Credit Rating Agency in India
Content
Rizvi Institute of Management Studies & Research
A
Project report
On
A STUDY ON THE CREDIT RATING AGENCIES IN INDIA AND THEIR
RATING METHODOLOGY
In partial fulfilment of the requirements of
The Summer Internship of
Master of Management Studies
Through
Rizvi Institute of Management Studies and Research
Under the guidance of
Prof. Imran Kazi
Submitted by
Mohammed Maaz Kazi
MMS
Batch: 2013 – 2015
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CERTIFICATE
This is to certify that Mr. Mohammed Maaz Kazi, a student of Rizvi Institute of
Management Studies and Research, of MMS bearing Roll No. 55 and specializing in
Finance has successfully completed the project titled
“A STUDY ON THE CREDIT RATING AGENCIES IN INDIA AND THEIR
RATING METHODOLOGY”
under the guidance of Prof. Imran Kazi in partial fulfillment of the requirement of
Master of Management Studies by Rizvi Institute of Management Studies and
Research for the academic year 2013– 2015.
_______________
Prof. Imran Kazi
Project Guide
_______________
Prof. Umar Farooq
Academic Coordinator
_________________
Dr. Kalim Khan
Director
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PAGE
CHAPTER
No
TITLE
1
2
3
Introduction
5
History of Credit Rating Agency
6
Need for Credit Rating Agency
9
Importance
10
Benefits
10
Role
11
Features
12
3.1
3.2
3.3
3.4
Credit Rating in India
4
4.1
4.2
4.3
5.1
5.2
15
Conditions for setting up of Credit Rating Agency
17
Process of getting Certification
19
25
Conditions to be followed while assigning ratings
26
Restrictions on Ratings
26
Prominent Rating Agencies in India
28
Activities undertaken by them
33
Instruments Rated By Agencies
38
Rating Symbols
40
Methodology Adopted
46
Rating Process Adopted
58
6.1
6.2
6.3
6.4
6.5
7
8
Bond Rating Methodology
56
IPO Grading Process
62
Grading of Ratnakar Bank
8.1
9
10
24
Products & Instruments requiring mandatory rating
5.3
6
14
Determinants of Credit Ratings
Regulatory Framework
5
No
70
Conclusion
76
Bibliography
80
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EXCECUTIVE SUMMARY
Credit Rating is an symbolic indicator of the current opinion of the rating
agencies regarding the capability of Issuer of Debt Instrument. The
corporations with specialized functions namely, assessment of the likelihood
of the timely payments by an issuer on a financial obligation is known as
Credit Rating Agencies. With the increasing scope of Capital markets in
country like India, Credit Rating Agencies tends to play an important role of
strengthening the Capital Markets and building investors confidence in further
decision making process. Considering the importance of credit rating, the
project work has been undertaken to study the need for a Credit Rating System
in a economy, the regulatory environment affecting the credit rating activities
in India, to examine the operational performance of four SEBI recognized
credit rating agencies, viz. CRISIL, ICRA, CARE and FITCH, to assess the
consistency in their avenues like Bond rating methodology & IPO grading
process and to know how a Credit Rating Agency has an impact on the Indian
Capital Markets.
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1. INTRODUCTION
A credit rating is a measure used by creditors to determine how much they can trust a
certain borrower, whether the borrower is an individual, a corporation, or a country.
The credit rating is derived using past financial data or the borrower’s credit history.
There are several factors that can affect the credit rating of an individual including:
The person’s ability to pay a loan – Reflected by the person’s salary and other assets
The amount of credit in existence – This is what credit limits are for. If the person is
near his credit limit or has reached it is harder to get a loan. This also reflects whether
the person is in the habit of going into debt
Credit history – Shows whether the person makes payments on time. This also reflects
the persons spending and saving patterns.
According to the Moody’s, “A rating on the future ability and legal obligation of the
issuer to make timely payments of Principal and interest on a specific fixed income
security. The rating measures the probability that the issuer will default on the
security over its life, which depending on the instrument of the expected monetary
loss, should a default occur."
According to Standard & Poor’s, "it helps investors by providing an easily
recognizable, simple tool that couples a possibly Unknown issuer with an informative
and meaningful symbol of credit quality. "
According to ICRA, “Credit ratings are opinions on the relative capability of timely
servicing of corporate debt and obligations."
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2. HISTORY OF CREDIT RATING AGENCY
The World Scene
US has been the birth place of rating agencies as in the background of great financial
crisis of 1837 in USA the need was felt to predict the ability of merchants and traders
to pay their financial obligations. In this context, one of the pioneer professional
thinker, Louis Tappan established the first mercantile bank credit rating agency in
New York in 1841, which rated the debt paying ability of the merchants. This
mercantile rating agency was further acquired by Robert Dun, and its first rating guide
was published in 1859. Another similar agency was set up by John Bradstreet, a
financial analyst, in 1849, who published the analytical work done by it in its rating
book in 1857. The mercantile rating agency acquired by Robert Dun and agency set
up by John Bradstreet were merged together to form Dun & Bradstreet in 1933.
Corporate bond ratings were developed prior to World War-I in response to a
commercially viable need for independent and reliable judgment about the quality of
corporate bonds (Pogue and Soldofsky, 1969). As such in 1900 John Moody founded
Moody‘s Investors Service in US and in 1909 published his Manual of Railroad
Securities with comments on 200 major railroad companies by John Moody. Further,
utility and industrial bonds were rated by the Moody‘s in 1914 followed by bonds
issued by US cities and other municipalities in the early 1920s. Moody‘s also assigned
sovereign ratings to debt of various nations including Britain, Italy, Japan, China, etc.
Further, the Moody‘s started rating the debt of international issues in 1950 by rating
the Yankee bond issue of Canada and the World Bank.
The purpose of Moody‘s ratings is to provide the American investor with a simple
system of gradation by which the relative investment qualities of bonds may be noted.
Gradations of investment qualities are indicated by rating symbols representing a
group in which the quality of characteristics are broadly the same (Pogue and
Soldofsky, 1969). Thus, Moody‘s was the first to use the alphabetical symbols like
"Ass" ;"As" and so on in the credit rating system which became the base of modern
credit rating.
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Then in 1962, the Dun and Bradstreet which was formed in 1933, acquired the
Moody‘s Investor Services. Evidence of the application of credit rating to corporate
instruments for the first time is also traceable to the time when Henry Vernum Poor (a
journalist) and his son started a firm to publish Poor‘s Manual of Railroad of the
United States‘ in 1860s in USA. The manual reported financial and operating
statistics covering several years for most of the major American railroads. After John
Moody began his ratings of railroad bond in 1909, the Poor‘s company also entered
the bond rating business, by publishing its first ratings in 1916.
A new entrant in information and rating business by the name of Standard Statistics
Company also started its operations in 1922 followed by Fitch Publishing Company in
1924. The Poor‘s Publishing Company and Standard Statistics. Company merged
together in 1941 to form Standard and Poor‘s (S&P). S&P was further taken over by
McGraw-Hill, the publishing giant in 1966. The credit rating agencies expanded from
the 1970s through the 1990s, much as they did from 1909, when John Moody
introduced the concept, to the 1930s (Jutur, 2005). In the 1970s a number of rating
agencies started rating activities all over the world.
In 1972, Canadian Bonds Rating Service
was established followed by the
incorporation of Thomson Bank Watch in 1974, which was based in Toronto, Canada
and which was exclusively following financial institutions including banks, securities
firms and finance companies.
In 1975, Japanese Bond Rating Institute was incorporated by Japan Economic Journal.
The other rating agencies in Japan such as Japan Bond Research Institute, Japan
Credit Rating Agency, and Nippon Investor‘s Services came to be established soon
thereafter. In 1975, McCarthy Crisanti and Maffei was established in USA which was
acquired by Duff and Phelps in 1991. Dominion Bond Rating Service was established
in 1977 in Canada, and IBCA Limited in 1978. IBCA Ltd. was an independent and
privately owned international credit rating agency based in London (UK) and was
established with the objective of offering credit analysis of bonds in different
countries.
In 1980, Duff and Phelps Credit Rating Company was formed which is a major
source of credit information internationally. It rates all major types of fixed income
securities, long and short-term debts of corporations, sovereign nations and financial
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institutions. This company operates in Latin American countries and also in Asian
countries, viz. Pakistan and India. US is the originator of concept of credit rating but
now with the development of capital markets the world over, it is becoming a
universal phenomenon.
