any business remaining outstanding is

transferred to registered person in accordance with any instructions of the affected

clients/investors.

18. A credit rating agency shall maintain an arm’s length relationship between its credit rating

activity and any other activity.

19. . A credit rating agency shall develop its own internal code of conduct for governing its internal

operations and laying down its standards of appropriate conduct for its employees and officers’

in the carrying out of their duties within the credit rating agency and as a part of the industry.

20. A credit rating agency shall provide adequate freedom and powers to its compliance officer for

the effective discharge of his duties.

21. A credit rating agency shall ensure that the senior management, particularly decision makers

have access to all relevant information about the business on a timely basis.

22. A credit rating agency shall ensure that good corporate policies and corporate governance are in

place

23. A credit rating agency shall not, generally and particularly in respect of issue of securities rated

by it, be party to or instrumental for—

(a) Creation of false market;

(b) Price rigging or manipulation

(c)Dissemination of any unpublished price sensitive information in respect of securities which

are listed and proposed to be listed in any stock exchange, unless required, as part of rationale

for the rating accorded.

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COMPARISON OF REGULATIONS RELATED TO CREDIT RATING AGENCIES IN INDIA AND OTHER COUNTRIES

1. INDIA

The RBI prescribes a number of regulatory uses of ratings. The RBI requires that a NBFC must

have minimum investment grade credit rating if it intends to accept public deposits. Furthermore,

unrated or underrated NBFCs in the category of equipment leasing and hire purchase finance

companies are required to disclose the fact of their being unrated, to the public, if they intend

raising deposits. Finally, as per money-market regulations of RBI, a corporate must get an issue of

CP rated and can issue such paper subject to a minimum rating. In the area of investments, SEBI

stipulated that ratings are compulsory on all public issues of debentures with maturity exceeding

18 months. SEBI has also made ratings mandatory for acceptance of public deposits by Collective

Investment Schemes. If the size of the issue is larger than Rs.100 crore, two ratings are required.

Pension funds can only invest in debt-securities that have two ratings, as per the stipulations of

Government of India.

In India, in 1998, SEBI constituted a Committee to look into draft regulation for Credit rating

agencies that were prepared internally by SEBI. The Committee held the view that in keeping

with international practice, SEBI Act 1992 should be amended to bring Credit rating agencies

outside the purview of SEBI for a variety of reasons. According to the Committee, a regulator will

not be in a position to objectively judge the appropriateness of one rating over another. The

competency and the credibility of a rating and CREDIT

RATING AGENCY should be judged by the market, based on historical record, and not by a

regulator. The Committee suggested that instead of regulation, SEBI could just recognise certain

agencies for particular purposes only, such as allowing ratings by Credit rating agencies

recognised by it for inclusion in the public/rights issue offer documents. In consultation with

Government, in July 1999, SEBI issued a notification bringing the Credit rating agencies under its

regulatory ambit in exercise of powers conferred on it by Section 30 read with Section 11 of the

SEBI Act 1992. The Act now requires all Credit rating agencies to be registered with SEBI. Since

then, all the four Credit rating agencies in India have been registered with SEBI. SEBI Act now

defines “credit rating agency”, “rating”, and “securities”. Details of who could promote a

CREDIT RATING AGENCY and their eligibility criteria are specified. The Act also mentions

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about agreement with clients, method of monitoring of ratings, procedures for review of ratings,

disclosure of ratings and submission of

2. OTHER COUNTRIES

Regulators of both developed and emerging markets rely on credit ratings for a variety of

purposes. USA introduced the concept of regulatory use of ratings in 1931. The Office of the

Comptroller of Currency used ratings as a means to determine the basis of valuation of bonds.

