Credit Rating Agencies in India

By Kunal Hansda (25), Sangeeta Tirkey (26), Shanu Sharma (40), Arpit R. Arthur(59), Swapnil Barjo (15), Franklin Surin (28) Department of Finance I Batch of 2010-2012, XISS, Ranchi.
Study in origin of credit rating agencies in India, their development, regulatory framework in which they work in and their importance.

Credit Rating Agencies in India

Credit Rating Agencies in India

By Kunal Hansda (25), Sangeeta Tirkey (26), Shanu Sharma (40), Arpit R. Arthur(59), Swapnil Barjo (15), Franklin Surin (28) Department of Finance I Batch of 2010-2012, XISS, Ranchi.

Table of Content
S L N O . C ONTENTS P AGE NO .

Introduction Importance of CRAs Features of CRAs Benefits of Credit Rating

Credit Rating Agencies in India

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Growth of Credit Rating in India Rating Methodology CRISIL Credit Rating Products Non Rating Related Activities Framework of Operations Limitations of Credit Rating Agencies References

Introduction:
Credit rating agencies play an important role in assessing risk and its location and distribution in the financial system. By facilitating investment decisions they can help investors in achieving a balance in the risk return profile and at the same time assist firms in accessing capital at low cost. CRAs can thus potentially help to allocate capital efficiently across all sectors of the economy by pricing risk appropriately. However, in view of the fact that CRAs that rate capital market instruments are regulated by SEBI4 and those entities regulated by other regulators (IRDA, PFRDA and RBI) predominantly use the ratings. Credit rating is the assessment of a borrowers credit quality .It performs the function of credit risk evaluation reflecting the borrowers expected capability to repay the debt as per terms of issue. A credit rating estimates the credit worthiness of an individual, corporation, or even a country. It is an evaluation made by credit bureaus of a borrowers overall credit history. Credit ratings are calculated from financial history. A poor credit rating indicates a high risk of defaulting on a loan, and thus leads to high interest rates, or the refusal of a loan by the creditor

Importance of CRAs:
1) Plays a key role in the infrastructure of the modern financial system. 2) Credit rating enables investors to draw up the credit-risk profile and assess the adequacy or otherwise of the risk-premium offered by the market. 3) It is a tool in the hands of financial intermediaries. 4) Credit rating helps the market regulators in promoting stability and efficiency in the securities market.

Features of CRAs:
The ratings are expressed in code numbers which can be easily comprehended by the lay investors. Credit rating, as exists in India, is done for a specific security and not for a company as a whole.

Credit Rating Agencies in India

A debt rating is not one time evaluation of credit risk, which can be regarded as valid for the entire life of the security. A credit rating does not create fiduciary relationship between the agency and the users.

Benefits of Credit Rating:

Credit Rating Agencies in India Credit ratings enable investors to draw up the credit risk profile of a company and make informed judgement in investments. Ratings are a tool in hands in hands for financial intermediaries. Helps the market regulators in promoting stability and efficiency in the security market. Rating affects the quantum of financial and investment flow in a country. Reflects overall health of the economy of the country.

Features of Credit Rating:

The ratings are expressed in code numbers which can be easily comprehended by the lay investors. Credit rating, as exists in India, is done for a specific security and not for a company as a whole. A debt rating is not one time evaluation of credit risk, which can be regarded as valid for the entire life of the security. A credit rating does not create fiduciary relationship between the agency and the users.

Growth of Credit Rating in India:

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The concept of credit rating started in America when the founder of Moodys Investors, John Moody rated the US Rail road bonds in 1909. Initially the rating was done free of charge in US. Then rating agencies offer both solicited and unsolicited ratings. CRISIL was the first CRA in India

established in 1987, promoted by ICICI and other financial institutions. Following credit rating agencies are currently functioning in India; CRISIL :- Credit Rating Information Services of IndiaLimited ICRA:- Investment Information and Credit Rating Agency of India CARE:- Credit Analysis and Research on equity DCR INDIA:- Duff and Phelps Credit Rating Pvt. Ltd

Rating Methodology:
The following is the credit rating methodology followed by CRAs in India; Business Analysis- Business Analysis consists of the following functions Industry risk The risk of the whole industry is studied as a whole. Future growth trends of the industry are determined. Market position Competitor analysis, market share of the firm and its competitors are done. Operating Efficiency Operating efficiency of the company is studied. Legal Position Legal framework of operations is studied and change in the same is studied. Credit Rating Agencies in India

Financial Analysis Accounting Quality - Conformity and quality of accounting standards are checked. Earning Protection Cash Flow Financial Flexibility

Management Evaluation Quality of management and their capability to overcome difficult situation, there management style and organizational culture is studied. Fundamental Analysis Fundamental analysis consists of by calculating various accounting ratios. Liquidity Management

Asset Quality Profitability Interest and Tax sensitivity

Regulatory Framework of Functioning:

SEBI Code of conduct
Credit Rating Agencies in India A CRA shall make all efforts to protect the interests of investors. A CRA shall at all times exercise due diligence, ensure proper care and exercise independent professional judgment in order to achieve and maintain objectivity and independence in the rating process. A CRA shall have in place a rating process that reflects consistent and international rating standards. A CRA shall keep track of all important changes relating to the client companies and shall develop efficient and responsive systems to yield timely and accurate ratings. Further a CRA shall also monitor closely all relevant factors that might affect the creditworthiness of the issuers. A CRA shall disclose its rating methodology to clients, users and the public. A CRA shall not make any exaggerated statement, whether oral or written, to the client either about its qualification or its capability to render certain services or its achievements with regard to the services rendered to other clients.