Now there are credit rating agencies operating in many other countries of the world
also including Malaysia, Bahrain, Bangladesh, China, Philippines, Mexico, Indonesia,
Israel, Pakistan, Cyprus, Korea, Thailand, Kazakhstan, Uzbekistan and Australia.
Reasons for the Origin of Credit Rating Agencies.
The increasing role of capital and money markets consequent to disintermediation.
Globalization of Credit market.
Continuing growth of Information Technology.
Growth of confidence in the efficiency of the open market mechanism.
Withdrawal of Government safety nets and the Trend towards Privatization.
GROWTH OF CREDIT RATING AGENCIES
1841- Mercantile Credit Agency(USA)
1900- Moody’s Investors Services (USA)
1916- Poor Publishing Company (USA)
1922- Standard Statistics Company (USA)
1924- Pitch Publishing Company (USA)
1941- Standard and Poor (USA)
1974- Thomson Bank Watch (USA)
1975- Japanese Bond Rating Institution (JAPAN)
1987- CRISIL by ICICI (INDIA)
1991- ICRA by IFCI (INDIA)
1994- CARE by IDBI (INDIA)
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3. NEED FOR CREDIT RATING
The credit rating system originated in the USA in seventies. The high levels of
default, which occurred after Great Depression, in the US capital markets, gave the
impetus for the growth of credit rating. The default of $82 million of commercial
paper by Penn Central in the year 1970 and the consequent panic of investor in
commercial papers, resulted in massive defaults and liquidity crisis.US made rating
Mandatory for institutions such as Government Pension funds, and Insurance
companies.
Regulatory Agencies started Stipulating that Government Pension funds and
Insurance companies could not buy securities rated below a particular level. The
growing awareness of the investors was also another factor for the growth of Rating
business. Moreover Underwriters, Merchant Bankers and other Intermediaries
involved in the debt market also found Rating useful for planning and pricing the
placement of debt instrument.
Besides the increasing level of defaults resulting from growing access to the financial
markets the following Developments led to a growing importance of Credit Rating
System around the world.
The emergence of the Capital market as the primary allocator of resources in the
economy has underlined the need for reliable information in order to facilitate the
flow of resources to the most productive uses .In search of Investment avenues,
investors use various sources of information in order to arrive at their investment
decisions. These includes Offer Document of the Issuers, Research Reports & Media
Reports.
In Addition to the above sources, in the developed capital markets of the world, Credit
Rating Agencies have come to occupy a leading position as information providers,
particularly for the credit related opinions in respect of Debt instruments. This Role of
information providers has been strengthened by the fact that their opinions are
Independent, Objectives well researched and Credible.
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3.1 IMPORTANCE OF CREDIT RATING
1.
A wide range of industries take advantage of credit scores to improve fairness,
effectiveness and efficiency.
2. Financial companies use credit scores to predict the risk of delinquencies and losses,
which enables them to better allocate costs.
3.
Insurance companies use specialized credit scores to make fairer underwriting
decisions.
4.
Credit scores even provide benefits at the macroeconomic level by helping small
enterprises attain the funds they need and by facilitating the securitization and sale of
financial products in the secondary markets, substantially increasing the influx of
capital into a country.
3.2 BENEFITS
To Investors :The central function of credit rating is to communicate to the investors the relative
ranking of the default loss probability for a given fixed income investment in
comparison with the other rated instruments. Credit Rating in that sense is essentially
an information service.
Even for an organized Institutional Investor, rating provides a low cost supplement to
its own in house appraisal system. Large investors may use credit rating for Portfolio
Diversification by electing appropriate instruments from a broad spectrum of
investment option where he can use the information provided by Rating changes, by
carefully watching upgrades and downgrades and altering its Portfolio.
Another benefits derives by investors is the other services provided by credit rating
agencies, like RESEARCH in the form of industry reports. CORPORATE REPORTS,
SEMINARS.
To Issuers
The benefit of credit rating for issuers stems from the faith placed by the market on
the opinions of credit rating, and the widespread use of ratings as a guide for
investment decisions. The issuers of rated securities are likely to have access to a
much wider investor base as compared to unrated securities as a large section of
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investors, not having the required resources and skills to analyze each and every
investment opportunity would prefer to rely on the opinion of the Credit Rating
Agency.
Opinion of a rating agency enjoying investor confidence could therefore enable the
issuers of highly rated instruments to access the market even under adverse market
conditions. Credit Rating provides a basis for determining the additional return which
investors must get over and above its risk free return and also to get compensated for
the additional risk they bear. This is useful benchmark for issue pricing and could lead
to significant cost savings for highly rated instruments.
To Intermediaries
Rating is a useful tool for Merchant Bankers and other capital market intermediaries
in the process of
planning, pricing, underwriting and placement of issues. The
intermediaries like brokers and dealers in securities could use ratings as an input for
their monitoring of risk exposures . Regulators in some countries specify capital
adequacy rules linked to credit rating of securities in a portfolio. The merchant
bankers are also using credit rating for pre packaging of issues by way of asset
securitization obligation.
To Regulatory Bodies
Credit Ratings are used not only by Investors, Issuers, Intermediaries, but also by
various
regulatory authorities in major capital and money market. Regulatory
Authorities in various countries have specified rules that restrict entry to the market
of new issues rated below a particular grade, that stipulate different margin
requirements for mortgage of rated and unrated instruments, that prohibit institutional
investors from purchasing or holding of instrument rated below a particular level and
so on.
3.3 Role Of Credit Rating
Credit rating establishes a link between Risk and Return. They thus provide a
yardstick against which to measure the risk inherent in any instrument. An investor
uses the ratings to assess the risk level and compares the offered rate of return with
this expected rate of return (for the particular level of risk) to optimize his risk-return
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trade-off. The risk perception of a common investor, in the absence of a credit rating
system, largely depends on his familiarity with the names of the promoters or the
collaborators. It is not feasible for the corporate issuer of a debt instrument to offer
every prospective investor the opportunity to undertake a detailed risk evaluation. It is
very uncommon for different classes of investors to arrive at some uniform conclusion
as to the relative quality of the instrument. Moreover they do not possess the requisite
skills of credit evaluation. Thus, the need for credit rating in today’s world cannot be
overemphasized. It is of great assistance to the investors in making investment
decisions. It also helps the issuers of the debt instruments to price their issues
correctly and to reach out to new investors. The analysis is based on an all-round
analysis of quantitative as well as qualitative factors like past performance, economic
environment, market positioning, quality of management and predictions about future,
and is thus as complete as can be. The increasing levels of default resulting from easy
availability of finance, has led to the growing importance of the credit rating. The
other factors are:
1) The growth of information technology.
2) Globalization of financial markets.
3) Increasing role of capital and money markets.
4) Lack of government safety measures.
5) The trend towards privatization.
6) Securitization of debt.
3.4 Features
Credit rating essentially indicates the credit worthiness of the borrowers and the
probability that the borrowers will pay the interest and principal on due dates. A credit
rating system is considered of good quality if debtors with a lower credit rating
default more often than debtors with a higher credit rating Here are some important
features/facts about credit rating:
(a)Rating can be revised.
(b) Rating is not based on audit.
(c) Rating only helps in investment decision-making.
(d) Rating is based on current information.
(e) Rating is assigned to specific instrument.
(f) Rating aims at guiding the investors.
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(g) Rating does not provide any recommendation to buy, hold or sell any instrument.
(h) Rating process is based on broad parameters of information supplied by the issuer
and collected from various other sources.
(i) The rating furnished by the agency does not provide any guarantee for the
completeness or accuracy of information on which it is based.
(j) In rating business, the users of the rating services such as investors, financial
intermediaries and other end users do not pay for it but the issuers, of the financial
instrument, who do not use rating, pay for it. This is one of the most peculiar feature
of credit rating.
(k) A key feature of rating is that they contain a limited number of categories. Hence,
equally rated bonds are not claimed to be of identical quality and rating cannot be
inverted into unique default probabilities.
Thus, Credit rating is expected to improve the quality consciousness in the market and
establish, over a period of time, a more meaningful relationship between the quality of
debt and the yield from it. Nowadays, the outlook of credit rating industry appears to
be positive but the industry has to continuously strive to improve the professional
capabilities and sustain credibility. The credit rating agencies today have ample
opportunities to play a unique role in strengthening the capital market and building
the investor's confidence in the financial system. Clearly, accurate assessment of the
credit worthiness of obligators is an important precondition for the stability of a
financial system since inadequately high exposure to credit risk has been one of the
leading sources for problems in financial institutions worldwide for many decades.
