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Credit rating in India
SUMMERY
Credit rating usually expressed in alphabetical
symbols, are a simple and easily understood tool
enabling the investor to differentiate between
instruments on the basis of their credit quality.
Credit rating had its origin in the financial crisis of
the U.S. in 1837. The first mercantile credit: Rating
agency was set up in New York in 1841 to rate the
ability of the merchants to pay financial obligations.
Importance of credit rating to Investors for risk
recognition and Fair Assessment of issuer’s
credibility, Quick decision better choice Advantages
to Intermediaries, Advantages to Regulators Credit
rating is of recent origin in India. The first credit
rating institution in India was setup in 1988.
It was christened as Credit Rating and Information
Services of India Ltd. (CRISIL) in all there are four
credit rating agencies functioning in the country the
most dominating factors is the reputation of the
credit rating agency and its analytical credibility.
Credible and Independent Structures and Procedures.
Market forces viz., issuers, Corporate Disclosure and
Credit Education underwriters, Reliance on the
Market Mechanism d Government. Existence of Debt
Market
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Credit rating in India
Issuer Company appoints Rating Agency The rating
agencies are approached by a prospective issuer
through a formal request to rate its debt/commercial
paper/fixed deposits.The rating agency appoints a
team to undertake therating work.
The team normally comprises members having ‘the
required expertise and skills to evaluate the issue of
the firm.The issuer is requested to provide
information with Regard to several important
business and financial risks. Business risk includes
details of industry characteristics, market position,
The rating agency minutely examines the information
about the industry characteristics of the issuer as it
is a key determinant of the level of volatility in
earnings of any business.
The Rating Committee after the analysis and
preparation of report holds a preview meeting
followed by rating meeting to assign rating Business
Analysis Financial Analysis is, Management Eva
Credit Rating Agencies Many Factors contributing to
success of credit rating &Problem Faced by CRISIL
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Credit rating in India
HISTORICAL BACKGROUND
Journalist Thomas Friedman once said,” There are
two superpowers in the world today. There’s the
United States and there’s Moody’s Bound Rating
Service. The US can destroy by dropping bombs and
Moody’s can destroy them by downgrading their
bounds “.rating agencies play a key role in the
infrastructure of modern financial system.
The origin of credit rating can be traced to the
1840s, following the financial crisis of 1837, Louis
Tappan established the first mercantile credit agency
in New York in 1841. The agency rated the ability of
merchants to pay their financial obligations. It was
subsequently acquired by Robert Dun and its first
rating guide was published in 1859. Another similar
agency was set up by John Bradstreet in 1849, which
published a rating book in 1857.These two agencies
were merged together to from Dum & Bradstreet in
1933, which became the owner of Moody’s Investors
Service in 1962. The history of Moody’s itself goes
back about 100 years John Moody founded Moody’s
Investors Service, and in 1909 published his ‘Manual
of Railroad Securities” with comments on 200 major
railroad companies by John Moody. This manual
covered the railroad companies operating then in the
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Credit rating in India
United States. This was followed by other reports
wherein John Mood assigned ratings to all types of
issuers. This was followed by the rating of utility
and industrial bounds in 1941, and the rating of
bounds issued by US cities and other municipalities
in the early 1920s.
Further expansion of the credit rating industry took
place in 1916, when the Poor’s publishing Company
and the Poor’s publishing company merged in 1941
to form Standard and Poor’s which was subsequently
taken over by McGraw-Hill in 1966.
In 1941 Standard and Poor’s Corporation started
credit rating operation and over a period of time
Moody and Standards & poor came to be widely
recognized for rating business as international rating
agency in Japan which had a major investor market.
Other agencies such as Japan Bond Research
Institute, Japan credit Rating Agency and Nippon
Investors’ Services came to be established soon
thereafter.
For almost 50 years, since the setting up of Fitch
Publishing in 1924, there were no major new entrants
in the field of credit rating agencies commenced
operation all over the world.
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Credit rating in India
CONCEPT OF CREDIT RATING
Ratings, usually expressed in alphabetical symbols,
are a simple and easily understood tool enabling the
investor to differentiate betw instruments on the
basis of theit credit quality. Credit ratingis the
symbolic indicator of the current opinion of the
relative birity of1fi to service debt obligations in a
timely fashion with specific reference to the
instrument being rated. It is focused on
communicating to investors the relative ranking of
the different loss probability for a given fixed
income investment, in comparison with other rated
instruments.
The term “Credit Rating” comprises two words:
“credit” and “rating”. Credit is trust in a person’s
ability and intention to pay or reputation of solvency
and honesty. Rating means estith of, or to assign Iiie
tOëlassifying a person’s position with reference to a
particular subject matter. In other words, credit is an
act of assigning values by estimating worth or
reputation of solvency and honesty so as to repose
trust in a person’s ability and intention to repay.
Thus, credit rating could be defined as an expression
of an opinion through symbols about credit quality of
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Credit rating in India
the issuer of securities or company with reference to
sell that security. It provides risk which is one of the
several factors in investor decision making. It does
not indicate market risk or forecast future market
price. It is always a specific evaluation done for a
particular instrument. The rating process is itself
based on certain “givens”. The agency, for instance,
does not perform an audit. Instead it: s required rely
information and opinion provided by the issuer and
collected by analysts from different sources,
including personal interaction with various entities.
In determining rating, both quantitative and
qualitative analyses are employed. The judgment is
qualitative it nature and the use of quantitative
analysis is to make the best possible overall
qualitative judgment because ultimately the rating is
an opinion.
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Credit rating in India
ORIGIN OF CREDIT RATING
Credit rating had its origin in the financial crisis of
the U.S. in 1837. The first mercantile credit: Rating
agency was set up in New York in 1841 to rate the
ability of the merchants to pay financial obligations.
This agency was later acquired by Robert Dun. It
published its first Rating Guide in 1859. John
Bradstreet set up the second credit rating agency in
1849. It published a rating book in 1857. In 1933,
these two agencies were merged to form Dun &
Bradstreet. In 1900, John Moody established
Moody’s Investor Service. He published in 1909 the
Manual of Railroad Securities. Moody’s further
published a rating of utility and industrial bonds in
1914 and the rating of bonds issued by U.S. cities
and other municipalities in the early 1920s.
In 1916, Poor’s Publishing Company published their
first rating. This was followed by Standard Statistics
Company in 1922. These two were merged in 1941 to
form Standard & Poor’s which was subsequently
taken over by McGraw Hill in 1966. A number of
credit rating Agencies were set up in the 1970s.
These included the Canadian Bond Rating Services.
Thompson Bankwatch, Japanese Bond Rating
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Credit rating in India
Institute, McCarthy Cristani and Maffei, Dominican
Bond Rating Service, IBCA Ltd., and Duff & Phelps
Credit Rating Company. In India, the first credit
rating agency, viz., the Credit Rating and
Information Services of India Ltd., (CRISIL), was
set up in 1987. This was followed by the setting up
of ICRA Ltd., in1 formerly called as Investment
Information and Credit Rating Agency of India Ltd.
Credit Analysis and Research Ltd. (CARE), was set
up in 1994. In 1996, Duff & Phelps Credit Rating (P)
Ltd., was set up by Duff & Phelps in association with
Indian non-banking finance Companies (NBFCs).
IMPORTANCE OF CREDIT RATING
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Credit rating in India
Credit rating is highly useful to Investors, Issuers,
Intermediaries and Regulators. The merits of credit
rating as related to each of these groups are
discussed hereunder
.
Advantages to Investors: -
(i) Credit rating provides symbols which represent
degree of risk involved.
(ii) Absence of any link between the issuer and
rating agency ensures fair assessment of credibility
of Issuer Company.
(iii)It tells the investor about safety and risks
involved.
(iv)It saves time and energy and thus, relieves the
investor from the burden of getting first-hand correct
information about the instrument and the issuer.
(v)Quick decisions and easy understanding of
investment opportunities.
Advantages to Issuers:
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Credit rating in India
(i)Wider investor base is exposed.
(ii) Rating acts as a marketing tool.
(iii) It reduces the cost of borrowing as a highly
rated instrument may carry lesser returns or interest.
(iv)Enhancement in company’s reputation and
goodwill.
Advantages to Intermediaries:
(i)It is a useful tool in the process f nm racing
underwriting, placement, and promotion o issues.
(ii) The brokers, dealers and merchant bankers could
use rating as an input for their monitoring.
(iii) The merchant use credit rating for pre-
packaging of issues by way of asset securitization.
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Credit rating in India
Advantages to Regulators:
(i) The regulators have promoted the use of credit
rating by making it obligatory for Issuers.
(ii) The regulators restrict entry into the market of
new issues rated below a particular grade.
(iii) The regulators stipulate different margin
requirements for mortgage of rated and unrated
instruments and prevent institutional investors from
purchasing or holding of instruments rated below a
particular level.
In India, as per the regulations of the Securities and
Exchange Board of India, public issues of debentures
and bonds redeemable beyond a period of 18 months
need credit rating.
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Credit rating in India
CREDIT RATING
THE INDIAN SCENARIO
Credit rating is of recent origin in India. The first
credit rating institution in India was setup in 1988. It
was christened as Credit Rating and Information
Services of India Ltd. (CRISIL) in all there are four
credit rating agencies functioning in the country.
Credit Rating and Information Services of India Ltd.,
was promoted by the Industrial Credit and
Investment Corporation of India, Nationalized Banks,
Foreign Banks and Insurance Companies in 1988. It
floated an equity issue in 1992 and is, now, a listed
company. It entered a strategic alliance with
Standard and Poor’s in 1995. Its services offered
comprise rating, Information infrastructure services
and consults. It’s rating services of long, medium
and short term debt instrument and securitized assets
and constructions. Its information services offer
corporate research reports. It also prepares CRISIL
500 Index. Its consultancy division provides
assistance to infrastructure industries, viz., power,
telecom and infrastructure financing.
ICRA Ltd. was promoted by the Industrial Finance
Corporation of India, nationalized banks, foreign
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Credit rating in India
banks, and insurance companies in 1991. It provides
services dealing with advisor and investment
information matters. Its .analytical services include
rating 0f debt instruments and crea1tiiii c
isesifagiccounselling, assessment regard to
restructuring advice for sector specific services such
as for power, telecommunication, ports and
municipal ratings. In 1994, ICRA negotiated a
strategic alliance with Financial Programmed Inc.,
which is a subsidiary of Moody’s, offering services
on software and risk management training.
The Credit Analysis and Research Ltd., (CARE), was
promoted by the Industrial Development Bank of
India and several banks and insurance Companies in
1992; it offers services concerning rating of debt
instruments. It also prepares sector-specific industry
reports.