Provisions relating to conflict of interest:

A CRA shall, wherever necessary, disclose to the clients, possible sources of conflict of duties and interests, which could impair its ability to make fair, objective and unbiased ratings. Further it shall ensure that no conflict of interest exists among any member of its rating committee participating in the rating analysis, and that of its client. A CRA or any of its employees shall not render, directly or indirectly, any investment advice about any security in the publicly accessible media.

A CRA shall not offer fee-based services to the rated entities, beyond credit ratings and research. A CRA shall maintain an arms length relationship between its credit rating activity and any other activity. A CRA shall develop its own internal code of conduct for governing its internal operations and laying down its standards of appropriate conduct for its employees and officers in the carrying out of their duties within the CRA and as a part of the industry. Such a code may extend to the maintenance of professional excellence and standards, integrity, confidentiality, objectivity, avoidance of conflict of interests, disclosure of shareholdings and interests, etc. Such a code shall also provide for procedures and guidelines in relation to the establishment and conduct of rating committees and duties of the officers and employees serving on such committees. Credit Rating Agencies in India

Regulatory Concern
1. Oligopolistic nature of the rating industry because of natural barriers or propriety barriers of entry leading to lack of competition. 2. Inadequacy of existing methodologies adopted by CRAs for structured products given their complexity, multiple tranches and their susceptibility to rapid, multiple-notch downgrades which are pro-cyclical. 3. A basic conflict of interest which is partly inherent, since the sponsor/issuer of new instruments pays the CRA for being rated. 4. A general lack of accountability as CRAs do not have a legal duty of accuracy and are often protected from liability in case of inaccurate ratings. 5. CRAs sometimes provide ancillary services in addition to credit ratings. The issuer may use the incentive of providing the CRA with more ancillary business in order to obtain higher ratings. There is a clear conflict of interest in offering advisory services or consulting services to entities rated by the CRA.

CRISIL:
History:
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1987 January 29: CRISIL, India's first credit rating agency, is incorporated, promoted by the erstwhile ICICI Ltd, along with UTI and other financial institutions.

Mr. N Vaghul and Mr. Pradip Shah are CRISIL's first Chairman and Managing Director, respectively. 1988: January 1: CRISIL commences operations within a year of its incorporation. The business environment is far from promising for the one-year old - the lending rates are fixed, and India has no such thing as a corporate bond market as yet. And, what's more, credit rating is an idea that's far ahead of its times. 1990: The CRISILCARD Service - providing comprehensive information and analytical opinion on India's corporate entities - is launched. 1991: Despite the odds, and the initial lack of market acceptance of credit ratings, CRISIL's operations are now well established. It begins to acquire brand identity, with a reputation for analytical rigour and independence. 1992: CRISIL offers technical assistance and training to help set up Rating Agency Malaysia Berhad, and MAALOT, the Israeli securities rating company.

Credit Rating Agencies in India

Credit Rating Products:

1. Bonds/ debentures- [the main product] 2. Commercial paper 3. Structured finance products 4. Bank loans 5. Fixed deposits and bank certificate of deposits 6. Mutual fund debt schemes 7. Initial Public Offers (IPOs)

Non Rating Related Activities of CRAs:

Economy and Company Research Risk consulting Funds research Advisory services

Knowledge Process Outsourcing:

Framework of operations of CRISIL:

Limitations of Credit Rating:

Not a recommendation to buy, hold or sell any shares, bonds, debentures or other instruments issued by the rated entity, or derivatives thereof. A rating is one of the many inputs that are used by investors to make an investment decision. Not Intended to measure many other factors that debt investors must consider in relation to risk - such as yield offered, liquidity risk, pre-payment risk, interest rate risk, taxation aspects, risk of secondary market loss, exchange loss risk, etc.

Credit Rating Agencies in India

Not a general-purpose credit or performance evaluation of the rated entity, unless otherwise specified. The rating is usually specific to the instrument and is not the rating of the issuer. Not an opinion on associate, affiliate or group companies of the rated entity, or on promoters, directors or officers of the rated entity. Not a statutory or non-statutory audit of the rated entity Not an indication of compliance or otherwise with legal or statutory requirements Not a guarantee against default of the rated instrument. Even the highest-rated instrument faces some risk of default, although the risks associated with this are lower than lower-rated instruments.

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Credit Rating Agencies in India

References:
1. Wikipedia 2. The Indian Financial System, Bharati V. Pathak 3. Report of the Committee on Comprehensive Regulation for Credit Rating Agencies, MINISTRY OF FINANCE CAPITAL MARKETS DIVISION Credit Rating Agencies in India

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