The use of ratings spread to other activities such as determination of capital prescription or

margin money for brokers/dealers, disclosure requirements under Securities and Exchange

Commission norms, exemption from registration and regulation for certain issuers of asset-backed

securities, etc. The National Association of Insurance Commissioners (NAIC), which determines

insurance company’s regulatory capital charges, also relies on ratings. Japan promoted credit

ratings in 1974 and regulators used the ratings of Japan Bond Research Institute (a rating agency)

as one of the eligibility criteria for bond issues in the 1980s. The Ministry of Finance relies on

ratings in a variety of ways, including regulation of money reserve funds. In 1993, the European

Community stipulated capital requirements for market risk for banks and security houses based on

ratings. UK adopted rating based Capital Adequacy Directives in 1996. Favoured treatment is also

accorded to firms engaged in securities business based on rating. France, Italy, Australia,

Switzerland, Canada, Argentina, Chile, Mexico, Indonesia, Korea, Malaysia, Philippines, Taiwan

Province of China and Thailand are other countries that have regulatory uses for ratings. In fact,

the adoption of rating based regulations was the main force leading to the creation of rating

agencies in emerging markets in Latin America and Asia. An important issue is the criteria for

recognising a credit rating agency for use of its ratings in regulation. It is now commonly

accepted that criteria are : assured continuous objectivity in methodology; independence from

outside influences; credibility, though this should not be an entry barrier; access to all parties with

legitimate interest; and adequacy of resources. Most regulators stipulate a list of recognised

agencies whose ratings can be used to satisfy rating requirements. Broadly, there are three areas

where extensive use is made of ratings in the regulatory process, viz., investment restrictions on

regulated institutions; establishing capital requirements for financial and disclosure as well as

issuance requirements. The issues faced by regulators in use of ratings include reconciling

divergent ratings by different Credit rating agencies and deciding cut-off of level of ratings. In the

aftermath of the Asian crisis and the scathing criticism on the failure of Credit rating agencies to

predict the crisis and later on its role in precipitating it through downgrades, the role of credit

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rating agencies has been placed under microscopic scrutiny. The merits and demerits of regulating

credit rating agencies and the issue of rating the rating agencies have been discussed in many

international forums. There is no international regulatory authority overseeing rating agencies.

Whether they are regulated or not depends on specific country circumstances. In general,

however, countries impose a modest regulation over Credit rating agencies. In USA, Securities

and Exchange Commission gives recognition to Credit rating agencies as Nationally Recognised

Statistical Rating Organisations (NRSO) for specific purposes. The main form of regulation is

USA is in officially recognising a credit rating agency. Thereafter, there is hardly any regulation.

Similarly in UK, recognition as a rating agency is required from the Financial Services Authority

(FSA). So is the case in Japan, Australia, France and Spain.

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STANDARD & POOR'S

Introduction

Standard & Poor's (S&P) is a United States-based financial services company. It is a division of

the McGraw-Hill Companies that publishes financial research and analysis on stocks and bonds. It

is well known for the stock market indices, the US-based S&P 500, the Australian S&P/ASX 200,

the Canadian S&P/TSX, the Italian S&P/MIB and India's S&P CNX Nifty. It is one of the Big

Three (credit rating agencies) (Standard& Poor's, Moody's Investor Service and Fitch Ratings)

Standard & Poor's, as a credit rating agency (CRA), issues credit ratings for the debt of public and

private corporations. It is one of several CRAs that have been designated a Nationally Recognized

Statistical Rating Organization by the U.S. Securities and Exchange Commission. It issues both

short-term and long-term credit ratings.

History of Standard and Poor’s

Standard & Poor's traces its history back to 1860, with the publication by Henry Varnum Poor of

History of Railroads and Canals in the United States .This book was an attempt to compile

comprehensive information about the financial and operational state of U.S. railroad companies.

Henry Varnum went on to establish H.V. and H.W. Poor Co with his son, Henry William, and

published updated versions of this book on an annual basis.