During 1996, the fourth credit rating agency was
setup in India as a joint venture between Alliance
Capital Ltd., Calcutta, and Duff and Phelps, US.
FATCORS CONTRIBUTING TO SUCCESS
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Credit rating in India
A number of factors contributor to the success of
credit rating. However, the most dominating factors
is the reputation of the credit rating agency and its
analytical credibility. Some of the factors
contributing to success of credit rating are discussed
as below:
(I) Credible and Independent Structures and
Procedures:-
The credibility of the credit rating agency depends
on the objectivity which results from the rater being
independent of the issuer’s business.
As credibility is a primary ingredient of credit
rating, agency, it must maintain independence from
all interested market forces viz., issuers,
underwriters and Government. Some of the factors
that could enhance the credibility of a rating agency
include o and impartiality of opinions,
professionalism, consistency, relevant expertise
across relating to the sensitive and confidential
information of the issuer, timeliness of rating review
and announcement of changes and activity to reach a
wide range of investors by means of press reports,
print or electronic and more friendly research
services.
(ii) Reliance on the Market Mechanism: -
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Credit rating in India
Reliance on the capital market for resource
allocation generates a strong demand for investment-
related information. Rating agencies provide this
information.
(iii) Corporate Disclosure and Credit Education: -
As a part of corporate disclosure and credit
education, it is n for rating agencies to ensure that
the information about the regulatory guidelines for
mandatory disclosures of ratings reaches the users.
However, the rating should not be taken as the final
word about financial health. The users should be
intelligent enough to arrive at meaningful and
conclusions by interpreting the assigned rating. They
should also be aware of the limitations of credit
rating and not take credit rating as a synonym for
insurance or guarantee against default or risk.
(iv) Existence of Debt Market:-
The phenomenal growth of the debt market has
resulted in tremendous demand for the credit rating
business. The rating agencies in order to continue to
provide their services need an active primary and
secondary debt market.
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Credit rating in India
Analytical Factors Considered by Indian
Agencies
The analytical framework of the rating methodology
adopted by four Indian credit rating agencies viz.,
CRISIL, ICRA, CARE and Fitch includes analysis
and appraisal of all the relevant factors that affect
the credit worthiness of the borrowing entity. The
analytical framework for rating agencies is divided
into two interdependent segments dealing
respectively with operational characteristics and
financial characteristics of the issuers of the debt
instruments. Besides quantitative and objective
factors, qualitative aspects like assessment of
management capabilities play a very important role
in arriving at the final rating for an instrument. The
relative importance of quantitative and qualitative
components of analysis vary with the type of issuer
and is analyzed independently and collectively.
The key factors considered for the assessment of
(i)Manufacturing companies
(ii) Financial companies
(ii) Indian states
(iii) Banks and
(iv) Bond fund ratings
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Credit rating in India
Manufacturing Companies:-
The analytical framework consists of three broad sets
of factors, i.e. business analysis, financial analysis
and management evaluation.
(1)Business Analysis:-
This includes an analysis of industry risk, market
position, operating efficiency and legal risk of the
company. The main elements of these components of
Business analysis are as under:
(i) Industry Risk:-
Industry Risk is analysed with reference to the
estimated current demand / supply and industrial
growth prospect; intensity of competition in the
industry; entry barriers and threats of new entrants
in the industry; government regulations and policies
relating to the industry; vulnerability to
technological changes and to substitutes;
cyclicality / seasonality factors and principal
companies in the industry and their strengths and
weakness.
(ii)Market Position:-
Market Position is evaluated from different angles
viz., market share and its stability, competitive
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Credit rating in India
position in market Segments, competitive advantages
and disadvantages vis-à vis the nearest competitors,
diversity of products and customers, selling and
distribution arrangements and research and
development with linkage to product obsolescence.
(iii)Operating Efficiency:-
Operating Efficiency is assessed with reference to
production process indicating strength/weakness vis-
à-vis the nearest competitors, productivities and
efficiencies compared to other players, location
advantages, labour relationships, product cost
structure and manufacturing efficiency as compared
to the nearest competitors, level of capital and
employee productivity, energy costs and compliance
of pollution control requirements.
(iv)Legal Position:-
Legal Position considers aspects such as terms of
offer document - prospectus or letter of offer, terms
of debenture trust deed, trustees and defined
parameters of their responsibilities, protection
against forgery, modalities and arrangements for
buy-back facilities.
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Credit rating in India
(2)Financial Analysis:
All relevant aspects connected with the business
and financial positions of the company are assessed
which include accounting quality, earnings
protection, adequacy of cash flows and financial
flexibility.
(i)Accounting Quality:-
Accounting Quality depends on auditor’s
qualification, overstatement / understatement of
profits, method of income recognition, inventory
valuation and depreciation policies, undervaluation
overvaluation of fixed assets, off -balance sheet
liabilities and the like.
(ii)Earnings Protection:-
Earnings Protection is assessed through profitability
ratios, pre-tax coverage ratios, earnings in relation
to fixed income charges, sources of future earnings
growth and so on.
(iii)Adequacy of Cash:-
Flows is appraised in relation to debt and fixed and
working capital requirements, variability of Future
cash flows, capital spending flexibility, working
capital management etc.
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Credit rating in India
(iv)Financial Flexibility:-
Financial Flexibility is examined in terms of
alternative financing plans in times of stress, ability
to raise funds or raise capital to meet stress
requirements, asset redeployment potential, and debt
service schedule and so on.
(3)Management Evaluation:-
Track Record of the management is evaluated with
reference to goals, philosophy, strategies and ability
to overcome adverse situations. Management
competence is judged from past operating and
financial results. Other aspects considered for
judging the caliber of management include
conservative outlook or aggressiveness with respect
to financial risk, planning and control system, depth
of managerial talents and succession plans,
commitment, consistency & credibility.
(i)Financial Companies:-
The assessment of financial companies lays
emphasis on the regulatory environment and
fundamental analysis in addition to the financial
analysis and management evaluation as already
discussed.
 Regulatory Environment is evaluated in relation to
structure and regulatory framework of the
financial system and trends in
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Credit rating in India
regulation/deregulation and their impact on the
company.
 Fundamental Analysis covers aspects such as
liquidity management, asset quality, profitability
and financial position and interest and tax
sensitivity of the company.
 Liquidity Management: is analysed in terms of
capital structure, term-matching of assets and
liabilities, policy on liquid assets in relation to
financing commitments and maturing deposits.
 Asset Quality: is reflected in the quality of the
company’s credit risk management, systems for
monitoring credit, sector risk, exposure to
individual borrowers, management Of problem
credits etc.
 Profitability and financial position: is examined
on the basis of historic profits, spreads on fund
deployment, revenues on non-fund based services,
accretion to reserves and so on.
 Interest and Tax Sensitivity: refers to exposure to
interest rate changes, hedge against interest rate
and tax law changes and the like.
The evaluation is carried out by a team of
professionally qualified persons and includes data
collection, analysis and meetings with key personnel
in the company to discuss strategies, plans and other
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Credit rating in India
issues that may influence credit evaluation of the
company. Discussions also include the company’s
forecasted business and financial plans. The process
g takes four to six weeks. In addition, the initial
assigned ratings are monitored on continuous basis
by analyst.
Credit Rating Agencies
The concept of credit rating has been widely
discussed and debated in India in recent times. Since
the setting up of the first credit rating agency Credit
Raring and Information Services of India Ltd.
(CRISIL) in India in 1987, there has been a rapid
growth of credit rating agencies in India. The major
players in the Indian market, apart from CRISIL
include Investment Information and Credit Rating
Agency of India Ltd. (ICRA), promoted by IDBI in
1991 and Credit Analysis and Research Ltd.(CARE),
promoted by IFCI in 1994. Duff and Phelps has tied
up with two Indian NBFCs to set up Duff and Phelps
credit Rating India (private) Ltd in 1996.
Rating Services
The primary objective of CRISIL is to rate debt
obligations of Indian companies. The instruments
rated by it are long-term such as debentures I bonds
and preference shares, medium-term including
certificates of deposits, fixed deposits and short-term
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Credit rating in India
including commercial paper. CRISIL also rates other
new and innovative instruments including asset-
backed securities, municipal bonds and bond funds.
Its rating services also extend to real estate
developers, parallel marketers of Liquefied
Petroleum Gas (LPG), chit funds, banks and states.
Credit Rating Services
Operations
-Manufacturing Cos. -Debt investment-
-Finance Companies -Structure obligation
-Banks -Fixed Deposits
Programme
-Commercial Papers
-Project Report
-Builder’s rating
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Rating Rating Watch Rating Update
Coverage
Instruments
Rated
Credit rating in India
CRISIL Research and Information Services
(CRIS)
Although credit rating remains its primary business,
CRISIL has also diversified into information services
as a thrust area: Tor future. The extensive
compilation and analysis of data by e CRISIL for
rating business is also used to provide: services to
the corporate clients. They provide - services
through CRISIL Card, CRISIL Sector view, CRISIL
View, CRISIL Judge, and CRISIL Index ,the
corporate and balance sheet data, formulated for easy
analysis of selected companies is provided by
CR1SIL Card. The CRISIL View Supplied
information to the fund managers, investors and
lenders on the basis of published data relating to the
industry and companies, on the outlook and solvency
of the Concerned companies. CRISIL Sector View
provides an in-depth analysis of the important and
potential growth industries India on the industry
structure, the present industry dynamics and
CRISIL’s outlook on the industry. The CRISLL
Judge is a software package with data and analysis
of Indian corporate. It also has a comprehensive
value added data-base on India which is available on
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Credit rating in India
wire services BLOOMBERG catering to 60,000
investment and corporate clients. Recurred and
Knight Riddes also carry .J data-base on their
screens. CRISIL also launched the CRISIL—500
equity index, a market value weighted composite
index of 500 companies, representing about 73% f
the market capitalisation of the Mumbai stock
exchange, and77 industry group.
The main objective of the broad based CRISIL-500
equity Index is to capture the market movement of
the: Indian stock markets in a comprehensive manner
and thus? Provide the investment community with an
accurate performance benchmark against which they
can measure Portfolio performance. CRISIL has
recently launched the CRISIL Midcap 200 Equity
Index, comprising 200 medium capitalized
companies, captures about 86% of the market
capitalisation.
The CRISIL Research and Information Services
(CRIS) disseminates value-added research and
undertakes customized studies in four areas viz.,
Indian economy; Indian capital markets; Indian
Industries and the Indian corporate sector. CRIS has
a large client base, in India and overseas, comprising
institutional investors, investment bankers,
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Credit rating in India
commercial banks, financial institutions, corporate
planners, mutual funds and asset management.
