19BAL110 Corporate Governance

SEMESTER-VIII
B.A.LLB. (Hons.) Course

CORPORATE GOVERNANCE
RESEARCH PAPER

TOPIC – RELIABLE CREDIT RATINGS IN INDIA: SEBI

REGULATIONS, BASEL III COMPLIANCE AND CORPORATE
GOVERNANCE

SUBMITTED BY:
SHRISHTI DWIVEDI
19BAL110
19BAL110 Corporate Governance

TOPIC – RELIABLE CREDIT RATINGS IN INDIA: SEBI

REGULATIONS, BASEL III COMPLIANCE AND CORPORATE
GOVERNANCE

ABSTRACT
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The purpose of this abstract is to examine how efficiently the Securities and Exchange Board
of India (Credit Rating Agencies) Regulations, 1999 and investment regulations ensure that
credit rating agencies (CRAs) provide accurate credit ratings. Guidelines for CRAs that are
acceptable for use in determining banks’ capital adequacy ratios are provided under the Basel
III Capital Regulations. On February 13, 2019, the Standing Committee on Finance, led by Dr.
M. Veerappa Moily, turned in a report titled “Strengthening of the Credit Rating Framework
in the Country.” The report emphasises the necessity of tightening the regulatory framework
for credit rating agencies (CRAs) in order to raise the calibre and dependability of credit
ratings. In order to determine if the regulations are effective in ensuring trustworthy credit
ratings, the study will examine the regulatory framework and the application of investment
legislation in India.

Key words:-Credit rating, Basel III regulation, credit rating agencies, financial ratios, corporate
credit rating.

OBJECTIVES
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1. To assess how well the Securities and Exchange Board of India (Credit Rating
Agencies) Regulations, 1999, ensure that credit rating agencies provide accurate credit
ratings.
2. To examine how India’s investment regulations are being put into practise and how it
affects the accuracy and dependability of CRAs’ credit ratings.
3. To evaluate the effect of Basel III Capital Regulations on the choice of credit rating
agencies that are eligible to be used in the calculation of banks’ capital adequacy ratios.
4. To make suggestions for upgrading India’s credit rating agencies’ regulatory structure
in order to raise the standard and dependability of credit ratings.
RESEARCH QUESTIONS
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1. In what ways do the Securities and Exchange Board of India (Credit Rating Agencies)
Regulations, 1999 help to ensure that credit rating agencies provide accurate credit
reports?
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2. What effects do Indian investment laws have on the accuracy and dependability of credit
ratings provided by rating agencies?
3. How are approved credit rating agencies chosen for use in determining banks’ capital
adequacy ratios influenced by Basel III Capital Regulations?
4. What suggestions may be made to improve the calibre and dependability of credit
ratings by strengthening the regulatory environment for credit rating companies in
India?
RESEARCH METHODOLOGY
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Method of Research: The present study is exploratory cum descriptive in nature. This study
will adopt a comparative research design to explore the emerging issues and SEBI regulations
in India. It will compare and contrast the regulatory frameworks, market infrastructure, investor
protection mechanisms, and market performance of the two countries to identify similarities
and differences in the market and SEBI regulations
Sources of Data: The primary sources of the data are books, legislations, The secondary
sources are reports, amendments, judgements, case studies, journal.
Mode of Citation: The researcher has followed the bluebook method of citation throughout
the course of this research paper.

STATEMENT OF PROBLEM
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By providing credit ratings that are trusted by investors, issuers, and regulators, credit rating
agencies (CRAs) serve a critical role in the financial system. The failure of a number of well-
known businesses with high credit ratings, however, has raised concerns about the validity of
credit ratings in recent years. Investment regulations and the Securities and Exchange Board of
India (Credit Rating Agencies) Regulations, 1999 both aim to ensure that CRAs provide
accurate credit ratings. The success of these restrictions in assuring the calibre and
dependability of credit ratings is not entirely clear, though. As a result, the stated problem is to
assess how well these restrictions perform to ensure credible credit ratings along with
suggestions for improving the regulatory environment.

