Credit rating agencies provide letter grades to communicate the level of credit risk and likelihood of default for issuers. There are seven agencies regulated by SEBI in India, with high barriers to entry. Agencies earn revenue from paid ratings where issuers pay for an assessment, or through subscriber fees. The process involves a rating team conducting analysis and presenting to a committee which determines the grade. Multiple factors like financials and debt are considered. Regulators have increased scrutiny of agencies following issues like the 2008 crisis where inaccurate ratings contributed to problems.

1. The creditworthiness is expressed in a letter grade that ranges from ‘AAA’ to ‘D’ to
communicate the agency’s opinion of relative level of credit risk and the likelihood of
default and financial loss in the event of such default.
CREDIT RATING GRADES
CONCEPT
Speculative grade

2. CREDIT RATING AGENCIES- OLIGOPOLY IN INDIA
CRISIL Limited India Ratings and Research Pvt Ltd ICRA Limited CARE
Brickwork Ratings India Pvt Ltd SMERA Ratings Limited Infometrics Valuation and Rating Pvt Ltd:
SEBI has permitted only seven credit rating agencies
CONCEPT
Eligibility criteria
REASON:HIGH ENTRY BARRIERS

3. REVENUE MODEL OF CREDIT RATING AGENCIES
UNSOLICITED
RATINGS
PAID RATINGS
ISSUER PAY
Assessment
made on request
of issuers
SUBSCRIBER PAY/
USER PAY
Available on
user’s(Investor)
subscription
CONCEPT
(VOLUNTARY)

4. GENERAL RATING PROCESS OF CRAs
ISSUER CRA
Request for rating
Signs rating agreement,
Provides information and
Rating fees
Rating Team assigned.
Team conducts preliminary analysis
Interaction with the management
Analysis presented to the rating
committee
Does Issuer accept the rating?
Does Issuer appeal against the
rating?
Rating disseminated on website.
Rating kept under surveillance
Details of unaccepted ratings
disclosed on the website.
Rating assigned and communicated
to issuer
YES YES
NO
NO
CONCEPT
AS PER SEBI
The rating agencies have the power to downgrade, suspend or withdraw a rating.

5. FACTORS INVOLVED IN DETERMINING THE
CREDIT GRADE
Each rating agency has its own method to calculate credit ratings.
At the time of calculating the rating, credit rating agencies take into consideration several
factors like the financial statements, level and type of debt, lending and borrowing history,
ability to repay the debt, and past debts of the entity before rating them.

6. RATING SHOPPING 2006 AND NOW AGAIN
http://www.markadelson.com/pubs/Rating_Shopping.pdf
CONCEPT
•Rating shopping occurs when an issuer chooses the
rating agency that will assign the highest rating or that
has the most lax criteria for achieving a desired rating.
COMPANIES
CRA 1
CRA 2
CRA 3
CRA 4
AA
AAA
AA+
D+
LET’S GO
RATING
SHOPPING•Rating shopping refers to how, a
company or a debt paper
manages to get same or better
rating from another agency
within three months of it getting
a poor rating.
NEWS - RBI blasts credit rating agencies for allowing 'rating
shopping' to large borrowers
•Most rating shopping happened
around 'BBB' or lower graded
instruments, FSR suggests.
https://economictimes.indiatimes.com/markets/stocks/news/rbi-blasts-credit-rating-agencies-for-
allowing-rating-shopping-to-large-borrowers/articleshow/73016267.cms?from=mdr

7. FINANCIAL CRISIS, 2008
o During the 2008 financial crisis, a lot of worthless mortgage-related
securities were given AAA ratings: the highest and safest investment
grade.
o In 2007, as housing prices began to tumble, Moody’s downgraded 83
percent of the $869 billion in mortgage securities it had rated at the AAA
level in 2006
o The credit ratings agencies aimed for increasing profits and market
share by giving inaccurately strong ratings to underperforming assets.
o In connection with the financial crisis, the big three global credit ratings
agencies have faced heavy fines and have come under scrutiny for
playing a pivotal role in the 2008 meltdown(S&P agreed to pay $1.375
billion in a settlement)
o But the fines paid for misrepresentation seem insignificant when
compared to the profits generated by some of the large credit ratings
agencies.
o Rating shopping (Nomura)
https://www.cfr.org/backgrounder/credit-rating-controversy
CASE
http://www.markadelson.com/pubs/Rating_Shopping.pdf