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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. In 1941, Poor and

Standard Statistics merged to become Standard& Poor's Corp. Then in 1966 S&P was acquired by

The McGraw- Hill Companies, and now encompasses the Financial Services division

From this source, it shows that Standard & Poor’s expects a brief earnings dip in the fourth

quarter of 2007 with the earnings trend returning to the prior growth pattern by the second quarter

of 2008.Remember that much of the growth in earnings was driven by the growth in revenues

which was fueled by the rapid expansion of credit that is now contracting significantly. The

problem is this earnings forecast doesn’t do not seem very logical nor does it follow history.

According to McKinsey & Company, the strategic consulting firm, in order for overall S&P 500

earnings to reach the long-run average proportion of GDP, profits would have to fall 20 percent

from their 2007 levels. This excludes the financial and energy sectors, so we get a better focus on

the underlying economy.

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Long-term credit ratings

S&P rates borrowers on a scale from AAA to D. Intermediate ratings are offered at each level

between AA and CCC (e.g., BBB+, BBB and BBB)

Investment Grade

AAA: the best quality borrowers, reliable and stable (many of them governments)

AA: quality borrowers, a bit higher risk than AAA. Includes:

AA+: equivalent to Moody's and Fitch

AA: equivalent to Aa2

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AA-: equivalent to Aa3

A: quality borrowers whose financial stability could be affected by certain economic situations

A+: equivalent to A1

A: equivalent to A2

BBB: medium class borrowers, which are satisfactory at the moment

Non-Investment Grade (also known as junk bonds)

BB: more prone to changes in the economy

B: financial situation varies noticeably

CCC: currently vulnerable and dependent on favorable economic conditions to meet its

commitments

CC: highly vulnerable, very speculative bonds

C: highly vulnerable, perhaps in bankruptcy or in arrears but still continuing to pay out on

obligations

CI: past due on interest

R: under regulatory supervision due to its financial situation

SD: has selectively defaulted on some obligations

D: has defaulted on obligations and S&P believes that it will generally default on most or all

obligations

NR: not rated

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CRISIL SME RATINGS:

BACKGROUND

Recent years have seen rapid growth in the Small and Medium Enterprises (SME) sector, and an

enhanced appreciation of this sector's critical role in driving economic growth. However, authentic

and independent credit research in this sector has so far been minimal. With many private and public

sector banks directing resources and focus towards SME lending, the need has arisen for

independent credit opinions. CRISIL offers its rating services to SMEs to meet this need. SME

ratings are offered on an exclusive rating scale, distinct from regular ratings offered to large

corporations, banks and government entities.

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Credit evaluation in the SME sector needs a specialized approach, as the issues and drivers of credit

quality are different from those applicable for large companies. The weightages assigned to various

parameters of evaluation therefore need to be different. There has to be a good understanding of the

particular cluster or area where the SME is operating.

When Lalchand Nathalal Gandhi was approached by Crisil three years ago to get a credit rating

exercise done for his companies, LN Chemicals and Modera Chemicals, he was skeptical but

decided to go ahead anyway. The experiment worked. While Gandhi’s businesses already had a

good relationship with Saraswat Bank for years, the rating helped them get an additional 0.5%

interest rate reduction on their bank borrowings. “We were also noticed by other companies sand

new enquiries began to flow in,” says Gandhi, whose firms—with a combined turnover of Rs 40

crore—make chemicals that are used in textile processing, and soap, paper and paint manufacture.

Now, as Gandhi looks to expand his business, he’s already being approached by other banks to fund

his expansion plans. “This could be due to the rating we got from Crisil over the past three years,” he

says. Cultivating healthy relationships with banks may have helped small companies tide over credit

access issues to an extent.

However, banks’ reluctance to lend to MSMEs often stems from lack of information, and the fact

that evaluating risk in such firms is often a difficult and time consuming process. Credit rating could

be the solution. A rating report provided by an independent agency like Crisil, ICRA or CARE offers

deep insights into a company’s operations.

It can reveal the creditworthiness of the company in relation to its peers in the sector, and an

assessment of its strengths and weaknesses based on its financial condition. “Anyone who sees the

report is instantly appraised of the health of the company,” says Yogesh Dixit, head-SME Ratings at

Crisil. Large corporates have been getting themselves rated for many years now, but in the world of

small business this is a relatively recent and emerging trend.