HYPOTHESIS
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Credit rating agencies are required to provide accurate credit ratings by the Securities and
Exchange Board of India (Credit Rating Agencies) Regulations, 1999, which are effective in
this regard.

LITERATURE REVIEW
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• Bolton, Patric1 With the aid of a model, Xavier Freixas and Joel Shapira (2012)
investigated the competition between credit rating organisations, which was predicted
to decrease market efficiency. Additionally, they succinctly explained the
characteristics of credit rating agencies. The examination is divided into sections that
explain how credit rating agencies are contrasted and extended. Regarding the
information on Savings-Investment, they have also come to alternative findings. By
examining the game Credit rating businesses as a monopoly, they were able to explain
their analysis. They presented credit rating competition organisations and their
methodological consequences.
• Timothy E. Lynch (2009) looked at the basics of credit rating organisations and the
significant part they play in the flow of information to investments. Author evaluated
capital market companies’ credit standing and investment approach. He described how
the credit rating information is used by private contractual parties. He does, too. outlined
the significant issues that credit rating agencies raised. He bemoaned the protections for
honesty provided by credit rating organisations. Numerous concerns related to the
current regulatory environment are studied in study. Finally, the author has brought
attention to the importance of the credit rating sector. Challenges posed by the current
regulatory structure for the stock market and the credit rating sector. Additionally, he
mentioned the issuer-pay conflicts of interest.
• Omaima G. Hassan and Ray Barrell (2013) investigate the question of how accurately
bank ratings represent banks, and the Features delineate the accounting information to
assist in evaluating the problem. By using examples from the USA and the UK for
descriptive analysis, the author clarified the thesis. Research is decided using statistical
tools like matrix correlation and effects of regression. The findings demonstrated model
efficacy, which enabled 74–78% of banks to provide accurate credit ratings. There was
a discrepancy in the scores given to banks, with some receiving the highest rankings
while others received the lowest.
• According to Raghunathan and Verma’s (1997) analysis, CRISIL not only failed to
meet international rating standards but also suffered from international norm
inconsistency. The same was true for Raghunathan and Varma in 1997, using the same
methods as in 1992. The investigation showed that the financial ratios match the
currencies. The There is a close disparity with worldwide norms. Investment grade
scores have become more elusive as a result of stricter criteria.
• Timothy E.Lynch(2009) examined ,The credit rating fundamentals Agencies and the
important role credit rating Agencies have in the Flow of information to the investment.
Author assessed credit rating position Capital market Companies, and investment
strategy. He explained the Private contracting parties use the credit rating information.
He also does. Specified concerning the problematic concerns posed by credit rating
Organizations. He complained About credit rating agencies’ protections on honesty’.
The current regulatory climate includes many issues that are analyzed in research. The
author has finally highlighted the value of credit rating industry. The stock market and
The credit rating industry’s challenges under the present system of regulations. He also
reported issues with the Issuer- pay conflicts of interest.

1
BoltonP.,Freixas X.,Shapira J.(2012),The Credit rating games, The journal of finance 67(1),85-111
19BAL110 Corporate Governance

TOPIC – RELIABLE CREDIT RATINGS IN INDIA: SEBI

REGULATIONS, AND BASEL III COMPLIANCE AND CORPORATE
GOVERNANCE

INTRODUCTION
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Since they produce credit ratings that are trusted by investors, issuers, and regulators, credit
rating agencies (CRAs) are crucial players in the financial system. A credit rating is a
determination of an issuer’s creditworthiness, such as a government or business. Because
regulators and investors both rely on credit ratings to determine the risks posed by financial
institutions, their accuracy is essential to the financial system’s capacity to operate.
Since some well-known businesses with excellent credit ratings have proved futile leaving
investors with large losses, the validity of credit ratings has recently come under scrutiny.
Investment regulations and the Securities and Exchange Board of India (Credit Rating
Agencies) Regulations, 1999 both aim to ensure that CRAs provide accurate credit ratings. The
success of these restrictions in assuring the calibre and dependability of credit ratings is not
entirely clear, though.
This study attempts to assess how well investment rules and regulations ensure that credit
reporting agencies (CRAs) provide accurate credit ratings. The study will also look at how
Basel III Capital Regulations affect the choice of credit rating agencies that can be used to
determine banks’ capital adequacy ratios. Finally, in order to raise the standard and
dependability of credit ratings, the study will offer suggestions for improving the regulatory
framework for credit rating firms in India.
This study is important because it will shed light on the regulatory frameworks necessary to
guarantee accurate and reliable credit ratings by CRAs, which are essential for the financial
system to operate. For policymakers, regulators, and market actors in India dealing with related
concerns, the study’s conclusions will be helpful.