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4. CREDIT RATING IN INDIA
Credit ratings are playing an increasingly important role in financial markets. The
most significant change in the recent relates to emphasis on their accountability and
more important, the caution in regulators' use of ratings. In India, rating is a more
recent phenomenon, but the changing global perspectives on the subject do impact the
financial system. India was perhaps the first amongst developing countries to set up a
credit rating agency in 1988.
The function of credit rating was institutionalized when RBI made it mandatory for
the issue of Commercial Paper (CP) and subsequently by SEBI, when it made credit
rating compulsory for certain categories of debentures and debt instruments. In June
1994, RBI made it mandatory for Non- Banking Financial Companies (NBFCs) to be
rated. Credit rating is optional for Public Sector Undertakings (PSUs) bonds and
privately placed non-convertible debentures up to Rs. 50 million. Fixed deposits of
manufacturing companies also come under the purview of optional credit rating.
Rating agencies are constantly subject to scrutiny, evaluation and questioning by
investors, media and regulators. Since ratings are opinions, it is important that
markets are convinced about their robustness before acting on them. Rating agencies
therefore publish extensive data on rating default and transition statistics, and metrics
on predictive capability of ratings vis-a-vis macro- economic and corporate
performance.
Although Credit Rating has gained importance in the developing countries of the
world after it originated in the USA about 100 years back, in India the practice of
credit rating began in 1987 with the setting up of CREDIT RATING
INFORMATION SERVICES OF INDIA LIMITED (CRISIL).
Initially it rather played a subdued role presumably because the institutional investors
did not favor the wisdom of a rating agency. In the changed perspective of the
increased dependence of the corporate on the public, the removal of restrictions on
interest rates, opening up the economy to foreign investment and the stipulation of
mandatory credit rating since 1991 by the government /Securities and Exchange
Board of India (SEBI), Credit Rating has emerged as the critical element in the
functioning of the Indian Debt Market. In response to the ever -increasing role of
credit rating, two more agencies INVESTMENT INFORMATION AND CREDIT
RATING AGENCY OF INDIA (ICRA) and CREDIT ANALYSIS AND
RESEARCH LIMITED (CARE) were setup in 1991 and 1993 respectively.
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The first Private sector Credit Rating institution was set up as a joint venture between
JM Financials, Alliance Group and the International Rating agency Duffs and Phelps
in 1995; known as Duffs and Phelps Credit Rating PVT. Limited (DCR) which have
merged to form a new entity FITCH INDIA LTD, which is 100 percent subsidiary of
Fitch IBCA and is the only wholly-owned foreign operator.
The Indian Credit Rating Industry is next to USA in terms of number of ratings
issued and in the number of agencies. Between the 4 Rating Agencies in India over
5,000 ratings have been issued for around 1,400 issuers. CRISIL is the market leader
in credit rating agency with a 65% market share. The regulators support played an
important role in the development of the credit rating industry. In 1992, for the first
time, the Reserve Bank introduced the requirement of rating for commercial papers.
SEBI followed up by introducing mandatory ratings of bonds.
The other growth drivers of the credit rating industry were declining interest rates, a
shift towards market borrowings from bank loans and a steep increase in the state
government borrowings through special purpose vehicles. Besides these factors the
growth in the private placement market of debt increased business volume in the
credit rating industry.
4.1 Determinants Of Credit Ratings
Credit rating is a symbolic indicator of the current opinion of a rating agency of the
willingness and relative of an issuer debt instrument to pay interest and repay
principal as per the terms of the contract. A rating agency assigns quality ratings that
measures the default risk of a security and sells rating to their subscribers. The default
risks primarily determined by the amount of work available to the issuer relative to
the amount of funds to be paid to the security holders. The ability to pay is evaluated
by financial ratios. Ratio analysis is done to analyze the present and future earning
power of the company issuing the security. Ratio analysis of the issuer’s financial
statements yields insights about the strength and weaknesses of the company. The
credit rating agencies have written guidelines about what values particular ratios
should have in order to earn each different quality ratings.
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Credit rating appraises the default risk which is a combination of business risk and
financial risk.
Business Risk:
Business risk relates to the market position of the company, operating efficiency and
management quality. The key factor taken into consideration are: the nature of the
industry the company is in, the demand-supply position, cyclical/ seasonal factors and
government policies vis-à-vis the industry; and the competition its facing within the
industry.
Market Position: The market share the company enjoys, it is competitive advantages
and selling and distribution arrangements.
Operating Efficiency: Locational advantages, labor relationships, cost structure,
technological and manufacturing efficiency as compared to its competitors.
Legal Position: Terms of prospectus, systems for timely payment, and for protection
against fraud.
Financial Risk:
Financial risk is a function of the profitability, debt leverage flexibility and adequate
cash flow. The assessment of financial risk is done on the basis of:
Financial analysis, including accounting quality: accuracy of statement of profit,
auditors comments, valuation and depreciation policies.
Earnings protection: Sources of future earning growth, profitability ratios and
earnings in relation to fixed income charges.
Adequacy of cash flow: Sustainability of cash flows and working capital
management.
Financial flexibility: Ability to raise funds.
Management: An evaluation of the management, which is qualitative in nature and
imparts certain amount of subjective element is done on the basis of track record of
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the management; planning and control system, depth of managerial talent, succession
plans. Evaluation of capacity to meet adverse situations, goals, philosophy and
strategies.
Environment:
An analysis of environment covering regulatory and operating environment, national
economic outlook, pending litigation and unpaid taxes are also attempted.
Rating thus is not based on a predetermined formula which specifies the relevant
variables and as well as weights attached to each one of them. Further the emphasis
on different aspects varies from agency to agency. Broadly the rating agencies assures
itself that there is good congruence between assets and liabilities of a company and
downgrades the rating if the quality of the assets depreciates.
The rating agencies employ qualified professionals to ensure consistency and
reliability. The agencies also ensure the integrity of rating by insulating rating from
conflicts of interest.
4.2 Conditions For Setting Up A Credit Rating Agency
1. Eligibility Criteria:
Certain conditions have been prescribed by SEBI, for granting certificate of
registration to the body corporate, which must be fulfilled by the body corporate in
order to get the certificate. These conditions include the following:
The body corporate must be registered as a company under the Companies Act, 1956.
The Rating activity must be specified as one of its main object in the Memorandum of
Association by the Body Corporate.
The Body Corporate must have adequate infrastructure so that it can provide rating
services in accordance with the provisions of the act.
The Body Corporate must have a minimum net worth of rupees five crore but the
Body Corporate set up before the commencement of these regulations and having net
worth less than Rupees Five crore must be allowed to increase its net worth to the
required amount within a period of three years from such commencement.
The Body Corporate and its promoters must have professional competence, financial
soundness and general reputation of fairness and integrity in business transactions.
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The Body Corporate, its promoters or directors might not be convicted of any offence
involving moral turpitude or any economic offence, any time in the past.
The Body Corporate, its promoters or directors might not be involved in any legal
proceedings connected with the securities market, which may have an adverse impact
on the interest of the investors.
The employees of the Body Corporate must have an adequate professional and
relevant experience to the satisfaction of the board.
The Body Corporate in all respects must be fit and proper for the grant of a certificate.
The grant of certificate must be in the interest of the investors and securities market.
The Body Corporate or any of its associates must not, in the past, be refused by the
board to grant a certificate under these regulations and they must not have
contravened the act or any of rules or regulations made under the act`.
2. Promoters of a Body Corporate:
The Body Corporate, wanting to get the certificate of registration as a Credit Rating
Agency must be promoted by the persons, which include the following:
A public financial institution, as defined in section 4A of the Companies Act, 1956.
A scheduled commercial bank included in the second schedule to the Reserve Bank of
India Act, 1934.
A foreign credit rating agency recognized by law in force in the country of its
incorporation and having at least five years experience in rating securities.
Any company or a body corporate having continuous net worth of minimum rupees
one hundred crore as per its audited annual accounts for previous five years prior to
filing application with the board for the grant of certificate.