Four years ago, the National Small Industries Corporation (NSIC) launched a programme where a

micro or small enterprise (with a maximum investment of Rs 5crore in plant and machinery) would

receive a 75% subsidy on rating fees (around Rs 50,000) charged by any of the six empanelled rating

agencies– Crisil, ICRA,D&B , SMERA, Fitch and CARE. This has had a positive effect with around

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5,000units getting rated last year, and NSIC expects that at least another 7,000 will follow suit this

year.

Under the new Basel II norms that came into effect from April 1 this year, rating is mandatory for

businesses with investments over Rs 10 crore. For those firms that are below the Rs 10-crore level,

rating is also beneficial, especially when it comes to dealing with customers. “For a small business, a

rating by a recognized agency helps it command better terms with its buyers,” says HP Kumar,

chairman and managing director of NSIC.

A robust rating process includes a visit to the factories and warehouses to authenticate information

provided by the company, verifying if the insurance of assets is in order and also taking feedback

from suppliers, customers and bankers of the firm, among other aspects.

The NSIC rating scale takes into account two factors—performance capability and financial

strength. For example, a company with moderate performance capability and high financial strength

will be rated SE3A, while one with weak performance capability and moderate financial strength

will be rated SE4B.

On the basis of rating reports, banks are able to take faster decisions on project loans as well as on

renewing and increasing credit limits for those clients. Every bank has its own internal guidelines on

lending but Dixit says ratings are useful since information about small companies is not readily

available. “It is an independent third party assessment of the overall condition of the SME,” he

says.In that sense, ratings bring credibility and a better image to a sector that’s fragmented and often

opaque about the financial health of its companies. “Ratingscan be revealed to vendors and

customers without furnishing all financial data,”says Rajesh Dubey, executive director, ICRA

Online.

Take the case of In marco Industries, which makes high-tech industrial sealing products. The Rs 25-

crore (turnover) firm has been getting rated by Crisil everyyear for the past four years and has

managed to obtain the highest level of SE1Aeach time. “We have been able to establish JVs and

partnerships with the help of the rating,” says Chetan Doshi, executive director, In marco, adding

that it’s a calibration tool for his business that could come handy when he decides to go for an IPO

later. “It helps us in self-analysis as we expand.” Many companies have been leveraging ratings to

enhance their brand image and acquire new clients.70

For instance, Gandhi says his firms’ rating is displayed prominently on the company stationery and

website. “It gives us an identity in new markets and with new customers,” he says. Moreover some

supply tender notices insist the applying companies be rated. Rating is also bringing a shift in

thinking among SMEs in terms of self-regulation. “Rated companies today understand that good

corporate governance, transparency and a sound accounting policy are all important in this changing

world,” says Dixit.

That doesn’t mean ratings have become fully accepted among small companies and their bankers.

There have been cases reported where banks have not honoured ratings done by external agencies,

and have relied only on their own due diligence. Rajeev Karwal, CEO, Milagrow Business and

Knowledge Solutions, a small business advisory firm says, “Banks should accept it. Only if they

give loans on the basis of the rating will it have any meaning.” At Meerut-based Kanohar Electricals,

managing director Dinesh Singhal contends that mandatory rating due to Basel II adds to his cost

and provides no additional value. “These rating agencies are not fully equipped to rate according to

Basel II.

They prepare reports after just looking at the balance sheets,” he says. While the maximum benefit to

a company getting rated is an interest reduction of 0.5%, the cost of rating works out to be higher

than the savings, he says. There are other limitations to the ratings system as well, says Anil

Bhardwaj, secretary general of the Federation of Indian Micro and Small & Medium Enterprises

(FISME). “Most banks have a tacit understanding with one or two rating agencies and they do not

accept ratings by other agencies. Therefore, a serious re-look is required in the models and the

mandatory nature of ratings. Secondly, the field must be opened up to more credit rating players to

bring in greater competition and customer service orientation,” he says.