8. Consistently good ratings provided by Credit Rating Agencies from June 2012 to June 2018:
Identified instances which indicated liquidity issues/ stress in the IL&FS group since 2015:
Significant increase in debt , Decreasing profitability of IL&FS group; Supporting weaker companies in
the IL&FS group; etc
Potential favors/gifts provided to the representatives of the credit rating agencies:
1.Ramesh Bawa facilitated villa purchased for Ambreesh Srivastava (India Ratings),
2.Arun Saha arranged football tickets for D Ravishankar (Brickwork Ratings) relating to the matches
in Real Madrid,
3.IL&FS group donated to the Sameeksha Trust INR 25 lakhs where the managing trustee D. N. Ghosh
is also the chairman of ICRA.
4.Further, our email review indicates that the various key officials of rating agency were provided
gifts such as smartwatches, shirts, coasters, etc
SOURCE: Draft update pertaining to observations relating to Credit Rating Agencies- GRANT THORTON, 12 July 2019
SEBI levied a penalty of ₹25 lakh each on three rating agencies ICRA ltd, India Ratings & Research and
Care Ratings Ltd for not exercising due-diligence and lapsing on their duties to investors by not taking
timely rating actions.
IL & FSCASE

9. DEBT FUNDS/ MUTUAL FUNDS RELYING ON CRA
https://www.livemint.com/Companies/nKiB6RuSI5fXpvPVqxBr6H/Have-rating-agencies-been-caught-
napping.html
NEWS: Sebi warns mutual funds: Evaluate your
investments, don’t just rely on ratings(2005)
 Debt funds holding bonds issued by the Jindal Steel & Power Ltd (JSPL) suffered
a steep fall on Tuesday after Crisil downgraded the company’s credit rating to
A4+ from A3+, indicating a negative outlook.
 The company has long-term debt of almost Rs 34,976 crore and debt mutual
funds hold around Rs 3,000 crore worth of bonds.
 Debt funds of Franklin Templeton India were the worst hit, with some schemes
falling by over 1.5 per cent on Tuesday.
 Similarly JPMorgan funds suffered a steep crash due to the downgrading of
Amtek Auto.
 Debt funds are considered low-risk investments
https://economictimes.indiatimes.com/markets/bonds/debt-funds-holding-jspl-bonds-crash-after-
crisil-downgrade/articleshow/51015820.cms?from=mdr
Fund houses should be using the rating as an additional input and not as a primary
input. They should be having the skills to evaluate credit. Yes, a rated paper can
help you to find companies you have to shortlist. Beyond that, there has to be an
internal analysis that approves the paper.
CASE

10. • Credit ratings, debt ratings, or bond ratings are issued to individual companies and
to specific classes of individual securities.
• In addition, Countries are issued sovereign credit ratings.
• Sovereign credit ratings take the overall economic conditions of a country into
account, including the volume of foreign, public and private investment, capital
market transparency,, and foreign currency reserves .
• Institutional investors rely on sovereign ratings to qualify and quantify the
general investment atmosphere of a particular country.
EXAMPLE-Moody’s downgrades India’s outlook to
negative from stable
• country's economic growth will remain materially lower than in the past.
Moody’s projects a budget deficit of 3.7 per cent of GDP in the year through
March 2020.
• After downgrading India’s sovereign outlook, Moody’s Investors Service on
Friday downgraded its view to 'negative' from 'stable' on many top Indian
companies, including SBI, HDFC BankTCS, Infosys, BPCLNSE , NTPC, NHAI and
GAIL.
• In total, the rating agency on Friday cut outlook on 21 Indian firms.
SOVEREIGN CREDIT RATING
CONCEPT