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4.3 Process Of Getting Certificate Of Registration
1. Application for Grant of Certificate:
The body corporate which fulfils the required eligibility criteria and which wants to
commence activities as a credit rating agency shall make an application to SEBI for
the grant of certificate of registration. The application shall be accompanied with the
application fees of Rs. 50,000 being paid by way of a bank draft in favour of
“Securities and Exchange Board of India” payable at Mumbai. Any person/ body
corporate already working as a credit rating agency, on the date of commencement of
the SEBI (Credit Rating Agencies) Regulations, 1999 is also required to apply for the
grant of certificate of registration within a period of three months from such
commencement (the time period may be extended up to six months by SEBI in special
cases) failing to which they said credit rating agency shall cease to carry on the rating
activities.
The application to be filled, for the grant of certificate of registration, shall contain the
following particulars
Particulars of the Applicant:
1) The application should contain the following information of the applicant:
2) Name of the applicant
3) Telephone Number and Fax Number
4) Address of the registered office
5) Address of the branch office, if any
6) Name of the contact person of the company
7) The date of incorporation of the applicant company
8) The objects of the applicant company, including both main and ancillary
9) The authorized, issued, subscribed and paid-up capital of the company
10) The category to which the applicant company belongs, i.e., Limited company
(Public or Private) or Unlimited company
11) If the company is listed then the names of Stock Exchanges and the latest
share prices should be specified
12) Whether the applicant company belongs to the category of companies already
undertaking rating activities or whether the company is proposing to undertake
rating activities.
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Eligibility Criteria:
The applicant company should specify the category to which their promoter(s) belong
to, which include :
A public financial institution
A scheduled commercial bank
A foreign bank
A foreign credit rating agency
In case the promoter is the company with continuous net worth of Rupees one
hundred crore for previous 5 years, a certificate by a Chartered Accountant certifying
the same shall be enclosed.
Particulars of Directors/ Key Personnel:
The application should contain the following particulars regarding Directors:
Name
Qualification
Experience
Shareholding in the company
Directorship in the company.
The particulars regarding Key Personnel should include:
Name
Designation in the company
Qualification
Previous position held
Experience
Date of appointment in the company
Functional areas.
Information regarding Infrastructure: The application should contain following
details regarding infrastructure:
Computing facilities
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Facilities for research and database available with the company
Whether existing infrastructure is adequate to carry on rating activities
Any further plan for addition/ improvement of infrastructure.
List of Major Shareholders:
This should contain the following:
Name of the shareholder
Number of the shares held in the company
Percentage of total paid up capital.
Particulars of Associate Concerns:
The application should contain the details of associate companies/ concerns including:
Name
Address
Type of activity handled
Nature of interest of applicant company in associate
Nature of interest of promoter(s) of applicant company in associate.
Details of Business Information of the Applicant:
The application should contain the following details regarding business information of
Major events and present activities
Details of experience in credit rating and other activities
The projected volume of activities if the company is proposing to engage in credit
rating activities The details of securities rating activities handled by the company
during last three years including – Name of the client, type of security, size of the
issue, year of issue, security/ instrument rated and whether they are listed or unlisted.
Details of Financial Information of the Applicant:
The details of Financial Information of the applicant should include:
Details of net worth
The audited annual reports for the last three years should be enclosed
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Name and address of the principal bankers of the applicant company should be
specified
Name and address of the auditors should also be specified.
Any Other Relevant Information:
The application should also contain the details regarding:
All pending litigations against the applicant company, directors and employees
specifying the nature of dispute, name of the party and status.
Indictment or involvement in any fraud or economic offences by the applicant or any
of its Directors or key managerial personnel in the last three years.
Declaration by the Directors:
The application shall contain a declaration regarding the truth of the information
given in the application signed by atleast two directors.
2. Clarification Regarding Application:
SEBI, if not satisfied with the filled application may ask the applicant to furnish such
information or clarification as SEBI may consider necessary for the purpose of
processing of the application. SEBI may also ask the applicant or its authorized
representative to appear for personal clarification in connection with the grant of a
certificate.
3. Conditions for Grant of Certificate of Registration:
The grant of certificate by SEBI shall be subject to the following conditions:
The credit rating agency shall comply with the provisions and regulations of the act
and the guidelines, directions, circulars and instructions issued by the Board from
time to time on the subject of credit rating.
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The credit rating agency shall inform the Board in writing in case any information/
particulars furnished by credit rating agency are found to be false or misleading on a
particular matter or if that information has undergone a subsequent change.
4. Registration Fees, Grant of Certificate of Registration and its Validity:
After being satisfied by the eligibility criteria of the applicant/ corporate body
regarding the grant of certificate of registration, SEBI shall grant a certificate but this
grant of certificate is subject to the payment of registration fees of Rs. 5,00,000 being
paid by way of bank draft drawn in favour of “Securities and Exchange Board of
India” and payable at Mumbai. This certificate of registration carries the registration
code and the period of validity of certificate which shall be three years.
5. Application for Renewal of Certificate:
As the validity of the certificate of registration as given above is three years, so the
credit rating agency must apply to SEBI for renewal of certificate at least three
months before the expiry of the period of validity. This application for renewal of
certificate of registration must be accompanied by the desired renewal fee of Rs.
10,00,000 being paid by way of bank draft drawn in favour of “Securities and
Exchange Board of India” and payable at Mumbai. This application shall be dealt
with in the same manner as if it were an application for the grant of a fresh certificate.
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5. REGULATORY FRAMEWORK
SEBI:SEBI issued regulations for credit rating agencies in 1999. These regulations
are called as Securities
and Exchange board of India. (Credit Rating Agencies)
Regulations, 1999.
1) Only commercial banks, public financial institutions, foreign banks operating
in India, foreign credit rating agencies, and companies with a minimum net
worth of Rs 100 crore as per its audited annual accounts for the previous five
years are eligible to promote rating agencies in India.
2) Rating agencies are required to have a minimum net worth of Rs 5 crore.
3) Rating agencies cannot assess financial instruments of their promoters who
have 10 % stake in them.
4) Rating agencies cannot rate a security issued by an entity, which is
a borrower of its promoter.
a subsidiary of its promoter.
an associate of its promoter, if
(i) there are common chairman, directors between credit rating agency and these
entities
(ii) there are common employees
(iii) there are common chairman, directors, employees on the rating committee.
1) Rating agencies cannot rate a security issued by its associated or subsidiary, if the
credit rating agency or its rating committee has a chairman, director or employee, who
is also a chairman, director or employee of any such entity.
2) Rating agencies can choose their methodology of operation but self regulatory
mechanism will give a better maturity status for agencies.
3) Period of validity of registration shall be 3 years.
4) Sebi has decided to incorporate a clause in the listing agreement of stock exchanges
requiring companies to corporate with agencies by providing correct information.
Refusal to do so many lead to breach of contract between rating agency & client.
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A penalty of suspension of the certificate of registration or a penalty of cancellation of
registration may be imposed on the rating agency if it fails to comply with the
condition or contravenes any of the provisions of the Act
SEBI:
As per the regulations of SEBI, a public issue of debentures and bonds
convertible/redeemable beyond a period of 18 months, needs credit rating.
RBI:
According to the guidelines of RBI, one of the conditions for issuance of commercial
paper in India is that the issue must have a rating not below the P2 grade from
CRISIL/A2 grade from ICRA/PR2 from CARE.
5.1 Products / Instruments Requiring Mandatory Rating Before Issuance
Sr.No
Instrument
Regulator
1
Public/Rights/Listed
issue
of SEBI
bonds
2
IPO Grading
SEBI
3
Capital protection-oriented funds
SEBI
4
Collective Investment Schemes of SEBI
plantation companies
5
Commercial Paper
RBI
6
Bank loans
RBI (Basel-II capital computation for
banks)
7
Security Receipts
8
Securitized
instruments
Through Certificates)
9
RBI (For NAV declaration)
(Pass RBI (Basel-II capital computation for
banks)
Fixed Deposits by NBFCs & RBI
HFCs
10
LPG/SKO Rating
Ministry of Petroleum and Natural Gas
11
Maritime Grading
Directorate General of Shipping
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5.2 Conditions To Be Followed While Assigning Ratings
SEBI has prescribed certain conditions for credit rating agency, which must be
fulfilled during the process of rating:
1). Every credit rating agency shall specify a particular rating process, copy of which
should be filed with the board for record and any further modifications or additions
should also be intimated to the board.
2). Every credit rating agency shall appoint adequately qualified and knowledgeable
persons and form a professional rating committee to assign a rating. All the rating
decisions including the decisions regarding changes in rating shall be taken by the
committee.
3). Adequately qualified analysts shall be appointed by every credit rating agency for
carrying out a rating assignment.