FINDINGS

Ratings are not a guarantee against loss.

Credit ratings are assigned to companies through Credit rating agency.

The rating given by the agency is very important for:

o Investor 

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o Issuer 

o Financial Intermediaries

o Business Counter-parties

o Regulators

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

correct decision of investment.

Issuer can Appeal to the credit rating agency if they would not satisfy with the

ratings

Converting a Bad Credit Rating into Good Credit Rating

Even if past mistakes have brought your company to the despair and the credit rating is very poor,

you always have the chances to improve. However, to rebuild the credit rating, your financial

management team should have all the relevant information with it.There are several computer

software programs available in the market that help alot in this regard. Law also permits to

convert the bad credit rating in to good credit rating and repairing the damage done by poor credit

rating. According to latest regulations, credit bureaus have to wipe out negative remarks from

your organizations' credit report after a certain period of time. You can argue with them regarding

any information that you feel objectionable. They have to delete it if they cannot verify such

information.

Know the common myths related to your credit report

Today the consumers have been really informed and vast majority of them are also aware about

the credit report system or even their own credit scores. However it is astonishing to know that the

there are some myths that people believe in connection to their credit reports. Some of the

common ones are mentioned below:

Checking your credit report hurts your credit score

Often it has been believed that checking your own credit report and credit score will put a

negative impact on your credit score. However the fact is that a soft inquiry does not go against

your score. On the other hand, if anyone else like a lender or Credit Card Company is checking

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your credit report, then this is considered as a hard inquiry and normally it take off about 5 credit

points from your score. Moreover one should know that multiple inquiries in a 14 days period are

just treated as just one inquiry in the credit score rating system. Also the system ignores all

inquiries made within 30 days before the day when the credit score is computed. Therefore if you

want to minimize the damage on your credit score through credit inquiries then try shopping for a

loan within 14 days period.

Closing old accounts and canceling credit cards improves your credit report score

This is a very common myth because sometimes even your lenders tell you to close your old and

inactive accounts in order to improve your credit scores. But closing old accounts and canceling

credit cards may actually have an opposite effect with the current credit score rating system. It

may leave a negative impact as it will make your credit history appear shorter and thereby lower

your credit score.

Credit counseling causes harm to your score

Attending a debt management program will not cause any harm to credit score. The current FICO

credit score rating system take no notice of any reference to credit counseling that may be

mentioned in your file. The researchers have found that people who have opted for credit

counseling have not defaulted on their debts and therefore it is not taken into consideration while

tabulating credit score.

However late payments can hurt your credit report and credit counseling can hurt your ability to

avail a loan because you probably have had trouble paying creditors.

All credit reports are the same

Most people believe that credit reports from all the three credit rating agencies is same but it is not

so. These days, most creditors across the country do report their information to all three major

agencies – Equifax, Experian, TransUnion – and as they are separate firms, the method and the

pace in which they update records may not necessarily be the same. So make sure you get your

credit reports from all three major credit reporting bureaus before you apply for a big loan.

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SOME MORE QUESTIONS

Which Companies Are Affected by Ratings?

Every company or country that has a rating will be affected in its borrowing costs, at least in

public markets. A higher ranking means lower interest rates for the borrower and vice versa. The

price of credit is set not only by relative credit ratings but also by the general supply of money

and the specifics of an individual borrowing. A low-rated borrower, for example, can sometimes

borrow more cheaply by securing the bond with a claim on specific assets, or by paying a third-

party to insure the bond. Conversely, a highly-rated borrower may choose a structure that attracts

a lower rating because of special characteristics of the issue, including its standing in the

borrower's capital structure or the jurisdiction in which it is issued.

How do I Improve the Credit Rating of My Organization?