The services rendered by CRISIL earlier as CRISIL,
Cared Services and CRISIL’s Economic Services
have been. Reorganised and assimilated under CRIS.
CRIS renders the following set of services:
1. CRISIL Sectorview
2. CRISIL View
3. International Information Vending
4. CRISIL Index Services
(1)CRISIL Sectorview:
CRISIL sector view is an in-depth analysis of the
important and potential growth industries in India.
CRISIIL considers the quality of research and
analysis as its forte. Contents of CRISIL Sectorview
includes the following: A brief of the industry;
Structure of the industry and its characteristics; An
analysis of the different products in the industry
based on factors like Product Specifications, Cost
Structure, Capacities, Technology, Sector Use;
Demand Supply Analysis both present and future; An
analysis of the major players in the industry;
Government policies; Industry Risks/Constraints;
International Competitiveness; Key Factors; and
CRISIL’s Outlook on the industry.
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Credit rating in India
A monthly update is also provided for all the CRJSIL
Sector views. Client Segments utilizing CRISIL
Sector view Includes Financial Institutions; Mutual
Funds; Corporate Bodies; Merchant Banks; Banks;
Investment Institutions; Asset Management
Companies; Finance Companies;
Leasing Companies; Constituencies; Brokers,
Government Departments; Foreign Institutional
Investors; Industry Associations; and Academicians
and Industry Analysis.
The following industry classifications are also
available from CRISIL’s research desk, viz.,
Aluminum; Automobiles — Two wheelers;
Automobiles — Commercial vehicles & Cars;
Cement; Petrochemicals (Covering Basic chemicals,
polymers, fiber intermediaries & Linear alkyl
benzene/Anhydride/ Orthoxylene), Polyester Staple
fibre/Polyester Filament Yam; Power; Soda Ash;
Software; Steel (covering flats and longs); Tractors.
(2)CRISILVIEW:
CRISILVIEW provides CRISIL’s analysis of and
opinion on the business and financial outlook of
company, based on which investors can take
decisions having regards to individual risk
preferences. It also provides a useful basis for fund
27
Credit rating in India
managers in their portfolio allocation decisions.
Medium term lenders can use these reports to
benchmark their exposure limits.
CRISILVIEW is based on CRISIL’s in-depth
understanding of the industry in which the company
operates, as well as CRISIL’s understanding of the
relevant qualitative and quantitative factors affecting
the company’s performance.
The CRISILVIEWs is a comprehensive and
interactive tool for Business Managers, Investors,
Creditors and Corporate Decision. Makers.
According to CRISIL, the product has been
structured specifically to cater to the information
needs of a decision maker. It starts with a brief
introduction to the company, gives an overview of
the industry in which the company operates, analyses
the business and financial outlook, and deals with
detailed financial both actual till date and
projections in the medium term. The financial
projections are for two years in the future and are
based on certain assumptions and underlying logic,
all of which are outlined.
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Credit rating in India
(3)On-line Services: International Information
Vending
To make the CRISILs’ research available to its
international clients as well as to reach a wider
potential client base, its research and analysis is also
available via The Bloomberg. The menus that it
offers cover the rating and advisory assignments
carried out as well as research undertaken in the
three Division of CRISIL. The Bloomberg carries
extensive research and analysis in the following
areas; Indian Economy, Indian Capital Markets, Key
Industries and Indian Corporates. The client base for
this service include Fund Managers, Foreign
Institutional Investors, Investment Bankers,
Commercial Banks, Multilateral Development
Agencies, Constituencies, etc. In addition CRISIL
also has tie-ups with all the other leading
international information vendors like Reuters Inc.,
Knight-Ridder Information Inc. (The Dialog
Corporation), Internet Securities Inc., and Matrix
Services Pvt. Ltd. to disseminate its research and
analysis world-wide.
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Credit rating in India
(4)CRISIL Index Services
CRISIL offers the following Index Services which
are available online also.
(i)CRISIL — 500 Equity Index:
The CRISIL-500 Equity Index is a broad-based,
market value weighted Index comprising 500
companies across 79 industries and represents about
74% of the market capitalisation and more than 95%
of the turnover on The Stock Exchange, Mumbai. The
main objective of CRISIL —500 is to provide the
Investment community with a more accurate
reflection of the stock market movement. The Index
is responsive to market developments as it is
maintained by a dedicated team Of professionals
supported by a sophisticated computerized: The
index is computed daily and daily historical an are
available from 1991 onwards.
(ii) CRISJL-Midcap 200 Equity Index:
The CRISIL midCap 200 Equity index is a benchmark
for the midcap c the market. Comprising 200 midcap
stocks listed on the stock Exchange Mumbai. The
CRISIL Madcap 200 represents 74% and 80% of the
turnover of medium capitalized segment of the marlet
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Credit rating in India
computed daily, historical e available .from 1993
onwards.
(iii) CRISIL Industry Indices:
CRISIL’s 79 Industry Indices serve as a standard for
comparison of the stock Market performance of
Individual companies vis-à-vis their Group and also
enable fund managers to - NAV performance vs.
specific industries. It is Computed daily, historical
value of the indices are available m 1991 onwards.
(iv) CRISIL Industry Indices:
With a view to provide r-e investors, fund managers
and market intermediaries with a better perspective
of the relative stock market performance of the
various segments in the corporate sector. CRISIL has
developed 3 segment benchmark indices—
• CRISIL MNC Index, a market capitalize
weighted index comprising 50 MNCs’ listed •on
the Stock Exchange, Mumbai.
• CRISIL Indian Business Groups Index
comprising 250 listed companies on The Stock
Exchange, Mumbai representing 107 Indian
Business Group.
• CRISIL PSE Index, a market capitalisation
weighted index comprising 20 PSE stocks listed
on the Stock Exchange, Mumbai.
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Credit rating in India
(v)Customized Indices:
Customized Indices CRISIL’s emphasis on scientific
methodology of Index construction and dynamic
index maintenance is recognised by the market and
CRIS has received requests for developing
benchmark as well as customized indices. CRISIL
undertakes development, computation and
maintenance of customized indices for clients as well
as offers consultancy services for developing
indices.
(iv)CRISIL Index Bulletin:
The CRISIL Index Bulletin is a monthly market
activity update and covers the market performance of
constituents of CRISIL Indices.CRISIL with
approximate seven-tenth share of the credit rating
business is evidently the market leader in the
domestic rating industry. It also features among the
top five rating agencies in the world in terms of both
its coverage and analytical strength. The rating
business accounts for almost nine-tenth of its
operating income- the diversification into other
information and advisory services notwithstanding.
32
Credit rating in India
(v)CRISIL Advisory Services
CRISIL provides the financial advisory services to
the Government, banks, Public Sector Units,
financial institutions and other semi- government and
quasi- government bodies. CAS also undertakes
customized studies for national and international
project developers; multilateral lending agencies like
the World Bank, International Finance Corporation,
and other experts. The objective of these services is
to identify risks, mitigating risks and formulating
and executing strategies for the same. The activities
of the group cover two main areas, viz.,
infrastructure development and financial sector
Reforms.
(a)Infrastructure Sector Services:
It support and provide counseling on aspects, such as
privatization of public sector undertakings, debt
securitization, credit evaluation system and so on.
(b)Financial Sector Services:
CRISIL focus on the banking sectors and the capital
markets. Advisory services of this category are
provided at two levels: Strategic and Functional.
Strategic assistance includes diagnostic studies and
33
Credit rating in India
business process re-engineering or restructuring
studies based on a diagnostic analysis. Functional
assistance covers areas such as credit management;
resource mobilization; risk management etc. CAS
also advises central and state governments on their
disinvestment programmers. It has also collaborated
with up credit rating agencies in the neighboring
countries.
34
Credit rating in India
Rating Processes —The Indian Companies
A brief description of various rating processes
followed by the Indian rating agencies is mentioned
below.
CRISIL:-
CRISIL follows the rating process as per
international standards accompanied by minor
adjustments made therein suiting to domestic
conditions. CRISIL has publicised the working of its
rating process on the lines of S & P’s. CRISIL’s
rating process is described below:
(a) Rating Agreement and Assignment of the
Analytical Team:-
The process of rating starts with the issue of the
Rating Request letter by the issuer and the signing of
the Rating agreement. On receipt of the request,
CRISIL assigns an analytical team comprising of at
least two analysts of whom one would be the lead
analyst and would serve as the issuer’s primary
contact. The analysts who have expertise in relevant
business areas will be responsible for carrying out
the rating assignment.
35
Credit rating in India
(b) Management Meeting:-
Prior to meeting with the: issuer, the analytical team
obtains and analyses information Relating to the
issuers financial statements, cash flow projections
and other relevant information.
The analytical team then proceeds to have detailed
meetings with the company’s management. CRISIL
strongly believes that interest of investors are best
served if a direct dialogue is maintained with the
issuer, as this enables CRISIL to incorporate non-
public information in a rating decision and also
enables the rating to be forward looking.
Topics discussed during the management meeting are
wide-ranging, including competitive position,
strategies, financed policies, historical performance,
and near and long- term finance and business
outlook. Equal importance is placed on d the issuer
business risk profile and strategies. Addition to
reviewing financial data. The rating process ensures
complete con of the information provided by the
company. All information is kept strictly
confidential by the ratings group and is not used for
any other purpose, or by any third party other than
CRISIL.
36
Credit rating in India
(c) Rating Committee:-
After meeting with management, the analysts present
their report to a Rating Committee which then
decides on the rating. The Rating Committee Meeting
is the only aspect of the process in which the issuer
does not participate directly. The rating is arrived at
after a composite assessment of all the factors
concerning the issuer, with the key issues getting
greater attention from the Rating Committee.
(d) Communication to the Issuer:-
After the committee has assigned the rating, the
rating decision is communicated to the issuer along
with the reasons or rationale supporting the rating.
For a rating to have value to an issuer or to an
investor, the rating agency must have credibility.
The thoroughness and transparency of CRISIL’s
rating methodology and the integrity and fairness of
its approach are important factors in establishing and
maintaining credibility? CRISIL is therefore always
willing to discuss with the management, the critical
analytical factors that the committee focused on
while determining the rating and also any factors
that the company feels may not have been considered
while assigning the rating.
37
Credit rating in India
In case the issuer disagrees with the rating outcome,
they may appeal the decision for which
new/additional information, which is material to the
appeal and specifically addresses the concerns
expressed in the rating rationale; need to be
submitted to the analyst. Subsequently, a note is put
up once again before the Rating Committee where the
rating may or may not undergo a change. The client
has the right to reject the rating and the whole
exercise is kept confidential.