REGULATORY FRAMEWORK:
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• The Securities and Exchange Board of India (Credit Rating Agencies) Regulations,
1999, is one of the most important investment legislation in India that has an impact on
credit ratings. This law establishes the conditions for the registration, behaviour, and
performance of credit rating organisations in India and establishes the legal basis for
their operation. The legislation also stipulates that the Securities and Exchange Board
of India (SEBI), which is in charge of ensuring that credit rating agencies adhere to the
established norms and procedures, will supervise and monitor credit rating companies.
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• The Foreign Exchange Management Act (FEMA2) is another significant investment law
in India that has an impact on credit ratings. This law sets rules for the repatriation of
capital and profits by foreign investors and governs foreign investment in India. The
FEMA laws, which set the investment caps for foreign investors in Indian securities and
bonds, directly affect the credit rating sector. This in turn has an impact on the credit
ratings offered by credit rating organisations as well as the demand for credit ratings
from overseas investors
PRESENT LEGAL FRAMEWORK: SEBI (CREDIT RATING AGENCIES) REGULATIONS, 1999
REGULATION
A number of measures in the Regulations 3 ensure that CRAs give accurate credit ratings.
These specifications include the need for CRAs to follow a legitimate rating procedure,
disclose their rating techniques, and keep track of all their rating-related activities.
Additionally, they mandate that CRAs declare conflicts of interest along with a code of
conduct for its analysts. Additionally, CRAs must keep a rating history for each security
they assess and publish any changes to their ratings. Despite these rules, there have been
a number of cases where CRAs have given inaccurate credit ratings.
CASE STUDY
1. CASE STUDY I.: The case of IL&FS (Infrastructure Leasing & Financial Services), that
defaulted many loan payments in 2018, sparking a crisis in the Indian financial markets,
is one noteworthy instance. The laws governing CRAs were reviewed as a result of the
IL&FS disaster. SEBI published a circular in December 2018 that tightened the rules
governing CRAs. The circular mandated that CRAs carry out an annual evaluation of
their rating methodology, set up a committee to approve ratings, and increase the
transparency of their rating processes. The circular mandated further steps that CRAs
were to take to prevent conflicts of interest, such as mandating the rotation of lead
analysts.
2. CASE STUDY II. The story of Amtek Auto is another instance that emphasises the
necessity of adequate regulation of CRAs. Investors suffered a huge loss as a result of
Amtek car, a significant car components maker, defaulting on its loan obligations in
2015. Amtek Auto has received excellent credit ratings from a number of CRAs before
the default. It was discovered following the default that the corporation had been
exaggerating its profits for a number of years. This led to concerns being raised
regarding the accuracy of the credit ratings offered by CRAs. In regard to the Amtek
Auto case, SEBI published a circular in 2016 requiring CRAs to reassess their rating
methodology and take steps to raise the calibre of their ratings. Additionally, the circular
mandated that CRAs enhance its oversight of rating causes, such as changes in financial
parameters, and inform investors of the monitoring process.