To improve the credit rating of any corporation you need to increase the credit score. If the

persons who are managing your financial matters are cautious enough to pay all the bills on time,

they are doing the best thing to achieve higher credit rating. On the contrary, if they make

payments late, not only it adversely affects your company's credit rating but also the added

interest makes your organization in debted for a longer period for time. However, if they are

finding it difficult to pay according to present schedule, ask them to sit with the creditors and

reschedule payment dates. Whatever efforts you make to increase the credit rating of your

business organization will not go in the vain. Whenever you need extra money in the future, you

will be able to get it. Furthermore, you will get the money at lower interest rates as compared to

those organizations that have a bad credit rating. Similarly, getting mortgage loans or car loans

also become easier to the companies with good credit rating.

Is Service tax payable on Information and Advisory services rendered by Credit Rating

Agencies?

No, the information and advisory services, if any, rendered by credit rating agencies would not

attract service tax for the reason that taxable services in respect of credit rating agency means

service provided to a client only in relation to credit rating of any financial obligation, instrument

or security. Services of research and information such as analysis of industries in specific sectors

of financial and business aspects of a company, other customized services on say business houses

and capital markets, indexing services and information services such as privatization policy for

infrastructure projects, macro studies of infra-structure sector, implication of government policy

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in respect of any sector, financial modeling, bid evaluation, power purchase agreement,

restructuring of state electricity boards, etc are not services 'in relation to' the credit rating of any

financial obligation, instrument or security and are hence outside the ambit of service.

Is the Service tax payable on money received by Credit rating Agency for the purpose of

Credit Rating assignment, but returned to the client due to any reason subsequently?

No. The amount received in advance for the service of rating to be provided to the client, is only

an advance and the services can be deemed to have been provided only when the rating exercise

has been completed and when such rating has been assigned. In case rating is not done, for any

reason and the entire amount is returned back to the client,. it cannot be said that services have

been rendered and hence service tax is not attracted.

What would be the relevant date for determining the liability for payment of Service Tax?

The relevant date for determining the service tax liability would be the date when rating has been

assigned to a particular instrument. In the case of ongoing projects, where rating has been

assigned after the notified date i.e. 16th October, 1998, the service tax would be payable

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RECENT CREDIT RATING ARTICLES AND ACTIVITIES IN INDIA

THE HINDU New Delhi, June 18, 2012

Fitch downgrades India’s credit rating outlook to negative

Within three months of Standard & Poor’s action in April and its follow-up threat last week,

global rating agency Fitch, on Monday, scaled down India’s sovereign credit outlook to ‘negative’

from ‘stable’ while citing much the same reasons as S&P — corruption and the absence of or

inadequate reforms.

However, unlike in the case of S&P’s strictures when the government appeared to go on the

defensive, Finance Minister Pranab Mukherjee junked the downgrade saying that the rating

agencies’ observations were based on “old data” and did not reflect the recent developments.

In a statement, pointing out that the revision in rating outlook by Fitch to the lowest investment

grade notch was because it had ignored the recent positive economic trends, Mr. Mukherjee said:

“While the markets had already anticipated that Fitch would revise the outlook and so there is no

surprise in the announcement, it must be pointed out that Fitch has primarily relied on older data,

and has ignored the recent positive trends in the Indian economy”. Chief Economic Advisor

Kaushik Basu, on the other hand, dubbed Fitch’s action as “herd mentality” and expressed no

surprise over the outlook downgrade. “There is a herd mentality among policymakers, herd

mentality among corporates. There is also little bit of herding among credit rating agencies. We

were pretty much expecting Fitch to do so,” he said. He, however, admitted that even while there

was some deep strength in the country, “there is lot to be done. I think that the next six months

will be crucial,” he said.

Announcing the lowering of sovereign rating oulook, Fitch Ratings, in a statement, said that India

was faced with an “awkward combination” of slow growth and elevated inflation as well as

structural challenges surrounding its investment climate in the form of corruption and inadequate

economic reforms.