The rating process, from the initial management
meeting to the assignment of the rating, normally
takes three to four weeks. However, when required
CRISIL has been able to deliver rating decisions in
shorter time frames.
(e) Dissemination to the Public:-
Once the issuer accepts the rating, CRISIL then
disseminates it along with the rationale through print
media including Reuters. The ratings are also
disseminated through CRISIL’s monthly publication
CRISIL Rating Scan. The Financial Times, UK’s
quarterly publication FT CREM, and is also available
on other international services like Bloomberg and
Knight-Rider Services.
38
Credit rating in India
(f) Surveillance and Annual Review:-
After a rating has been assigned, CRISIL is required
to monitor the rating over the life of the debt
instrument. CRISIL keeps the rating under
continuous surveillance, monitoring both the on-
going performance of the issuer and the economic
environment in - which it operates. CRISIL typically
conducts a formal Annual review of the rating which
involves a meeting with the issuer.
These review meetings focus on developments over
the period since the last meeting and outlook for the
coming year, enabling analysts to stay abreast of
current developments, discuss potential problem
areas, and be appraised of any changes in issuer’s
plan. Following a full review, the rating may either
be affirmed or changed. Any change effected is made
public by CRISIL. In some instances, a credit rating
may be placed on ‘Rating Watch’. A Rating Watch
listing highlights an emerging situation which may
materially affect the profile of a rated entity and can
be designated with positive, developing, or negative
implications. Instances where an entity’s rating may
be placed on Rating Watch include the announcethent
of a merger or acquisition or the occurrence of an
event that could result in a substantial change in the
issuing entity risk, profile.
39
Credit rating in India
CRAMEL Model
CRISIL and ICRA conduct rating of banks also.
These Rating agencies typically follow the CRAMEL
model under Which banks are evaluated on six
different parameters?
• C (capital adequacy)
• R (resource raising ability)
• A (asset quality)
• M (management evaluation)
• E (earnings potential)
• L (liquidity)
Capital Adequacy:-
It gives an indication about the kind of cushion the
bank has to absorb future losses. A minimum capital
adequacy ratio of 8 per cent is mandatory for all
banks in India
Resource Raising Ability:-
The main aspects of raising resources by banks in
their rating are:
• Trends and diversity of deposits base;
• Trends in cost of funds;
• Funding policies, namely, tenure matching and
interest rate sensitivities; and
• Future plans.
40
Credit rating in India
Asset Quality:-
The important elements in the evaluation of the asset
quality of banks include, inter alia,
• Quality of credit risk management of banks as
reflected in the appraisal system and prudential
norms prescribed by the RBI;
• Quality of loan portfolio in terms of concentration,
diversity, recovery and overdue positions and
relative share of non-performing assets;
• Specific steps to expedite recovery; and
• Plans to improve asset quality.
Management Evaluation:-
The two crucial aspects of management evaluation of
banks are (1) management style and (2) in-depth
study of the tenure of personnel.
Earnings Potential of banks is analysed on the basis
of a Consideration of the following factors;
• Diversity of income profile;
• Trends in lending spreads;
• Trends in investments yields;
• Trends in fee-based income; and
• Expense level.
41
Credit rating in India
Liquidity of banks is examined with reference to
three Factors, namely;
• Liquid assets;
• Dependence on volatile funds; and
• Unutilized line of credit.
Bond Fund
CRISIL has introduced credit quality ratings for
bond funds to evaluate credit quality of the funds
underlying portfolio holdings. Under the scheme,
only pure bonds whose portfolio consist entirely of
fixed income securities, apart from a small
percentage of money market instruments held for
liquidity will be rated. CRTSIL methodology for
bond fund ratings covers the following aspects:
(i)Consistency of credit risk associated with a
particular security of fund with the overall fund
rating.
(ii)Examination of various systems and procedures
such as system for making and executing investment
decisions, back office systems, reconciliation with
custodians and registrars, calculation of net asset
value, tracking of payments, receivables etc.
(iii)Evaluation of management’s track record in the
funds management business, quality of key
personnel, and investment strategy for the fund and
so on.
42
Credit rating in India
Rated Instrument and Rating Symbols
The rating symbol. Are symbolic expressions of the
opinion assessment of the credit rating agency with
regard to the investment/credit quality/grade of the
debt/obligation instrument. They group together
similar, though not necessarily identical, entities in
terms of their relative capacity of timely servicing of
the obligations as per the terms of the contract. The
suffixes plus (+) or minus (-) are added to the
symbols to indicate the relative position of the
investment within the group covered by the symbol.
Appropriate prefixes and suffixes such as (FD) and
(CD) are used to denote specific instruments such as
fixed deposits, certificates of deposits and so on.
The rating symbols as the final expression of the
investment quality of a financial instruments used by
the Indian rating agencies are illustrated in this
section.
• Long-term Instruments:-
Debentures and bonds are mandatory rated by all the
three rating agencies, i.e. CRISIL, ICRA and CARE
• CRISIL Symbols:-
Categories debentures into three investment grades
listed as under: For preference shares, the letters (pf)
are pre-fixed and for structured obligations, letters
(so) are affixed to the debenture rating symbols; The
43
Credit rating in India
structured obligations mean procuring of a desirous
rating by fulfilling the essential formalities for the
proposed rating. An example of such rating is the
rating by CRISIL of the securitization of the car
hire-purchase receivables (asset- based securities) of
the Gujarat Lease Finance Ltd which was given a
triple A rating.
(A) High Investment Grades
AAA (Triple A):-
Highest Safety. Debentures rated ‘AAA’ are judged
to offer the highest safety of timely payment of
interest and principal. Though the circumstances
providing these degrees of safety are likely to
change, such changes as can be envisaged are most
unlikely to affect adversely the fundamentally strong
position of such issues.
AA (Double A):-
High Safety. Debentures rated ‘AA’ are judged to
offer high safety of timely payment of interest and
principal. They differ in safety from ‘AAA’ issues
only marginally.
(B) Investment Grades
A:
Adequate Safety. Debentures rated ‘A’ are indicator
of Offering adequate safety of timely payment of
interest and principal. However, changes in
44
Credit rating in India
circumstances can adversely affect such issues more
than those in the higher rated categories.
BBB (Triple B):-
Moderate Safety. Debentures rated ‘BBB’ are judged
to offer sufficient safety of timely payment of
interest and principal for the present. However,
changing circumstances are more likely to lead a
weakened capacity to pay interest and repay
principal than for debentures in higher rated
categories.
(C) Speculative Grades
BB (Double B):-
Inadequate Safety. Debentures rated ‘BB’ are judged
to carry inadequate safety of timely payment of
interest and principal; while they are less susceptible
to default than other speculative grade debentures in
the immediate future, the uncertainties that the
issuer faces could lead to inadequate capacity to
make timely interest and principal payments.
B: High Risk
Debentures rated ‘B’ are indicator of having greater
susceptibility to default; while currently interest and
principal payments are met, adverse business or
economic conditions would lead to lack of ability or
willingness to pay interest or principal.
C: Substantial Risk
45
Credit rating in India
Debentures rated ‘C’ are judged to have factors
present that make them vulnerable to default; timely
payment of interest and principal is possible only if
favorable factors / circumstances continue.
D: Default
Debentures rated ‘D’ are in default and in arrears of
interest / principal payments or are expected to
default on maturity. Such debentures are extremely
speculative and returns from these debentures may be
realized only on reorganization / liquidation.
Problem Faced by CRISIL
(i)The major problem faced by CRISIL was said to be
the non-availability of adequate information (both
from primary and secondary sources) from the
company It is felt that availability of information is
a function of co operation from the client and the
level of data base built for the industry supported by
extensive research.
(ii)The analysts evaluation is based on information
collected from annual reports of companies which are
neither sufficient nor adequate for any rating work.
Bankers and auditors are seldom forthcoming to
provide requisite information about the company.
46
Credit rating in India
(iii)The rating analysts feel that the complete
information is not provided by the companies. There
neither proper flow of information nor the adequate
transparency which make the proper ratings by the
analysts difficult. It needs special mention that
rating analysts cannot be expected to do a justice
unless the rating agencies have access to the reliable
data to carry out an unbiased and fair rating process.
(ivOne of the main problems faced by credit rating
had been that the firms were under no Obligation
notifies the rating given to them as it was
discretionary. As such, firms which are dissatisfied
with the rating assigned by an agency are under no
obligation to publish such a rating.
Rating analysts also face specific problems relating
to rating of different instruments. The estimation of
drawing powers and short-term volatility of cash-
flow in commercial paper, deposits renewal rates in
case of fixed deposit problem regarding uncertainty
about future goals and strategies of the firms .
47
Credit rating in India
DRAWBACKS OF CREDIT RATING
In spite of the advantages that the rating offers,
several drawbacks are:
(i) The ratings process to attempts to provide
guidance to investors/ creditors in
determining the risks associated with the
instrument/ credit obligation. It does not
attempt to provide a recommendation and
does not take in to account factors like
market prices, personal risk/ reward
preferences that might influence investment
decision.
(ii) The rating process is based on certain
primitives. The agency, for instance, does not
perform an audit. Instead, it has to rely
solely on information provided by the issuer.
Consequently, to the extent that the
information provided is inaccurate and
incomplete, the ratings process is
compromised.
(iii) To the extent that a certain instrument of a
specific company attracts a lower rating, the
company has an incentive to shop around for
the best possible rating, compromising the
authenticity of the rating process itself.
48
Credit rating in India
SEBI GUIDELINES FOR CREDIT RATING
 Disclosure of unaccepted rating to investors has
been made Compulsory.
 It has been made mandatory to obtain dual ratings
from different recognized agencies for all public
and right issues of debt instruments grater than
or equal to RS. 100 corers. Accordingly
disclosure and investor protection guidelines
have been amended.
 Rating agencies have been debarred from rating
debt instruments of their promoter institutions.
 Restrictions have been imposed on rating a debt
instrument of a corporate firm if it has any
common director with the rating agency’s
promoter institution. The guidelines cover even
the borrowers of their bodies.
 Rating agencies are mostly promoted by large
financial institutions or firms. This can cause an
evaluation bias as these rating agencies can not
afford to give correct rating to the weaker
companies since these are part of the firms
sponsoring rating agencies so that SEBI guideline
49
Credit rating in India
which specifies that no credit rating agency shall
rate a security issued by its promoter.