4). Every credit rating agency shall inform the board about new rating instruments or
symbols introduced by it but a credit rating agency shall not change the rating
definition or structure of a particular rating product without prior information to the
board.
5). Due diligence must be exercised by credit rating agency while rating a security to
ensure that the rating assigned is fair and appropriate.
6). A credit rating agency shall not rate the securities issued by it.
7). The ratings assigned to the securities of a client including the changed ratings,
shall be disclosed to the concerned stock exchange through press release and websites
for general investors by the credit rating agency.
5.3 Restrictions On Ratings
Certain restrictions have been placed by SEBI on rating of securities issued by
promoters or by certain other persons. These include:1). No credit rating agency shall rate the securities issued by its promoter, here
promoter means a person who hold 10 per cent or more, of the shares of credit rating
agency.
2). Securities issued by a person who is a chairman, director or employee of a credit
rating agency or its rating committee, shall not be rated by such credit rating agency.
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This regulation is enforceable within three months from the date of commencement of
SEBI regulations.
3). Any credit rating agency shall not rate a security issued by an entity which is
either a borrower, a subsidiary or an associate of its promoter and if there are common
Chairman, Director and Employees between credit rating agency and these entities.
4). A credit rating agency can rate a security issued by its associate having a common
independent Director with it or rating committee, if such person does not participate
in the discussion in rating decisions and disclosure regarding this thing should be
made in the rating announcements of such associate company.
5). None of the above restrictions shall apply to securities, whose rating has already
been done by a credit rating agency before the commencement of these regulations
and as such these securities shall, subject to various other provisions of these
regulations, continue to be rated.
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6. PROMINENT RATING AGENCIES IN INDIA
CRISIL: - Credit Rating Information Services of India Limited.
ICRA: - Investment Information and Credit Rating Agency of India Limited.
CARE: - Credit analysis and Research Limited.
FITCH Ratings India Private Limited.
CREDIT RATING INFORMATION SERVICES OF INDIA LTD. (CRISIL)
CRISIL is India's leading rating, research, risk and policy advisory company, and is
the fourth largest in the world. It was incorporated in 1987 and was promoted by
Industrial Credit and Investment Corporation of India Ltd. (ICICI) and Unit Trust of
India (UTI). It commenced its operations of rating in 1987-88. CRISIL has its
association with internationally recognized rating agency Standard and Poor's (S&P)
since 1996. CRISIL‟s majority shareholder is Standard and Poor's which is a
subsidiary of The McGraw-Hill Companies. The latter is the world's foremost
provider of independent credit ratings, indices, risk evaluation, investment research
and data. CRISIL has been recognized by SEBI under the Securities & Exchange
Board of India (Credit Rating Agencies) Regulations, 1999.
CRISIL is a group of businesses which offers the following diversified services:
Rating and Risk Assessment,
Infrastructure Advisory, and
Business Research.
CRISIL's services include credit ratings and risk assessment; research on India‟s
economy, industries and companies; financial research and analytics outsourcing;
fund services; risk management and infrastructure advisory services. Through its IPO
Grading initiative, CRISIL has also established a presence in the equity research
domain. It provides all these services through its different subsidiaries.
1.1 CRISIL Ratings
It is the only rating agency in India to operate on the basis of sectoral specialization.
It rates different kinds of organizations, including industrial companies, banks, SMEs,
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non-banking financial institutions, insurance providers, mutual funds, infrastructure
entities, state governments, and urban local bodies. It also rates securitized papers.
1.2 CRISIL Fund Services
CRISIL Fund provides fund evaluation services and risk solutions to the mutual fund
industry through use of various benchmarks and analytical tools.
1.3 CRISIL Research
CRISIL Research is India's largest independent integrated research house which
provides research, analysis and forecasts on the Indian economy, industries and
companies across financial, corporate, consulting and public sectors.
1.4 The CRISIL Centre for Economic Research
The CRISIL Centre for Economic Research was set up in April 2002. It provides
research offerings to different financial players, corporates and policy-makers. It
offers products and services based on economic analysis to external clients, both
independently and in collaboration with other group businesses.
1.5 Irevna
CRISIL entered in equity research business by acquiring Irevna. Irevna is a division
of CRISIL which provides customized equity research and analytics, and knowledge
process outsourcing, to the world's leading financial institutions, investment banks,
private equity firms and consulting companies. CRISIL transferred its advisory and
risk consulting business into a 100 per cent subsidiary CRISIL Risk and Infrastructure
Solutions Limited (CRIS) with effect from April 01, 2007. CRIS is engaged in the
areas of infrastructure policy and transaction advisory services; integrated risk
management services and consulting to banks and corporates, through its divisions
CRISIL Infrastructure Advisory and CRISIL Risk Solutions.
1.6 CRISIL Risk and Infrastructure Solutions Limited (CRIS) CRISIL Infrastructure
Advisory works extensively in the areas of policy-making and economic
development. Its range of activities include undertaking complex feasibility studies,
creation of appropriate policy frameworks, sector reforms, regulatory support and
project structuring for various large and complex projects.
CRISIL Risk Solutions business provides risk management solutions and advice to
banks and corporates in the areas of credit and market risk.
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INVESTMENT INFORMATION AND CREDIT RATING AGENCY OF
INDIA LTD. (ICRA)
ICRA is a full-service credit rating agency but besides Ratings, Group ICRA offers
Consulting services, IT-based services, Information services, and Outsourcing
services. Thus, along with the ICRA Limited, Group ICRA has three wholly-owned
subsidiaries which together form the ICRA Group of Companies (Group ICRA).
These are:
ICRA Management Consulting Services Limited (IMaCS);
ICRA Techno Analytics Limited (ICTEAS);
ICRA Online Limited (ICRON).
2.a ICRA Limited (formerly Investment Information and Credit Rating Agency of
India Limited)
It was incorporated in 1991 and was jointly sponsored by Industrial Finance
Corporation of India (IFCI) and other Financial Institutions and banks as an
independent and professional investment information and credit rating agency. ICRA
is an associate of the international rating agency Moody's Investors Services which is
ICRA‟s largest shareholder. Moody's assists ICRA in organizing formal training
programmes and it gives advice to ICRA on rating-products strategy and the ratings
business in general. ICRA has been granted registration with SEBI under the
Securities & Exchange Board of India (Credit Rating Agencies) Regulations, 1999.
ICRA provides information products, ratings and solutions to different businesses and
investors.
2.b ICRA Management Consulting Services Limited (IMaCS)
It is a wholly-owned subsidiary of ICRA Limited and offers consulting services in
strategy, risk management, regulation and reform, transaction advisory, development
consulting and process re- engineering. IMaCS clientele includes banks and financial
service companies, corporate entities, institutional investors, governments, regulators,
and multilateral agencies. IMaCS provides management consulting services to clients
based in India and abroad through five Business Groups: infrastructure, energy,
banking and insurance, corporate advisory, and government.
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2.c ICRA Techno Analytics Limited (ICTEAS)
It is a wholly-owned subsidiary of ICRA Limited, and offers Information Technology
(IT) solutions to meet the dynamic needs of present-day businesses. The services
range from the traditional development of client-server, web-centric and mobile
applications to the generation of cutting-edge business intelligence applications and
analytics solutions. ICTEAS has two subsidiaries, ICRA Sapphire Inc. (ICSAP) and
Axiom Technologies Limited (AXIOM).
ICSAP is a wholly-owned subsidiary of ICTEAS and is based in Connecticut, USA. It
provides business analytics and software development services backed by offshore
teams.
AXIOM is also a wholly-owned subsidiary of ICTEAS and it operates in Kolkata,
India. AXIOM provides various customization and implementation services on the
Oracle E-Business Suite.
2.d ICRA Online Limited (ICRON) I
It is a wholly-owned subsidiary of ICRA Limited. ICRON was incorporated in
January 1999 and is providing software and outsourcing solutions since then. ICRON
has a wholly-owned subsidiary M-Serve Business Solutions Private Limited, a KPO
services company which is headquartered in Kolkata, India. ICRON has two Strategic
Business Units.
The Knowledge Process Outsourcing Division (KPO Division)
ICRON diversified into the Knowledge Process Outsourcing (KPO) business in April
2004, with focus on the banking, financial services and insurance as well as on retail,
healthcare and pharmaceuticals sectors. The KPO Division of ICRON offers
Knowledge Process Outsourcing services by translating data and information into
structured business inputs.
The Information Services and Technology Solutions Division (MFI Division)
The MFI Division serves the Mutual Fund Industry through Research, Analytics and
Mutual Fund Ranking. Besides, the company provides several innovative products to
meet the varied needs of its clients.