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THE HINDU New Delhi, June 25, 2012

Moody’s reaffirms ‘stable’ rating outlook for India

Ushering in positive sentiments in an otherwise despondent economic environment, global rating

agency Moody’s, on Monday, retained India’s credit rating outlook at ‘stable’ as it viewed that

the current slowdown was unlikely to be a permanent feature of the country’s economy.

Unlike its peers such as Standard & Poor’s and Fitch, which lowered the outlook to ‘negative’ and

threatened to downgrade the sovereign credit rating to ‘speculative’ from ‘investment’ grade on

account of deteriorating growth prospects and the government’s inertia on the reforms front,

Moody's Investors Service chose to maintain its stable outlook on India's current ‘Baa3’ rating.

Giving reasons for the positive stance on India in its newly released ‘Frequently asked questions

about India's sovereign rating’, Moody’s stated that “various credit challenges — such as weak

fiscal performance, tendency towards inflation and an uncertain investment policy environment

— have characterized the Indian economy for decades, and are already incorporated into the

current Baa3 rating.”

On the other hand, the rating agency noted that certain recent negative trends such as lower

growth, slowing investment and poor business sentiment were “unlikely to become permanent or

even medium-term features of the Indian economy, although Moody's expects that global and

domestic factors, including potential shocks in agriculture, could keep India’s growth below trend

for the next few quarters.”

Moreover, the agency statement pointed out that its ratings “express a view on medium-term

sovereign creditworthiness and do not generally change with fluctuations in growth-related to the

direction of the business cycle at a particular point, if Moody's believes growth will recover and

sustain over time.”

Besides, it viewed that the “impact of lower growth and still-high inflation will deteriorate credit

metrics in the near term, but not to the extent that they will become incompatible with India's

current rating.”

Commenting on Moody’s rating outlook stance, Prime Minister's Economic Advisory Council

Chairman C. Ranagarajan said: “Well, I think it’s good that Moody's has affirmed the stable

grade. It also shows that the Indian economy is right on the track.”

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In its assessment of India's budget deficits, Moody’s has pointed out that the country’s

government debt and fiscal deficit ratios have always been worse than those of similarly-rated

peers while noting that its own assessment of low government financial strength is based not

merely on a comparison of ratios, but also on the underlying reasons for weak government

finances.

“These lie in the role fiscal policy plays in maintaining social stability in a highly diverse, poor

and unequal society, which limits government revenues and imposes demands on government

expenditure. This poverty constraint is effectively factored into the rating by assigning India a

'moderate' economic strength assessment, despite the well above global average size and growth

rates of its economy,” it said.

On the more current issue of rupee depreciation, Moody’s has maintained that as the

government’s foreign currency debt comprises only 5.3 per cent of its total debt and is equivalent

to 3.8 per cent of the GDP (gross domestic product), “the rupee’s decline does not raise the

government’s own debt service burden significantly, especially since most of its foreign currency

debt is owed to multilateral and bilateral creditors with low annual repayment requirements.”

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CONCLUSION

The credit market turmoil that began in the U.S. in the summer of 2007 has been amplified in recent

months by dramatic slowing of broader economic activity. What began as a significant, but relatively

isolated, deterioration in the performance of sub-prime housing loans has led to a wave of negative

events that have reverberated across a highly-leveraged, interconnected and, at times, opaque global

financial system. More importantly, a credit crisis has transformed into a much wider and deeper

crisis of confidence in the global markets. Credit rating agencies have an opportunity to help restore

confidence in markets by restoring confidence in our industry. Many necessary actions can and have

been undertaken at the individual firm and industry level and we are committed to continuing along

that path. Nonetheless, a few key actions and reforms as I have described above require help from

the broader market and oversight authorities. For 2009, the description of credit is identical to the

“way forward” for credit markets: confidence. The rebuilding process will be far more protracted

than the events that necessitated it – which is all the more reason to get on with the task with energy,

tenacity and coordination.

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BIBLIOGRAPHY

www.wikipedia.com

www.standardandpoors.com

www.nsic.com

www.crisil.com

www.icra.in

www.sebi.com

www.thehindu.com

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