 Rating in India has been made compulsory for any
company that chooses to raise money through a
public issue of debentures with conversion,
commercial papers,
50
Credit rating in India
CONCLUSION
The outlook for the credit rating industry is positive.
Credit ratings a leading role in the development of
the debt markets in India. The Rating Criteria &
Product Development Centre, responsible for policy
research, new product development and ratings'
quality assurance, has developed new ratings
methodologies. There are number of areas where
rating agencies will have to cover new ground in the
coming future. The rating of municipal bond, state
government borrowing, commercial banks and public
sector undertaking etc, will be covered in the near
future. Credit rating play very important role in
international landing. The importance of credit rating
is being increasingly recognized in the Euro-markets.
Rating is marketing too which indicate relative
capacities of companies to make timely repayment of
interest and principal on debt. CRISIL inspires trust
and confidence across industry for upholding values
that serve as tenets across the Group Companies. The
Indian credit rating agencies have made strategic
alliance with reputed international agencies.
Agencies are adopting large extent the rating
methodologies which adopted by western
counterparts.
51
Credit rating in India
So, I here by concluded that credit rating in India
having bright future.
52

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Credit rating in india

  • 1. Credit rating in India SUMMERY Credit rating usually expressed in alphabetical symbols, are a simple and easily understood tool enabling the investor to differentiate between instruments on the basis of their credit quality. Credit rating had its origin in the financial crisis of the U.S. in 1837. The first mercantile credit: Rating agency was set up in New York in 1841 to rate the ability of the merchants to pay financial obligations. Importance of credit rating to Investors for risk recognition and Fair Assessment of issuer’s credibility, Quick decision better choice Advantages to Intermediaries, Advantages to Regulators Credit rating is of recent origin in India. The first credit rating institution in India was setup in 1988. It was christened as Credit Rating and Information Services of India Ltd. (CRISIL) in all there are four credit rating agencies functioning in the country the most dominating factors is the reputation of the credit rating agency and its analytical credibility. Credible and Independent Structures and Procedures. Market forces viz., issuers, Corporate Disclosure and Credit Education underwriters, Reliance on the Market Mechanism d Government. Existence of Debt Market 1
  • 2. Credit rating in India Issuer Company appoints Rating Agency The rating agencies are approached by a prospective issuer through a formal request to rate its debt/commercial paper/fixed deposits.The rating agency appoints a team to undertake therating work. The team normally comprises members having ‘the required expertise and skills to evaluate the issue of the firm.The issuer is requested to provide information with Regard to several important business and financial risks. Business risk includes details of industry characteristics, market position, The rating agency minutely examines the information about the industry characteristics of the issuer as it is a key determinant of the level of volatility in earnings of any business. The Rating Committee after the analysis and preparation of report holds a preview meeting followed by rating meeting to assign rating Business Analysis Financial Analysis is, Management Eva Credit Rating Agencies Many Factors contributing to success of credit rating &Problem Faced by CRISIL 2
  • 3. Credit rating in India HISTORICAL BACKGROUND Journalist Thomas Friedman once said,” There are two superpowers in the world today. There’s the United States and there’s Moody’s Bound Rating Service. The US can destroy by dropping bombs and Moody’s can destroy them by downgrading their bounds “.rating agencies play a key role in the infrastructure of modern financial system. The origin of credit rating can be traced to the 1840s, following the financial crisis of 1837, Louis Tappan established the first mercantile credit agency in New York in 1841. The agency rated the ability of merchants to pay their financial obligations. It was subsequently acquired by Robert Dun and its first rating guide was published in 1859. Another similar agency was set up by John Bradstreet in 1849, which published a rating book in 1857.These two agencies were merged together to from Dum & Bradstreet in 1933, which became the owner of Moody’s Investors Service in 1962. The history of Moody’s itself goes back about 100 years John Moody founded Moody’s Investors Service, and in 1909 published his ‘Manual of Railroad Securities” with comments on 200 major railroad companies by John Moody. This manual covered the railroad companies operating then in the 3
  • 4. Credit rating in India United States. This was followed by other reports wherein John Mood assigned ratings to all types of issuers. This was followed by the rating of utility and industrial bounds in 1941, and the rating of bounds issued by US cities and other municipalities in the early 1920s. Further expansion of the credit rating industry took place in 1916, when the Poor’s publishing Company and the Poor’s publishing company merged in 1941 to form Standard and Poor’s which was subsequently taken over by McGraw-Hill in 1966. In 1941 Standard and Poor’s Corporation started credit rating operation and over a period of time Moody and Standards & poor came to be widely recognized for rating business as international rating agency in Japan which had a major investor market. Other agencies such as Japan Bond Research Institute, Japan credit Rating Agency and Nippon Investors’ Services came to be established soon thereafter. For almost 50 years, since the setting up of Fitch Publishing in 1924, there were no major new entrants in the field of credit rating agencies commenced operation all over the world. 4
  • 5. Credit rating in India CONCEPT OF CREDIT RATING Ratings, usually expressed in alphabetical symbols, are a simple and easily understood tool enabling the investor to differentiate betw instruments on the basis of theit credit quality. Credit ratingis the symbolic indicator of the current opinion of the relative birity of1fi to service debt obligations in a timely fashion with specific reference to the instrument being rated. It is focused on communicating to investors the relative ranking of the different loss probability for a given fixed income investment, in comparison with other rated instruments. The term “Credit Rating” comprises two words: “credit” and “rating”. Credit is trust in a person’s ability and intention to pay or reputation of solvency and honesty. Rating means estith of, or to assign Iiie tOëlassifying a person’s position with reference to a particular subject matter. In other words, credit is an act of assigning values by estimating worth or reputation of solvency and honesty so as to repose trust in a person’s ability and intention to repay. Thus, credit rating could be defined as an expression of an opinion through symbols about credit quality of 5
  • 6. Credit rating in India the issuer of securities or company with reference to sell that security. It provides risk which is one of the several factors in investor decision making. It does not indicate market risk or forecast future market price. It is always a specific evaluation done for a particular instrument. The rating process is itself based on certain “givens”. The agency, for instance, does not perform an audit. Instead it: s required rely information and opinion provided by the issuer and collected by analysts from different sources, including personal interaction with various entities. In determining rating, both quantitative and qualitative analyses are employed. The judgment is qualitative it nature and the use of quantitative analysis is to make the best possible overall qualitative judgment because ultimately the rating is an opinion. 6
  • 7. Credit rating in India ORIGIN OF CREDIT RATING Credit rating had its origin in the financial crisis of the U.S. in 1837. The first mercantile credit: Rating agency was set up in New York in 1841 to rate the ability of the merchants to pay financial obligations. This agency was later acquired by Robert Dun. It published its first Rating Guide in 1859. John Bradstreet set up the second credit rating agency in 1849. It published a rating book in 1857. In 1933, these two agencies were merged to form Dun & Bradstreet. In 1900, John Moody established Moody’s Investor Service. He published in 1909 the Manual of Railroad Securities. Moody’s further published a rating of utility and industrial bonds in 1914 and the rating of bonds issued by U.S. cities and other municipalities in the early 1920s. In 1916, Poor’s Publishing Company published their first rating. This was followed by Standard Statistics Company in 1922. These two were merged in 1941 to form Standard & Poor’s which was subsequently taken over by McGraw Hill in 1966. A number of credit rating Agencies were set up in the 1970s. These included the Canadian Bond Rating Services. Thompson Bankwatch, Japanese Bond Rating 7
  • 8. Credit rating in India Institute, McCarthy Cristani and Maffei, Dominican Bond Rating Service, IBCA Ltd., and Duff & Phelps Credit Rating Company. In India, the first credit rating agency, viz., the Credit Rating and Information Services of India Ltd., (CRISIL), was set up in 1987. This was followed by the setting up of ICRA Ltd., in1 formerly called as Investment Information and Credit Rating Agency of India Ltd. Credit Analysis and Research Ltd. (CARE), was set up in 1994. In 1996, Duff & Phelps Credit Rating (P) Ltd., was set up by Duff & Phelps in association with Indian non-banking finance Companies (NBFCs). IMPORTANCE OF CREDIT RATING 8
  • 9. Credit rating in India Credit rating is highly useful to Investors, Issuers, Intermediaries and Regulators. The merits of credit rating as related to each of these groups are discussed hereunder . Advantages to Investors: - (i) Credit rating provides symbols which represent degree of risk involved. (ii) Absence of any link between the issuer and rating agency ensures fair assessment of credibility of Issuer Company. (iii)It tells the investor about safety and risks involved. (iv)It saves time and energy and thus, relieves the investor from the burden of getting first-hand correct information about the instrument and the issuer. (v)Quick decisions and easy understanding of investment opportunities. Advantages to Issuers: 9
  • 10. Credit rating in India (i)Wider investor base is exposed. (ii) Rating acts as a marketing tool. (iii) It reduces the cost of borrowing as a highly rated instrument may carry lesser returns or interest. (iv)Enhancement in company’s reputation and goodwill. Advantages to Intermediaries: (i)It is a useful tool in the process f nm racing underwriting, placement, and promotion o issues. (ii) The brokers, dealers and merchant bankers could use rating as an input for their monitoring. (iii) The merchant use credit rating for pre- packaging of issues by way of asset securitization. 10
  • 11. Credit rating in India Advantages to Regulators: (i) The regulators have promoted the use of credit rating by making it obligatory for Issuers. (ii) The regulators restrict entry into the market of new issues rated below a particular grade. (iii) The regulators stipulate different margin requirements for mortgage of rated and unrated instruments and prevent institutional investors from purchasing or holding of instruments rated below a particular level. In India, as per the regulations of the Securities and Exchange Board of India, public issues of debentures and bonds redeemable beyond a period of 18 months need credit rating. 11
  • 12. Credit rating in India CREDIT RATING THE INDIAN SCENARIO Credit rating is of recent origin in India. The first credit rating institution in India was setup in 1988. It was christened as Credit Rating and Information Services of India Ltd. (CRISIL) in all there are four credit rating agencies functioning in the country. Credit Rating and Information Services of India Ltd., was promoted by the Industrial Credit and Investment Corporation of India, Nationalized Banks, Foreign Banks and Insurance Companies in 1988. It floated an equity issue in 1992 and is, now, a listed company. It entered a strategic alliance with Standard and Poor’s in 1995. Its services offered comprise rating, Information infrastructure services and consults. It’s rating services of long, medium and short term debt instrument and securitized assets and constructions. Its information services offer corporate research reports. It also prepares CRISIL 500 Index. Its consultancy division provides assistance to infrastructure industries, viz., power, telecom and infrastructure financing. ICRA Ltd. was promoted by the Industrial Finance Corporation of India, nationalized banks, foreign 12