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CREDIT ANALYSIS & RESEARCH LTD. (CARE)
Credit Analysis & Research Ltd. was incorporated in 1993 by consortium of
Banks/financial institutions in India. The three largest shareholders of CARE are IDBI
Bank, Canara Bank and State Bank of India. CARE‟s Ratings are recognized by
Govt. of India and all regulatory authorities like RBI and SEBI. CARE has been
granted registration with SEBI under the Securities & Exchange Board of India
(Credit Rating Agencies) Regulations, 1999. CARE is a founder member of
Association of Credit Rating Agencies in Asia (ACRAA). CARE is set up with two
divisions:
3.a CARE Ratings
CARE Ratings offers a wide range of rating and grading services across sectors.
Types of debt instruments rated by CARE Ratings include commercial paper, fixed
deposit, bonds, debentures, hybrid instruments, structured obligations, preference
shares, loans, etc. CARE Ratings provide investors and risk managers with credit
opinions based on detailed in-depth research, which encompasses detailed analysis of
risks that affect credit quality of an issuer.
3.b CARE Research and Information Services
CARE Research & Information Services is an independent division of CARE. The
research division undertakes two activities, i.e., providing an in-house support to the
ratings division and providing sectoral research to financial intermediaries, corporates
, analysts, policy-makers, etc. as an aid to their decision-making process. CARE
Research & Information Services offers both subscription based reports and also
customized reports on request.
Sector Research
Sector Research includes an in-depth analysis of business environment of industry,
trends, future direction, coverage on sectors in India, including updates at regular
intervals for a year forward.
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Customized Research
Customized Research involves business analysis and position in the market, financial
analysis, future outlook, etc. which helps the clients to make better credit/investment
decisions.
FITCH RATINGS INDIA PRIVATE LTD. (FITCH)
Fitch Ratings India Private Ltd., formerly Duff and Phelps Credit Rating (India)
Private Ltd. (DCR), was established in 1996. Duff & Phelps India became whollyowned subsidiary of FITCH in November 2001. Fitch Ratings credit ratings provide
the agency's views regarding the future performance and the relative ability of an
entity to meet financial commitments, such as interest, preferred dividends, repayment
of principal, insurance claims or counterparty obligations. FITCH rates sovereigns,
financial institutions, insurance companies, corporates, municipalities, structured
finance obligations, etc. FITCH has been recognized by SEBI under the Securities &
Exchange Board of India (Credit Rating Agencies) Regulations, 1999.
6.1 Activities Undertaken By The Credit Rating Agencies
Credit rating agencies (subsequently denoted as CRAs) specialize in analyzing and
evaluating the creditworthiness of corporate and sovereign issuers of debt securities.
Credit rating agencies are expected to become more important in the wake of various
services/activities being undertaken by various credit rating agencies, along with the
rating services that provide information and guidance to institutional and individual
investors/creditors. These agencies enhance the ability of borrowers/issuers to access
the money market and the capital market for lapping a large volume of resources from
a wider range of the investing public. These services provided by the credit rating
agencies also assist the regulators in promoting transparency in the financial markets.
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Table 1
Activities Undertaken
Activities
CRISIL
ICRA
CARE
FITCH
Rating & Grading
Information
Research Services
Business
Advisory Services
Process
Outsourcing
Information
--
--
--
Technology Services
Rating and Grading Services
Credit rating is the symbolic indicator of the relative capability of the corporate entity
to timely service its debt obligations, whereas grading is done to assess the quality of
performance of that particular entity. Ratings may be changed, qualified, placed on
rating watch or withdrawn as a result of changes in, additions to, accuracy of,
unavailability of or inadequacy of information or for any related reason. Different
types of rating and grading services provided by all rating agencies are shown below
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Table 2
Activities Undertaken
Rating/Grading
CRISIL
ICRA
CARE
FITCH
debt
of
Corporate Governance rating
Structured Finance/ Obligation
Issuer credit rating
IPO Grading
Loan/ Bank Loan rating
Healthcare
Rating of Subsidiaries & Joint
Rating of long /medium-term
debt instrument
Rating
of
short-term
instrument
Claims
paying
ability
insurance company
rating
Grading of Mutual Funds/Bond
Funds
Grading of real estate/ Project
finance rating
Assessment
of
State
Governments/ Rating of Urban
Local Bodies
Micro Finance Institution(MFI)
Grading
Grading of Maritime Training
--
Course
Grading
of
--
--
--
--
Institutions
--
Ventures of MNCs in India
SSI/ SME rating
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Information and Advisory Services
The information and advisory services are the next very important activity being
undertaken by rating agencies, which include information services, advisory services,
project and infrastructure advisory services, investment and risk management
advisory, Financial Restructuring advisory, etc. as highlighted in Table 3
Table 3
Information and Advisory Services
Services
CRISIL
ICRA
CARE
FITCH
Information Services
Advisory Services
Project/ Infrastructure Advisory
Investment & Risk Management
---
--
Advisory
Financial Restructuring Advice
--
Credit Appraisal System
--
--
--
--
Research Activities
Some Indian credit rating agencies have set up research arms to complement their
rating activities. These arms carry out research on the economy, industries and
specific companies, and make the same available to external subscribers for a fee.
Research being done by various agencies present an in-depth analysis into the matter
being researched and helps various users to properly make use of that information in
future planning or some policy formulation. In addition, they disseminate opinions on
the performance of the economy or specific industries. The research is also used
internally by the rating agencies for arriving at their rating opinions.
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Table 4
Research Services
Services
CRISIL
ICRA
CARE
FITCH
Industry/ Sector Analysis
Corporate Analysis
Customized Research
-
Equity Research
-
-
Business Process Outsourcing
Business process outsourcing services are being provided by CRISIL as well as
ICRA. These agencies provide knowledge process outsourcing to various financial
institutions, investment banks, private equity firms and consulting companies at the
global level, and help them to achieve sustainable competitive advantage. The
outsourcing services being provided include financial modeling, data analysis
valuation, outsourced research, financial assets pricing, etc. CRISIL provides
knowledge process outsourcing through one of its divisions called „Irevna‟, whereas
ICRA is involved in this service through its subsidiary ICRA Online Limited.
Information Technology Services
Information and Technology services are provided by ICRA only through its
subsidiary ICRA Techno Analytics Limited (ICTEAS). ICTEAS provides IT products
and solutions along with engineering services. It provides onsite and offshore design
expertise in the areas like automotive, plant design, construction and instrumentation
space.
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6.2 Instruments And Products Rated By Rating Agencies
The primary focus of the rating exercise is to assess the adequacy to meet debt
obligations of a particular instrument in adverse conditions. Different types of
products and instruments are being rated by all the rating agencies as shown Below
Table 4 - Instruments & Products Rated
CRISIL
ICRA
Long & Medium
Long
Term Instruments
Instruments
Term Long
Debentures Debenture
Bonds
Preference Preference shares Bonds
Obligations
Certificates
Loans/Bank
Structured
Obligations
of
Convertible
Short-Term
Short-Term
Preference Shares
Instruments
Instruments
Loans/Bank Loan
Short-term deposits
Loans
Loans/Bank Loans
of Medium-Term
Notes
Fixed deposits
Certificates
of
Deposit
Preference Shares
Redeemable
Commercial Papers Commercial
Bonds
Deposit
Deposit
Debentures
Fixed deposits
of Fixed deposits
Deposit
Term
Instruments
Debentures
Medium-Term
deposits Instruments
Certificates
Medium Long
Certificates
Structured
Fixed
&
Non-convertible
Bonds
Bank Loans
FITCH
Term Instruments
shares
CARE
Commercial
Papers
Preferred Stock
Papers
Short-Term
Loans
Instruments
Loans
Commercial Papers
Loans
IPOs
Others
Mutual
IPOs
Funds
Mutual funds
Others
Others
IPOs
IPOs
Mutual funds
Mutual funds
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Rating Fees:
In the credit rating business, the users of rating service, such as investors, financial
intermediaries and other end- users, do not pay for it. The issuer of the financial
instrument pays fees to the credit rating industry and this is the major source of
revenue to the rating agency. Today issuer’s fees constitute 95% of the total revenues
of the rating agencies. In India rating agencies charge 0.1 % of the instrument size as
rating fees. They also charge an annual surveillance fees at a rate of 0.03% to monitor
the instrument during his life.