BASEL III CAPITAL REGULATIONS – ELIGIBLE CREDIT RATING AGENCIES

2Foreign Exchange Management Act (FEMA)1991

3 SEBI (Credit Rating Agencies) Regulations, 1999
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1. The Reserve Bank of India (RBI) implemented the Basel III Capital Regulations 4,
which offer guidance for banks to maintain a certain amount of capital to cover their
risks. The determination of capital adequacy ratios (CAR) for banking institutions,
which depend upon the risk-weighted assets (RWA) of the bank, constitutes one of the
crucial parts of these rules. Banks must use external credit ratings provided by qualified
credit rating firms to calculate the risk weights of the assets. A list of credit rating
agencies that qualify for this use has been provided by the RBI. Based on their past
performance, their capacity to deliver precise and timely ratings, and their adherence to
the RBI's regulations, qualifying credit rating agencies are chosen. Depending on their
performance and compliance with the rules, the RBI evaluates & updates the list of
qualified credit rating agencies on a regular basis. Additionally, the rating agencies must
disclose information regarding their rating techniques and procedures and retain a
certain amount of capital.

2. Banks must compute the risk weights of their assets and assess their CAR using the
ratings given by recognised credit rating organisations. As a result, the choice of
acceptable credit rating agencies have a big impact on how banks’ CARs are calculated.
The RBI wants to improve the accuracy and uniformity of the CAR calculations, which
would bolster the financial system’s resilience. To that end, it will make sure that only
reputable and dependable rating firms are utilised.

ANALYSING THE SCOPE OF CREDIT RATING AGENCIES WITH THE LENS OF CORPORATE
GOVERNANCE AND INVESTOR PROTECTION

• Credit rating companies are obligated to defend the interests of investors who
rely on their ratings from the perspective of corporate governance. By providing
a neutral evaluation of the creditworthiness of companies and assets, credit
rating organisations give investors a crucial service. Investors use these ratings
to determine how much risk to take on when investing in a certain company or
security. However, in the past, particularly in the run-up to the 2008 financial
crisis, credit rating agencies have come under fire for failing to appropriately
gauge the risk associated with some instruments.5 Due to the substantial losses
that many investors experienced as a result, some contend that the credit rating
companies should be held accountable for their part in the crisis.
• From a corporate governance standpoint, it's critical to make sure that credit
rating companies operate honestly and transparently, and that they are held
responsible for their activities. This entails making sure they have sufficient
processes in place to effectively assess risk, that their ratings are based on
objective standards, and that they are free from conflicts of interest that could

4Master Circular, Basel III Capital Regulations

5
Ashshu A. (2013), Determinants and impacts of internal Credit Rating, International Journal of Financial
Research4 (1) (2013), 120-13
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jeopardise their independence. Credit rating companies should be held liable for
any negligence or improper behaviour that causes harm to investors. This could
be exaggerating the risk associated with a specific security or failing to exercise
sufficient due care when determining credit risk. Investors should have the right
to pursue compensation from the credit rating agency if they suffer losses as a
result of such carelessness or malfeasance.
• In the end, corporate governance in regard to credit rating agencies should
promote openness, responsibility, and accountability while also making sure
that investors are safeguarded from loss brought on by negligence or improper
behaviour on the part of credit rating agencies.

LIABILITY REGIME ON THE CREDIT RATING AGENCIES: A COMPARATIVE

ANALYSIS.
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1. Starting with the Dodd-Frank Act6 in the USA, which places expert liability on CRAs
and requires them to recklessly or intentionally fail to conduct an adequate investigation
of the rated security with reference to fact ingredients relied while using it’s
methodology for assessing credit risk, protection from any liability to investors has been
steadily lowered.7

2. The authority to control the securities market in India rests with the Security Exchange
Board of India (SEBI). The SEBI (Credit Rating Agencies) Regulations, 1999, which
govern CRAs, provide that they are not directly liable to investors for inaccurate ratings.
The obligation of CRAs was elevated to Expert obligation in the case of India Ratings
& Research Pvt. Ltd., meaning that CRAs are now required to make an independent
professional judgement regarding the financial standing of the debt security.