  • 13. Credit rating in India banks, and insurance companies in 1991. It provides services dealing with advisor and investment information matters. Its .analytical services include rating 0f debt instruments and crea1tiiii c isesifagiccounselling, assessment regard to restructuring advice for sector specific services such as for power, telecommunication, ports and municipal ratings. In 1994, ICRA negotiated a strategic alliance with Financial Programmed Inc., which is a subsidiary of Moody’s, offering services on software and risk management training. The Credit Analysis and Research Ltd., (CARE), was promoted by the Industrial Development Bank of India and several banks and insurance Companies in 1992; it offers services concerning rating of debt instruments. It also prepares sector-specific industry reports. During 1996, the fourth credit rating agency was setup in India as a joint venture between Alliance Capital Ltd., Calcutta, and Duff and Phelps, US. FATCORS CONTRIBUTING TO SUCCESS 13
  • 14. Credit rating in India A number of factors contributor to the success of credit rating. However, the most dominating factors is the reputation of the credit rating agency and its analytical credibility. Some of the factors contributing to success of credit rating are discussed as below: (I) Credible and Independent Structures and Procedures:- The credibility of the credit rating agency depends on the objectivity which results from the rater being independent of the issuer’s business. As credibility is a primary ingredient of credit rating, agency, it must maintain independence from all interested market forces viz., issuers, underwriters and Government. Some of the factors that could enhance the credibility of a rating agency include o and impartiality of opinions, professionalism, consistency, relevant expertise across relating to the sensitive and confidential information of the issuer, timeliness of rating review and announcement of changes and activity to reach a wide range of investors by means of press reports, print or electronic and more friendly research services. (ii) Reliance on the Market Mechanism: - 14
  • 15. Credit rating in India Reliance on the capital market for resource allocation generates a strong demand for investment- related information. Rating agencies provide this information. (iii) Corporate Disclosure and Credit Education: - As a part of corporate disclosure and credit education, it is n for rating agencies to ensure that the information about the regulatory guidelines for mandatory disclosures of ratings reaches the users. However, the rating should not be taken as the final word about financial health. The users should be intelligent enough to arrive at meaningful and conclusions by interpreting the assigned rating. They should also be aware of the limitations of credit rating and not take credit rating as a synonym for insurance or guarantee against default or risk. (iv) Existence of Debt Market:- The phenomenal growth of the debt market has resulted in tremendous demand for the credit rating business. The rating agencies in order to continue to provide their services need an active primary and secondary debt market. 15
  • 16. Credit rating in India Analytical Factors Considered by Indian Agencies The analytical framework of the rating methodology adopted by four Indian credit rating agencies viz., CRISIL, ICRA, CARE and Fitch includes analysis and appraisal of all the relevant factors that affect the credit worthiness of the borrowing entity. The analytical framework for rating agencies is divided into two interdependent segments dealing respectively with operational characteristics and financial characteristics of the issuers of the debt instruments. Besides quantitative and objective factors, qualitative aspects like assessment of management capabilities play a very important role in arriving at the final rating for an instrument. The relative importance of quantitative and qualitative components of analysis vary with the type of issuer and is analyzed independently and collectively. The key factors considered for the assessment of (i)Manufacturing companies (ii) Financial companies (ii) Indian states (iii) Banks and (iv) Bond fund ratings 16
  • 17. Credit rating in India Manufacturing Companies:- The analytical framework consists of three broad sets of factors, i.e. business analysis, financial analysis and management evaluation. (1)Business Analysis:- This includes an analysis of industry risk, market position, operating efficiency and legal risk of the company. The main elements of these components of Business analysis are as under: (i) Industry Risk:- Industry Risk is analysed with reference to the estimated current demand / supply and industrial growth prospect; intensity of competition in the industry; entry barriers and threats of new entrants in the industry; government regulations and policies relating to the industry; vulnerability to technological changes and to substitutes; cyclicality / seasonality factors and principal companies in the industry and their strengths and weakness. (ii)Market Position:- Market Position is evaluated from different angles viz., market share and its stability, competitive 17
  • 18. Credit rating in India position in market Segments, competitive advantages and disadvantages vis-à vis the nearest competitors, diversity of products and customers, selling and distribution arrangements and research and development with linkage to product obsolescence. (iii)Operating Efficiency:- Operating Efficiency is assessed with reference to production process indicating strength/weakness vis- à-vis the nearest competitors, productivities and efficiencies compared to other players, location advantages, labour relationships, product cost structure and manufacturing efficiency as compared to the nearest competitors, level of capital and employee productivity, energy costs and compliance of pollution control requirements. (iv)Legal Position:- Legal Position considers aspects such as terms of offer document - prospectus or letter of offer, terms of debenture trust deed, trustees and defined parameters of their responsibilities, protection against forgery, modalities and arrangements for buy-back facilities. 18
  • 19. Credit rating in India (2)Financial Analysis: All relevant aspects connected with the business and financial positions of the company are assessed which include accounting quality, earnings protection, adequacy of cash flows and financial flexibility. (i)Accounting Quality:- Accounting Quality depends on auditor’s qualification, overstatement / understatement of profits, method of income recognition, inventory valuation and depreciation policies, undervaluation overvaluation of fixed assets, off -balance sheet liabilities and the like. (ii)Earnings Protection:- Earnings Protection is assessed through profitability ratios, pre-tax coverage ratios, earnings in relation to fixed income charges, sources of future earnings growth and so on. (iii)Adequacy of Cash:- Flows is appraised in relation to debt and fixed and working capital requirements, variability of Future cash flows, capital spending flexibility, working capital management etc. 19
  • 20. Credit rating in India (iv)Financial Flexibility:- Financial Flexibility is examined in terms of alternative financing plans in times of stress, ability to raise funds or raise capital to meet stress requirements, asset redeployment potential, and debt service schedule and so on. (3)Management Evaluation:- Track Record of the management is evaluated with reference to goals, philosophy, strategies and ability to overcome adverse situations. Management competence is judged from past operating and financial results. Other aspects considered for judging the caliber of management include conservative outlook or aggressiveness with respect to financial risk, planning and control system, depth of managerial talents and succession plans, commitment, consistency & credibility. (i)Financial Companies:- The assessment of financial companies lays emphasis on the regulatory environment and fundamental analysis in addition to the financial analysis and management evaluation as already discussed.  Regulatory Environment is evaluated in relation to structure and regulatory framework of the financial system and trends in 20
  • 21. Credit rating in India regulation/deregulation and their impact on the company.  Fundamental Analysis covers aspects such as liquidity management, asset quality, profitability and financial position and interest and tax sensitivity of the company.  Liquidity Management: is analysed in terms of capital structure, term-matching of assets and liabilities, policy on liquid assets in relation to financing commitments and maturing deposits.  Asset Quality: is reflected in the quality of the company’s credit risk management, systems for monitoring credit, sector risk, exposure to individual borrowers, management Of problem credits etc.  Profitability and financial position: is examined on the basis of historic profits, spreads on fund deployment, revenues on non-fund based services, accretion to reserves and so on.  Interest and Tax Sensitivity: refers to exposure to interest rate changes, hedge against interest rate and tax law changes and the like. The evaluation is carried out by a team of professionally qualified persons and includes data collection, analysis and meetings with key personnel in the company to discuss strategies, plans and other 21
  • 22. Credit rating in India issues that may influence credit evaluation of the company. Discussions also include the company’s forecasted business and financial plans. The process g takes four to six weeks. In addition, the initial assigned ratings are monitored on continuous basis by analyst. Credit Rating Agencies The concept of credit rating has been widely discussed and debated in India in recent times. Since the setting up of the first credit rating agency Credit Raring and Information Services of India Ltd. (CRISIL) in India in 1987, there has been a rapid growth of credit rating agencies in India. The major players in the Indian market, apart from CRISIL include Investment Information and Credit Rating Agency of India Ltd. (ICRA), promoted by IDBI in 1991 and Credit Analysis and Research Ltd.(CARE), promoted by IFCI in 1994. Duff and Phelps has tied up with two Indian NBFCs to set up Duff and Phelps credit Rating India (private) Ltd in 1996. Rating Services The primary objective of CRISIL is to rate debt obligations of Indian companies. The instruments rated by it are long-term such as debentures I bonds and preference shares, medium-term including certificates of deposits, fixed deposits and short-term 22
  • 23. Credit rating in India including commercial paper. CRISIL also rates other new and innovative instruments including asset- backed securities, municipal bonds and bond funds. Its rating services also extend to real estate developers, parallel marketers of Liquefied Petroleum Gas (LPG), chit funds, banks and states. Credit Rating Services Operations -Manufacturing Cos. -Debt investment- -Finance Companies -Structure obligation -Banks -Fixed Deposits Programme -Commercial Papers -Project Report -Builder’s rating 23 Rating Rating Watch Rating Update Coverage Instruments Rated
  • 24. Credit rating in India CRISIL Research and Information Services (CRIS) Although credit rating remains its primary business, CRISIL has also diversified into information services as a thrust area: Tor future. The extensive compilation and analysis of data by e CRISIL for rating business is also used to provide: services to the corporate clients. They provide - services through CRISIL Card, CRISIL Sector view, CRISIL View, CRISIL Judge, and CRISIL Index ,the corporate and balance sheet data, formulated for easy analysis of selected companies is provided by CR1SIL Card. The CRISIL View Supplied information to the fund managers, investors and lenders on the basis of published data relating to the industry and companies, on the outlook and solvency of the Concerned companies. CRISIL Sector View provides an in-depth analysis of the important and potential growth industries India on the industry structure, the present industry dynamics and CRISIL’s outlook on the industry. The CRISLL Judge is a software package with data and analysis of Indian corporate. It also has a comprehensive value added data-base on India which is available on 24
  • 25. Credit rating in India wire services BLOOMBERG catering to 60,000 investment and corporate clients. Recurred and Knight Riddes also carry .J data-base on their screens. CRISIL also launched the CRISIL—500 equity index, a market value weighted composite index of 500 companies, representing about 73% f the market capitalisation of the Mumbai stock exchange, and77 industry group. The main objective of the broad based CRISIL-500 equity Index is to capture the market movement of the: Indian stock markets in a comprehensive manner and thus? Provide the investment community with an accurate performance benchmark against which they can measure Portfolio performance. CRISIL has recently launched the CRISIL Midcap 200 Equity Index, comprising 200 medium capitalized companies, captures about 86% of the market capitalisation. The CRISIL Research and Information Services (CRIS) disseminates value-added research and undertakes customized studies in four areas viz., Indian economy; Indian capital markets; Indian Industries and the Indian corporate sector. CRIS has a large client base, in India and overseas, comprising institutional investors, investment bankers, 25