11. EUROZONE DEBT CRISIS
o EU governments and ECB policymakers accused the Big Three of being overly
aggressive in rating eurozone countries’ creditworthiness, exacerbating the financial
crisis.
o S&P’s April 2010 decision to downgrade Greece’s debt to junk status weakened
investor confidence and raised the cost of borrowing.
o In 2011 private creditors were persuaded to take a “voluntary” loss on their bonds in
order to reduce Greece’s overall debt. This scheme—seen as necessary to restore
Greece’s financial health—was complicated by S&P’s July 2011 announcement that it
would consider such debt restructuring a “selective default.”
o Despite fears of a deeper crisis, the restructuring went smoothly enough for S&P to
raise Greece’s sovereign credit rating back to B- by December 2012.
CASE
http://news.bbc.co.uk/2/hi/business/8647441.stm

12. REGULATING THE CREDIT RATING AGENCIES
•In 2006, Congress passed the Credit Rating Agency Reform Act, which
gave the Securities and Exchange Commission (SEC) the power to
regulate the internal processes of credit ratings agencies regarding
record-keeping.
•The 2010 Dodd-Frank Wall Street Reform and Consumer Protection
Act adopted new rules that allowed the SEC to annually examine the 10
credit ratings agencies operating in the United States.
India’s seven rating agencies are regulated by both SEBI and RBI
 Over the last decade, 276 home-grown companies were assigned triple-A
billings by credit rating agencies in India. This compares with nine given by
Standard &Poor’s and 53 by Moody’s.
 Credit rating firms have put more companies under ‘rating watch’ in last
one year than they did in last 12 years following loan defaults by the IL&FS
Group, which heightened concerns over the health of indebted companies.

13. However, rating agencies have often sought to shift the blame to companies and
lenders by claiming that they do not get information about the delay in meeting
bank obligations and payment failures, which are considered early indicators of a
default.
SEBI amended its regulations for rating agencies to ensure that any listed or
unlisted entity, before getting rated, gives an explicit consent to obtain from their
lenders and other entities full details about their existing and future borrowings as
also their repayment and delay or default of any nature and provide the same to
the rating agencies.
SEBI MULLS REFORMS; TIGHTER CHECK ON
RATING AGENCIES
It can be noted that since 2016, Sebi had changed the regulations
governing raters at least six times.
https://www.sebi.gov.in/legal/regulations/sep-2019/securities-and-exchange-board-of-india-credit-rating-
agencies-amendment-regulations-2019_44439.html
https://www.sebi.gov.in/legal/regulations/jun-2018/securities-and-exchange-board-of-india-
credit-rating-agencies-regulations-1999-last-amended-on-may-30-2018-_39237.html

14. INDIAN COMPANIES ON
GLOBAL STANDARDS
CRISIL said that less than 1% of 32,500
rating Indian companies would actually
be able to achieve a top credit rating of
AAA. This is significantly less than
China (12.8%), Taiwan (8.6%) and even
Thailand (4.8%). Since India’s sovereign
debt is rating BBB, the debt of any
Indian company is usually assessed
against a ceiling of BBB.

15. DECLINE OF AAA RATED
COMPANIES GLOBALLY
There has been a steady decline in the number of
‘AAA’ rated companies globally. At S&P Global
Ratings, it reduced from 89 a decade back to 9 as
of January 1, 2018. For Moody’s, it went from 170
to 53. The high cost of maintaining AAA ratings
has contributed to this. For an entity to be rated
AAA on the global scale, it has to enjoy an
extraordinarily strong balance sheet that can
withstand stresses on a world scale. That puts
severe limits on debt levels and gearing
headroom for growth.

16. •The basic objection to the “issuer pays” model is the suspicion that the
issuer calls the shots, and therefore, the CRA is likely to subjugate its
independent judgment to its commercial interests.
•Many banking crimes are penalized with fees instead of criminal lawsuits,
and the story for credit ratings agencies is no different.
•At the same time, investors should rely less on such ratings, especially
when these credit ratings agencies have already been a part of one of the
biggest financial crises in the world.
•The rating agencies have the power to downgrade, suspend or withdraw a
rating. If there is high quality surveillance, no reason for an abrupt
downgrade by two or three notches, unless it is the result of a corporate
action, where there is some merger or acquisition or the company has
suppressed some facts, which came to light later on.
CONCLUSION