3. The legal status of CRA's liability and their level of care with regard to its operations
vary around the world. Contractual claims cannot be advanced because these
transactions are not covered by any special legislation other than general contract law.
Exclusion of liability is a frequent phrase in such situations. Furthermore, it is
challenging to hold a CRA liable in tort law because it is challenging to demonstrate
causation. In 2013, a regulation8 was passed in the European Union that made CRAs
subject to legal liability. That means that when the CRAs violate any of the regulations
in Annex III of Regulation (EC) 1060/ 2009 9, either intentionally or negligently and in
a way that causes harm, regulations liability may be attached.

4. In the case of Bathurst Regional Council v. Local Government Pvt. Ltd. 10, Standard and
Poor (S&P) was found responsible for its ratings due to allegations of carelessness and
deception. A notable feature of the decision was that the S&P was held accountable
because of its function in the securities market, notwithstanding all the provisions on

6
Dodd-Frank Wall Street Reform & Consumer Protection Act, 2010
7
Partnoy F. (2017), what’s (still) wrong with credit Rating? Washington law review 92
8
EC Regulation no. 1060/2009 European Parliament
9
EC Regulation no. 462/2013 European Parliament
10
Bathurst Regional Council v Local Government Financial Services pvt. ltd
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the documents that disclaimed duty. It was determined that CRAs owed potential
investors a duty of care because one of their roles is to inform investors.

STRENGTHENING OF THE CREDIT RATING FRAMEWORK IN THE COUNTRY

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1. Regulations change: The Committee underlined that capital markets, bankers, and
investors are increasingly relying on an instrument or entity's rating as a crucial input
for financial choices. In the Indian context, the crisis involving Infrastructure Leasing
and Financial Services Limited (IL&FS), a significant infrastructure development and
finance company of systemic relevance, with a debt obligation of Rs 91,000 crore, has
called into question the reliability of credit ratings. The credit rating agencies continued
to rate IL&FS with a AAA grade, the highest possible, despite the company's escalating
debt levels.
2. Evaluation of existing policies and amendments: To promote better impartiality,
openness, and credibility throughout the entire credit rating framework, the committee
advised that the regulators (such as SEBI and RBI) evaluate their policies and make the
necessary modifications 11.
3. Rotation of credit rating agencies: This is not currently provided for in the regulatory
framework. The Committee recommends looking into mandated rating agency rotation.
This would help to mitigate any unfavourable effects of continuing ties between the
issuer and the credit rating agency12.
4. This is especially important in light of recent instances in which credit rating companies
have failed to correctly identify problems with their client-entities. Additionally, the
Ministry may mandate that ratings be performed by multiple agencies, particularly in
the case of debt instruments or bank credit valued at more than Rs 100 crore.
5. To promote better impartiality, openness, and credibility throughout the entire credit
rating framework, the Indian authorities (such as SEBI and the RBI) should examine
existing regulations and make the necessary modifications. Important variables like the
following should be included in credit rating agencies' conflict of interest statements for
resolution: Size of promoter backing connections to subsidiaries and availability of
funds to address immediate financial needs

CONCLUSION
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After assessing the applicable advantages and disadvantages, Indian regulators may also take
alternative possibilities into consideration, such as the "investor pays model" or "regulator pays
model." As an alternative, within the framework now in place, a suitable rating fee structure,
depending on the amount due by the issuer, SEBI, the RBI, and the credit rating companies
may make that decision. To promote better impartiality, openness, and credibility throughout

11
Ash-shu A. (2013), Determinants and impacts of internal Credit Rating, International Journal of Financial
Research4 (1) (2013), 120-13
12 BoltonP.,Freixas X.,Shapira J.(2012),The Credit rating games, The journal of finance 67(1),85-111
19BAL110 Corporate Governance

the entire credit rating framework, the Indian authorities (such as SEBI and the RBI) should
examine existing regulations.
Rotation of credit rating agencies: This is not currently provided for in the regulatory
framework. It should be investigated whether rating agencies must rotate.
Mandatory audit rotation is a policy that requires frequent breaks between audit engagements
and is designed to prevent overly long connections between the auditor and the client.This
would help to mitigate any unfavourable effects of continuing ties between the credit rating
agency and the issuer. Given the recent cases of credit rating companies failing to detect
problems in their client-entities, this is especially noteworthy.