  • 26. Credit rating in India commercial banks, financial institutions, corporate planners, mutual funds and asset management. The services rendered by CRISIL earlier as CRISIL, Cared Services and CRISIL’s Economic Services have been. Reorganised and assimilated under CRIS. CRIS renders the following set of services: 1. CRISIL Sectorview 2. CRISIL View 3. International Information Vending 4. CRISIL Index Services (1)CRISIL Sectorview: CRISIL sector view is an in-depth analysis of the important and potential growth industries in India. CRISIIL considers the quality of research and analysis as its forte. Contents of CRISIL Sectorview includes the following: A brief of the industry; Structure of the industry and its characteristics; An analysis of the different products in the industry based on factors like Product Specifications, Cost Structure, Capacities, Technology, Sector Use; Demand Supply Analysis both present and future; An analysis of the major players in the industry; Government policies; Industry Risks/Constraints; International Competitiveness; Key Factors; and CRISIL’s Outlook on the industry. 26
  • 27. Credit rating in India A monthly update is also provided for all the CRJSIL Sector views. Client Segments utilizing CRISIL Sector view Includes Financial Institutions; Mutual Funds; Corporate Bodies; Merchant Banks; Banks; Investment Institutions; Asset Management Companies; Finance Companies; Leasing Companies; Constituencies; Brokers, Government Departments; Foreign Institutional Investors; Industry Associations; and Academicians and Industry Analysis. The following industry classifications are also available from CRISIL’s research desk, viz., Aluminum; Automobiles — Two wheelers; Automobiles — Commercial vehicles & Cars; Cement; Petrochemicals (Covering Basic chemicals, polymers, fiber intermediaries & Linear alkyl benzene/Anhydride/ Orthoxylene), Polyester Staple fibre/Polyester Filament Yam; Power; Soda Ash; Software; Steel (covering flats and longs); Tractors. (2)CRISILVIEW: CRISILVIEW provides CRISIL’s analysis of and opinion on the business and financial outlook of company, based on which investors can take decisions having regards to individual risk preferences. It also provides a useful basis for fund 27
  • 28. Credit rating in India managers in their portfolio allocation decisions. Medium term lenders can use these reports to benchmark their exposure limits. CRISILVIEW is based on CRISIL’s in-depth understanding of the industry in which the company operates, as well as CRISIL’s understanding of the relevant qualitative and quantitative factors affecting the company’s performance. The CRISILVIEWs is a comprehensive and interactive tool for Business Managers, Investors, Creditors and Corporate Decision. Makers. According to CRISIL, the product has been structured specifically to cater to the information needs of a decision maker. It starts with a brief introduction to the company, gives an overview of the industry in which the company operates, analyses the business and financial outlook, and deals with detailed financial both actual till date and projections in the medium term. The financial projections are for two years in the future and are based on certain assumptions and underlying logic, all of which are outlined. 28
  • 29. Credit rating in India (3)On-line Services: International Information Vending To make the CRISILs’ research available to its international clients as well as to reach a wider potential client base, its research and analysis is also available via The Bloomberg. The menus that it offers cover the rating and advisory assignments carried out as well as research undertaken in the three Division of CRISIL. The Bloomberg carries extensive research and analysis in the following areas; Indian Economy, Indian Capital Markets, Key Industries and Indian Corporates. The client base for this service include Fund Managers, Foreign Institutional Investors, Investment Bankers, Commercial Banks, Multilateral Development Agencies, Constituencies, etc. In addition CRISIL also has tie-ups with all the other leading international information vendors like Reuters Inc., Knight-Ridder Information Inc. (The Dialog Corporation), Internet Securities Inc., and Matrix Services Pvt. Ltd. to disseminate its research and analysis world-wide. 29
  • 30. Credit rating in India (4)CRISIL Index Services CRISIL offers the following Index Services which are available online also. (i)CRISIL — 500 Equity Index: The CRISIL-500 Equity Index is a broad-based, market value weighted Index comprising 500 companies across 79 industries and represents about 74% of the market capitalisation and more than 95% of the turnover on The Stock Exchange, Mumbai. The main objective of CRISIL —500 is to provide the Investment community with a more accurate reflection of the stock market movement. The Index is responsive to market developments as it is maintained by a dedicated team Of professionals supported by a sophisticated computerized: The index is computed daily and daily historical an are available from 1991 onwards. (ii) CRISJL-Midcap 200 Equity Index: The CRISIL midCap 200 Equity index is a benchmark for the midcap c the market. Comprising 200 midcap stocks listed on the stock Exchange Mumbai. The CRISIL Madcap 200 represents 74% and 80% of the turnover of medium capitalized segment of the marlet 30
  • 31. Credit rating in India computed daily, historical e available .from 1993 onwards. (iii) CRISIL Industry Indices: CRISIL’s 79 Industry Indices serve as a standard for comparison of the stock Market performance of Individual companies vis-à-vis their Group and also enable fund managers to - NAV performance vs. specific industries. It is Computed daily, historical value of the indices are available m 1991 onwards. (iv) CRISIL Industry Indices: With a view to provide r-e investors, fund managers and market intermediaries with a better perspective of the relative stock market performance of the various segments in the corporate sector. CRISIL has developed 3 segment benchmark indices— • CRISIL MNC Index, a market capitalize weighted index comprising 50 MNCs’ listed •on the Stock Exchange, Mumbai. • CRISIL Indian Business Groups Index comprising 250 listed companies on The Stock Exchange, Mumbai representing 107 Indian Business Group. • CRISIL PSE Index, a market capitalisation weighted index comprising 20 PSE stocks listed on the Stock Exchange, Mumbai. 31
  • 32. Credit rating in India (v)Customized Indices: Customized Indices CRISIL’s emphasis on scientific methodology of Index construction and dynamic index maintenance is recognised by the market and CRIS has received requests for developing benchmark as well as customized indices. CRISIL undertakes development, computation and maintenance of customized indices for clients as well as offers consultancy services for developing indices. (iv)CRISIL Index Bulletin: The CRISIL Index Bulletin is a monthly market activity update and covers the market performance of constituents of CRISIL Indices.CRISIL with approximate seven-tenth share of the credit rating business is evidently the market leader in the domestic rating industry. It also features among the top five rating agencies in the world in terms of both its coverage and analytical strength. The rating business accounts for almost nine-tenth of its operating income- the diversification into other information and advisory services notwithstanding. 32
  • 33. Credit rating in India (v)CRISIL Advisory Services CRISIL provides the financial advisory services to the Government, banks, Public Sector Units, financial institutions and other semi- government and quasi- government bodies. CAS also undertakes customized studies for national and international project developers; multilateral lending agencies like the World Bank, International Finance Corporation, and other experts. The objective of these services is to identify risks, mitigating risks and formulating and executing strategies for the same. The activities of the group cover two main areas, viz., infrastructure development and financial sector Reforms. (a)Infrastructure Sector Services: It support and provide counseling on aspects, such as privatization of public sector undertakings, debt securitization, credit evaluation system and so on. (b)Financial Sector Services: CRISIL focus on the banking sectors and the capital markets. Advisory services of this category are provided at two levels: Strategic and Functional. Strategic assistance includes diagnostic studies and 33
  • 34. Credit rating in India business process re-engineering or restructuring studies based on a diagnostic analysis. Functional assistance covers areas such as credit management; resource mobilization; risk management etc. CAS also advises central and state governments on their disinvestment programmers. It has also collaborated with up credit rating agencies in the neighboring countries. 34
  • 35. Credit rating in India Rating Processes —The Indian Companies A brief description of various rating processes followed by the Indian rating agencies is mentioned below. CRISIL:- CRISIL follows the rating process as per international standards accompanied by minor adjustments made therein suiting to domestic conditions. CRISIL has publicised the working of its rating process on the lines of S & P’s. CRISIL’s rating process is described below: (a) Rating Agreement and Assignment of the Analytical Team:- The process of rating starts with the issue of the Rating Request letter by the issuer and the signing of the Rating agreement. On receipt of the request, CRISIL assigns an analytical team comprising of at least two analysts of whom one would be the lead analyst and would serve as the issuer’s primary contact. The analysts who have expertise in relevant business areas will be responsible for carrying out the rating assignment. 35
  • 36. Credit rating in India (b) Management Meeting:- Prior to meeting with the: issuer, the analytical team obtains and analyses information Relating to the issuers financial statements, cash flow projections and other relevant information. The analytical team then proceeds to have detailed meetings with the company’s management. CRISIL strongly believes that interest of investors are best served if a direct dialogue is maintained with the issuer, as this enables CRISIL to incorporate non- public information in a rating decision and also enables the rating to be forward looking. Topics discussed during the management meeting are wide-ranging, including competitive position, strategies, financed policies, historical performance, and near and long- term finance and business outlook. Equal importance is placed on d the issuer business risk profile and strategies. Addition to reviewing financial data. The rating process ensures complete con of the information provided by the company. All information is kept strictly confidential by the ratings group and is not used for any other purpose, or by any third party other than CRISIL. 36
  • 37. Credit rating in India (c) Rating Committee:- After meeting with management, the analysts present their report to a Rating Committee which then decides on the rating. The Rating Committee Meeting is the only aspect of the process in which the issuer does not participate directly. The rating is arrived at after a composite assessment of all the factors concerning the issuer, with the key issues getting greater attention from the Rating Committee. (d) Communication to the Issuer:- After the committee has assigned the rating, the rating decision is communicated to the issuer along with the reasons or rationale supporting the rating. For a rating to have value to an issuer or to an investor, the rating agency must have credibility. The thoroughness and transparency of CRISIL’s rating methodology and the integrity and fairness of its approach are important factors in establishing and maintaining credibility? CRISIL is therefore always willing to discuss with the management, the critical analytical factors that the committee focused on while determining the rating and also any factors that the company feels may not have been considered while assigning the rating. 37
  • 38. Credit rating in India In case the issuer disagrees with the rating outcome, they may appeal the decision for which new/additional information, which is material to the appeal and specifically addresses the concerns expressed in the rating rationale; need to be submitted to the analyst. Subsequently, a note is put up once again before the Rating Committee where the rating may or may not undergo a change. The client has the right to reject the rating and the whole exercise is kept confidential. The rating process, from the initial management meeting to the assignment of the rating, normally takes three to four weeks. However, when required CRISIL has been able to deliver rating decisions in shorter time frames. (e) Dissemination to the Public:- Once the issuer accepts the rating, CRISIL then disseminates it along with the rationale through print media including Reuters. The ratings are also disseminated through CRISIL’s monthly publication CRISIL Rating Scan. The Financial Times, UK’s quarterly publication FT CREM, and is also available on other international services like Bloomberg and Knight-Rider Services. 38