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6.3 Rating Symbols
Rating agencies use symbols such as AAA, AA, BBB, B, C, D, to
convey the safety grade to the investor. Ratings are classified into three grades:
High Investment Grades
Investment Grades
Speculative Grades.
In all ratings is classified into 14 or 15 categories. Signs “+” or “-” are used to show
the certainty of timely payment. The suffix + or – may be used to indicate the
comparative position of the instrument within the group covered by the symbol. Thus
FAA- lies one notch above FA+. To provide finer gradations, rating industry attach +
or – to their ratings. The rating symbols for different instruments of the same
company need not necessarily be the same.
High Investment Grades
AAA: - Triple A denotes highest safety in terms of timely payment of interest and
principal. The issuer is fundamentally strong and any adverse changes are not going to
affect it.
AA: - Double A denotes high safety in terms of timely payment of interest and
principal. The issuer differs in safety from AAA issue only marginally.
Investment Grades
A : - denotes adequate safety in terms of timely payment of interest and principal.
Changes in circumstances can adversely affect such issues.
BBB: - Triple B denotes moderate safety in terms of timely payment of interest and
principal speculative grades.
Speculative Grades
BB: - Double B denotes inadequate safety terms of timely payment of interest and
principal. Uncertain changes can lead to inadequate financial capacity to make timely
payments in the immediate future.
B: - denotes high risk. Adverse changes could lead to inability or unwillingness to pay
timely payment.
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C: - denotes substantial risk. Issue rated is vulnerable to default.
D: - denoted default in terms of timely payment of interest and principal.
These symbols are just a current opinion of an agency and they are not
recommendations to invest or not to invest. The rating assigned applies to a particular
instrument of the company and is not a general evaluation of the company.
Table 1
Rating Symbols for Long-term Instruments
CRISIL
ICRA
CARE
FITCH
EXPLANATION
AAA
LAAA
CARE
AAA (ind) Highest Safety
AAA
AA
LAA
CARE AA
AA (ind)
High Safety
A
LA
CARE A
A (ind)
Adequate Safety
BBB
LBBB
CARE
BBB (ind)
Moderate Safety
BBB
BB
LBB
CARE BB
BB (ind)
Inadequate Safety
B
LB
CARE B
B (ind)
High Risk (ICRA Risk Prove)
C
LC
CARE C
C (ind)
Substantial Risk (ICRA Poor
Credit Quality)
D
LD
CARE D
D (ind)
Default (ICRA Lowest Credit
Note :1) AAA to BBB fall in investment grade
2) BB and below fall in speculative grade
3) For CRISIL, High Investment Grade, Viz. AAA And AA; Investment Grade, Viz. A
and BBB; and Speculative Grade, Viz. BB To D
4) ICRA uses prefix of letter "L" in every symbol, CARE uses as prefix the word
"CARE" symbol, whereas FITCH uses suffix "(ind)" in every symbol.
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Table 2
Rating Symbols for Medium-term Instruments
CRISIL
ICRA
CARE
FAAA
MAAA CARE
FITCH
AAA tAAA
(FD)/(CD)
FAA
MAA
EXPLANATION
Highest safety
(ind)
CARE
AA tAA (ind)
High safety
(FD)/(CD)
FA
MA
CARE A (FD)/(CD)
--
--
CARE
tA (ind)
BBB --
(FD)/(CD)
--
--
Adequate safety
Sufficient
safety(CARE
only)
CARE BB (FD)/(CD
--
Inadequate
safety(CARE
only)
FB
MB
CARE B (FD)/(CD
tB (ind)
Inadequate
safety(CARE
susceptible to default)
FC
MC
CARE C (FD)/(CD
tC (ind)
High risk
FD
MD
CARE D (FD)/(CD
tD (ind)
Default
NOTE :
1) 'F'
= fixed deposits of companies
2) 'M' = medium-term instruments
3) 'FD' = fixed deposits
4) 'CD' = certificates of deposit
Table 3
Rating Symbols for Short-term Instruments
CRISIL ICRA
CARE
FITCH
EXPLANATION
P1
A1
PR1
F1 (ind)
Highest credit quality /safety
P2
A2
PR2
F2 (ind)
Above average
credit
quality/Strong
safety.
P3
A3
PR3
F3 (ind)
Adequate credit quality/ safety
P4
A4
PR4
F4 (ind)
Risk prone/Highly uncertain
P5
A5
PR5
F5 (ind)
Lowest credit quality/Default
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Table 4
Rating Symbols Used for Claims Paying Ability of Insurance Company
CRISIL ICRA
CARE
FITCH
EXPALNATION
AAA
CARE
AAA
Highest ability to repay policyholder's
AAA(In)
(ind)
claims
CARE
AA (ind) High ability to repay policyholders
AA
iAAA
iAA
AA(In)
A
iA
CARE A(In)
claims
A (ind)
Adequate
ability
to
repay
to
repay
to
repay
policyholders claims
BBB
BB
iBBB
iBB
CARE
BBB
Moderate
BBB(In)
(ind)
policyholders claims
CARE
BB (ind)
Inadequate
BB(In)
B
iB
CARE B(In)
ability
ability
policyholders claims
B (ind)
Weak ability to repay policyholders
claims
C
IC
CARE C(In)
C (ind)
Lowest/poor
ability
to
repay
policyholders claims
D
--
CARE D(In)
D (ind)
Default to repay policyholders claims
Table 5
Rating Symbols Used for Mutual Funds Grading
CRISIL ICRA
CARE
FITCH
EXPLANATION
AAAf
CARE AAAf
AAA
Minimal Credit Risk
mfAAA
(ind)
AAf
mfAA
CARE AAf
AA (ind)
Very Low Credit Risk
Af
mfA
CARE Af
A(ind)
Low Credit Risk
BBBf
mfBBB
CARE BBBf
BBB
Moderate Credit Risk
(ind)
BBf
mfBB
CARE BBf
BB (ind)
High Credit Risk
Bf
mfB
CARE Cf
B (ind)
Very High Credit Risk
Cf
mfC
CARE Df
C (ind)
Extremely Higher Credit Risk
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Table 5
IPO Grading Symbols
CRISIL ICRA
5/5
Grade 5(ind) issuers concerned
Grade 4
Grade 4(ind) of the issuers concerned
Grade 3
Grade 3(ind) issuers concerned
IPO Grade CARE IPO FITCH IPO Below average fundamentals
2
1/5
Grade 5
IPO Grade CARE IPO FITCH IPO Average fundamentals of the
3
2/5
EXPLANATION
IPO Grade CARE IPO FITCH IPO Above average fundamentals
4
3/5
FITCH
IPO Grade CARE IPO FITCH IPO Strong Fundamentals of the
5
4/5
CARE
Grade 2
Grade 2(ind) of the issuers concerned
IPO Grade CARE IPO FITCH IPO Poor
1
Grade 1
fundamentals of the
Grade 1(ind) issuers concerned
These are the main Sector in which Credit Rating Agencies gives rating to various
Products & Instruments involved. Rating symbols used by all agencies vary from each
other in one way or the other in order to differentiate the symbols of all the agencies
from one another.
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Table 6
Micro Finance Institutions Grading Symbols
CRISIL ICRA CARE FITCH
EXPLANATION
mfR1
M1
MF1
F1
Highest ability to manage activities
mfr2
M2
MF2
F2
High ability to manage activities
mfR3
M3
MF3
F3
Moderate ability to manage activities(CRISIL
adequate ability)
mfR4
M4
MF4
F4
Below
average
ability
to
manage
activities(CRISIL- sufficient ability)
mfR5
M5
MF5
F5
Weak ability to manage activities(CRISILbelow average ability
mfR6
--
--
--
Poor ability to manage activities(CRISIL only)
mfR7
--
--
--
Very poor ability to manage activities(CRISIL
only)
mfR8
--
--
--
Poorest ability to manage activities(CRISIL
only)
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6.4 METHODOLOGY ADOPTED
Rating methodology is concerned with the use and appreciation of the tools in rating
process. Both qualitative as well as quantitative factors are considered by the agencies
before assigning any rating
CRISIL Rating Methodology:
CRISIL assesses all the factors that could affect credit worthiness of the borrowing
company and then assigns rating to debt instruments. The key factors, considered for
rating assessment are:
1) Business Analysis:
Every relevant piece of information concerning the business is evaluated by assessing
industrial risk, market position of the company within industry, operating efficiency
and legal position.