  • 39. Credit rating in India (f) Surveillance and Annual Review:- After a rating has been assigned, CRISIL is required to monitor the rating over the life of the debt instrument. CRISIL keeps the rating under continuous surveillance, monitoring both the on- going performance of the issuer and the economic environment in - which it operates. CRISIL typically conducts a formal Annual review of the rating which involves a meeting with the issuer. These review meetings focus on developments over the period since the last meeting and outlook for the coming year, enabling analysts to stay abreast of current developments, discuss potential problem areas, and be appraised of any changes in issuer’s plan. Following a full review, the rating may either be affirmed or changed. Any change effected is made public by CRISIL. In some instances, a credit rating may be placed on ‘Rating Watch’. A Rating Watch listing highlights an emerging situation which may materially affect the profile of a rated entity and can be designated with positive, developing, or negative implications. Instances where an entity’s rating may be placed on Rating Watch include the announcethent of a merger or acquisition or the occurrence of an event that could result in a substantial change in the issuing entity risk, profile. 39
  • 40. Credit rating in India CRAMEL Model CRISIL and ICRA conduct rating of banks also. These Rating agencies typically follow the CRAMEL model under Which banks are evaluated on six different parameters? • C (capital adequacy) • R (resource raising ability) • A (asset quality) • M (management evaluation) • E (earnings potential) • L (liquidity) Capital Adequacy:- It gives an indication about the kind of cushion the bank has to absorb future losses. A minimum capital adequacy ratio of 8 per cent is mandatory for all banks in India Resource Raising Ability:- The main aspects of raising resources by banks in their rating are: • Trends and diversity of deposits base; • Trends in cost of funds; • Funding policies, namely, tenure matching and interest rate sensitivities; and • Future plans. 40
  • 41. Credit rating in India Asset Quality:- The important elements in the evaluation of the asset quality of banks include, inter alia, • Quality of credit risk management of banks as reflected in the appraisal system and prudential norms prescribed by the RBI; • Quality of loan portfolio in terms of concentration, diversity, recovery and overdue positions and relative share of non-performing assets; • Specific steps to expedite recovery; and • Plans to improve asset quality. Management Evaluation:- The two crucial aspects of management evaluation of banks are (1) management style and (2) in-depth study of the tenure of personnel. Earnings Potential of banks is analysed on the basis of a Consideration of the following factors; • Diversity of income profile; • Trends in lending spreads; • Trends in investments yields; • Trends in fee-based income; and • Expense level. 41
  • 42. Credit rating in India Liquidity of banks is examined with reference to three Factors, namely; • Liquid assets; • Dependence on volatile funds; and • Unutilized line of credit. Bond Fund CRISIL has introduced credit quality ratings for bond funds to evaluate credit quality of the funds underlying portfolio holdings. Under the scheme, only pure bonds whose portfolio consist entirely of fixed income securities, apart from a small percentage of money market instruments held for liquidity will be rated. CRTSIL methodology for bond fund ratings covers the following aspects: (i)Consistency of credit risk associated with a particular security of fund with the overall fund rating. (ii)Examination of various systems and procedures such as system for making and executing investment decisions, back office systems, reconciliation with custodians and registrars, calculation of net asset value, tracking of payments, receivables etc. (iii)Evaluation of management’s track record in the funds management business, quality of key personnel, and investment strategy for the fund and so on. 42
  • 43. Credit rating in India Rated Instrument and Rating Symbols The rating symbol. Are symbolic expressions of the opinion assessment of the credit rating agency with regard to the investment/credit quality/grade of the debt/obligation instrument. They group together similar, though not necessarily identical, entities in terms of their relative capacity of timely servicing of the obligations as per the terms of the contract. The suffixes plus (+) or minus (-) are added to the symbols to indicate the relative position of the investment within the group covered by the symbol. Appropriate prefixes and suffixes such as (FD) and (CD) are used to denote specific instruments such as fixed deposits, certificates of deposits and so on. The rating symbols as the final expression of the investment quality of a financial instruments used by the Indian rating agencies are illustrated in this section. • Long-term Instruments:- Debentures and bonds are mandatory rated by all the three rating agencies, i.e. CRISIL, ICRA and CARE • CRISIL Symbols:- Categories debentures into three investment grades listed as under: For preference shares, the letters (pf) are pre-fixed and for structured obligations, letters (so) are affixed to the debenture rating symbols; The 43
  • 44. Credit rating in India structured obligations mean procuring of a desirous rating by fulfilling the essential formalities for the proposed rating. An example of such rating is the rating by CRISIL of the securitization of the car hire-purchase receivables (asset- based securities) of the Gujarat Lease Finance Ltd which was given a triple A rating. (A) High Investment Grades AAA (Triple A):- Highest Safety. Debentures rated ‘AAA’ are judged to offer the highest safety of timely payment of interest and principal. Though the circumstances providing these degrees of safety are likely to change, such changes as can be envisaged are most unlikely to affect adversely the fundamentally strong position of such issues. AA (Double A):- High Safety. Debentures rated ‘AA’ are judged to offer high safety of timely payment of interest and principal. They differ in safety from ‘AAA’ issues only marginally. (B) Investment Grades A: Adequate Safety. Debentures rated ‘A’ are indicator of Offering adequate safety of timely payment of interest and principal. However, changes in 44
  • 45. Credit rating in India circumstances can adversely affect such issues more than those in the higher rated categories. BBB (Triple B):- Moderate Safety. Debentures rated ‘BBB’ are judged to offer sufficient safety of timely payment of interest and principal for the present. However, changing circumstances are more likely to lead a weakened capacity to pay interest and repay principal than for debentures in higher rated categories. (C) Speculative Grades BB (Double B):- Inadequate Safety. Debentures rated ‘BB’ are judged to carry inadequate safety of timely payment of interest and principal; while they are less susceptible to default than other speculative grade debentures in the immediate future, the uncertainties that the issuer faces could lead to inadequate capacity to make timely interest and principal payments. B: High Risk Debentures rated ‘B’ are indicator of having greater susceptibility to default; while currently interest and principal payments are met, adverse business or economic conditions would lead to lack of ability or willingness to pay interest or principal. C: Substantial Risk 45
  • 46. Credit rating in India Debentures rated ‘C’ are judged to have factors present that make them vulnerable to default; timely payment of interest and principal is possible only if favorable factors / circumstances continue. D: Default Debentures rated ‘D’ are in default and in arrears of interest / principal payments or are expected to default on maturity. Such debentures are extremely speculative and returns from these debentures may be realized only on reorganization / liquidation. Problem Faced by CRISIL (i)The major problem faced by CRISIL was said to be the non-availability of adequate information (both from primary and secondary sources) from the company It is felt that availability of information is a function of co operation from the client and the level of data base built for the industry supported by extensive research. (ii)The analysts evaluation is based on information collected from annual reports of companies which are neither sufficient nor adequate for any rating work. Bankers and auditors are seldom forthcoming to provide requisite information about the company. 46
  • 47. Credit rating in India (iii)The rating analysts feel that the complete information is not provided by the companies. There neither proper flow of information nor the adequate transparency which make the proper ratings by the analysts difficult. It needs special mention that rating analysts cannot be expected to do a justice unless the rating agencies have access to the reliable data to carry out an unbiased and fair rating process. (ivOne of the main problems faced by credit rating had been that the firms were under no Obligation notifies the rating given to them as it was discretionary. As such, firms which are dissatisfied with the rating assigned by an agency are under no obligation to publish such a rating. Rating analysts also face specific problems relating to rating of different instruments. The estimation of drawing powers and short-term volatility of cash- flow in commercial paper, deposits renewal rates in case of fixed deposit problem regarding uncertainty about future goals and strategies of the firms . 47
  • 48. Credit rating in India DRAWBACKS OF CREDIT RATING In spite of the advantages that the rating offers, several drawbacks are: (i) The ratings process to attempts to provide guidance to investors/ creditors in determining the risks associated with the instrument/ credit obligation. It does not attempt to provide a recommendation and does not take in to account factors like market prices, personal risk/ reward preferences that might influence investment decision. (ii) The rating process is based on certain primitives. The agency, for instance, does not perform an audit. Instead, it has to rely solely on information provided by the issuer. Consequently, to the extent that the information provided is inaccurate and incomplete, the ratings process is compromised. (iii) To the extent that a certain instrument of a specific company attracts a lower rating, the company has an incentive to shop around for the best possible rating, compromising the authenticity of the rating process itself. 48
  • 49. Credit rating in India SEBI GUIDELINES FOR CREDIT RATING  Disclosure of unaccepted rating to investors has been made Compulsory.  It has been made mandatory to obtain dual ratings from different recognized agencies for all public and right issues of debt instruments grater than or equal to RS. 100 corers. Accordingly disclosure and investor protection guidelines have been amended.  Rating agencies have been debarred from rating debt instruments of their promoter institutions.  Restrictions have been imposed on rating a debt instrument of a corporate firm if it has any common director with the rating agency’s promoter institution. The guidelines cover even the borrowers of their bodies.  Rating agencies are mostly promoted by large financial institutions or firms. This can cause an evaluation bias as these rating agencies can not afford to give correct rating to the weaker companies since these are part of the firms sponsoring rating agencies so that SEBI guideline 49
  • 50. Credit rating in India which specifies that no credit rating agency shall rate a security issued by its promoter.  Rating in India has been made compulsory for any company that chooses to raise money through a public issue of debentures with conversion, commercial papers, 50
  • 51. Credit rating in India CONCLUSION The outlook for the credit rating industry is positive. Credit ratings a leading role in the development of the debt markets in India. The Rating Criteria & Product Development Centre, responsible for policy research, new product development and ratings' quality assurance, has developed new ratings methodologies. There are number of areas where rating agencies will have to cover new ground in the coming future. The rating of municipal bond, state government borrowing, commercial banks and public sector undertaking etc, will be covered in the near future. Credit rating play very important role in international landing. The importance of credit rating is being increasingly recognized in the Euro-markets. Rating is marketing too which indicate relative capacities of companies to make timely repayment of interest and principal on debt. CRISIL inspires trust and confidence across industry for upholding values that serve as tenets across the Group Companies. The Indian credit rating agencies have made strategic alliance with reputed international agencies. Agencies are adopting large extent the rating methodologies which adopted by western counterparts. 51
  • 52. Credit rating in India So, I here by concluded that credit rating in India having bright future. 52