2) Financial Analysis:
Under financial analysis, all relevant aspects connected with the business and
financial position of the company are assessed. The profitability, solvency and
liquidity ratios are taken into consideration. Thus, CRISIL considers Growth rate of
PAT, PAT/OI, PBIT/Net Worth, Earnings on Capital Employed, PBDITA/TI, Current
Ratio, Quick Ratio, Debt to Equity Ratio, Interest Coverage Ratio, Pre-tax Coverage
Ratio, Earnings on Assets to Capital Employed, etc.
3) Management Evaluation:
Judgment of management performance based on past operating and financial results,
planning and control system of management, depths of managerial talents are
considered.
4) Regulatory and Competitive Environment:
CRISIL evaluates structure and regulatory framework of financial system in which it
works.
5) Fundamental Analysis: It covers aspects on liquidity management (capital structure),
asset quality, economic as well as industrial analysis of that particular entity to take
the rating decision accordingly.
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ICRA Rating Methodology:
While assigning ratings ICRA considers all relevant factors that have a bearing on the
future cash generation of the issuer. A detailed analysis of the past financial
statements is made and estimates of future earnings under various scenarios are drawn
up, over the tenure of the instrument being rated. The other factors considered are:
1)Industry Characteristics:
Industrial features are evaluated by ICRA by taking into account various success
factors, demand and supply position, structure of industry and Government policies
related to that particular entity.
2)Competitive Position:
The competitive position of the issuer is evaluated by considering various factors
including nature and basis of competition, competitive advantage through marketing
and distribution, strength, weaknesses and opportunities available to the issuer in
comparison to the competitors.
3) Financial Risk Analysis:
Under this, ICRA considers various accounting policies, debt servicing track record,
cash flow position, profitability position and capital structure of the issuer. The ratios
considered specifically for the purpose include: Profit after Tax /Total Income, Profit
Before Depreciation Interest and Tax/Total Income, Earnings Before Depreciation
Interest and Tax/ Interest and Fixed Charges, Return on Capital Employed, Return on
Net Worth, Total Debt/ Net Worth, Current Ratio, Quick Ratio, Cash Accrual Ratio
and so on.
4) Operational Efficiency:
Operational efficiency of the company is assessed by evaluating the price or cost
advantage availability, cost and quality of raw material, availability of labour and
labour relations prevalent in the organization.
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5) Management Quality:
The quality of the management is evaluated by observing the goals and philosophies
of the management, and its strategies and abilities to overcome adverse situations.
6)Commitment to New Projects:
ICRA also evaluates the company's commitment to new projects by estimating its
progress in the initial stages and from past performance on similar projects.
7) Funding Policies of the Issuer:
The funding policies of the issuer are also evaluated to get the deep knowledge of the
sources of funds of the issuer company and the uses to which these funds have been
put into.
CARE Rating Methodology:
CARE also takes into account various quantitative as well as qualitative factors while
assigning rating which include:
1)Economy and Industry Risk:
The factors assessed by CARE include the effect of economic cycle on industry,
business cycles, tariff structure, basis of competition, environmental as well as
political factors concerning the issuer's business.
2)Business Risks (Competitor's Assessment):
Factors considered under this are size of company and market share, supply of raw
material and marketing arrangements, bargaining power of issuers, suppliers as well
as customers, and location advantages and disadvantages available to the business of
the issuer.
3)Financial Risk:
It includes analysis of financial management, capital structure, cash flow adequacy
and profitability as well as liquidity position of the company. The financial risk is
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evaluated by CARE by considering various ratios including, Growth in total Income,
Profit after Tax/Total Income, Profit before Depreciation Interest and Tax/ Total
Income, Return on Capital Employed, Return on Net Worth, Debt-Equity Ratio,
Interest Coverage Ratio, Overall Gearing Ratio, Current Ratio, Quick Ratio and
Average Collection Period.
4)Management Assessment:
CARE makes complete assessment of the background and history of the issuer,
corporate strategy adopted, philosophy and quality of management and the strength of
management capabilities under stress.
5) Terms of Instrument: Rating also depends on such factors as maturity of
instrument, nature of security (whether secured or unsecured), repayment terms,
coupon rates, etc. So, CARE also considers all these things before the assignment of
rating.
FITCH Rating Methodology:
FITCH rating analysis involves the assessment of the following:
1)Past Years’ Rating Methodology:
While assigning ratings FITCH takes into account last few years "rating
methodology" on the basis of which rating was done.
2)Past Years’ Financial Data:
The ratios considered by FITCH while evaluating the past years‟ financial data
include, Profit Before Depreciation Interest and Tax/ Total Income, Profit after
Tax/Total Income, Return on Capital Employed, Return on Net Worth, Operating
Profit/ Profit after Tax, Working Capital Turnover Ratio, Average Collection Period,
Debt-Equity Ratio, Interest Coverage Ratio, Current Ratio and Quick Ratio.
3)Forecast of Future Performance:
It means how much the business will be able to earn in future which will be helpful in
repayment of principal amount borrowed and interest thereof.
4)Comparison of Company’s Performance with the Competitors:
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Under this the agency compares the performance of the company being rated with
that of the competitors in the field to properly assess the relative standing of the
company
5)Analysis of Company’s Ability to Generate Cash from Operations:
The Company's ability to generate cash in future is also assessed by the agency to
find out the relative capability of the business to repay its obligations in time.
6.5 RATING PROCESS ADOPTED
Rating is a multi-layered decision-making process which requires interactive dialogue
with the issuer. The rating process is a fairly detailed exercise that starts with a rating
request from the issuer, the signing of a rating agreement and continues up to the
surveillance of rating. It involves among other things, analysis of published financial
information, visits to issuer's offices and work places, and intensive discussions with
issuer's auditors, bankers, creditors, etc. It also involves an in-depth study of the
industry itself and a degree of environment scanning. The rating process of various
rating agencies is explained below:
CRISIL Rating Process
The process of rating starts with a rating request from the issuer, and the signing of a
rating agreement. CRISIL‟s rating process normally takes three to four weeks.
However, rating can be arrived at shorter timeframes, to meet urgent requirements.
The CRISIL rating process includes the following steps:
1. Request for Rating:
The rating process starts with the issuer's request for rating. Then the rating agreement
is signed between the client and the rating agency. The rating agency assigns a rating
team for the purpose, and the client provides the relevant information to the rating
team along with the rating fees.
2. Analysis of Information:
The rating team conducts the preliminary analysis of the information provided by the
client. The team also conducts the site visits for the purpose of analysis.
3. Meeting:
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Then the meetings between the rating team and management of the issuer are
conducted and the rating team does the final analysis of the information after
clarification of any doubts in the management meeting.
4. Assignment of Rating:
The rating team presents its analysis to the rating committee which assigns the rating
to the given instrument and communicates the same to the issuer. The rating is then
accepted by the issuer or the issuer may appeal the rating agency to further refine the
rating.
5. Dissemination of Rating:
In case the rating is accepted by the issuer it is disseminated to CRISIL's subscriber
base, and to the local and international news media. Rating information is also
updated on line on the website of rating agency.
6. Continuous Surveillance:
All ratings are kept under continuous surveillance throughout its validity by the rating
agency.
ICRA Rating Process
The Rating involves assessment of a number of qualitative factors with a view to
estimating the future earnings of the issuer. This requires extensive interactions with
the issuer's management, specifically on subjects relating to plans, outlook,
competitive position, and funding policies. Thus, the following steps are included in
the ICRA rating process:
1. Formal Request for Rating:
ICRA‟s rating process is initiated on receipt of a formal request (or mandate) from the
prospective issuer.
2. Setting of Rating Team and Analysis of Information:
A Rating team, which usually consists of two analysts with the expertise and skills
required to evaluate the business of the issuer, is involved with the Rating assignment.
An issuer is provided a list of information requirements and the broad framework for
discussions. Then the Rating team analyzes that information.
3. Interaction with the Management of the Issuer:
Then there are extensive interactions between Rating Team and the issuer's
management, specifically on subjects relating to plans, outlook, competitive position,
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and funding policies. In some cases where the agency finds it necessary, the site visits
may be done by the rating team for proper analysis of information.
4. Preparation of Rating Report:
After completing the analysis, a Rating Report is prepared by the Rating Team, which
is then presented to the ICRA Rating Committee. A presentation on the issuer's
business and management is also made by the Rating Team.
5. Assignment of Rating:
The Rating Committee which is the final authority for assigning Ratings assigns the
rating. The assigned Rating, along with the key issues, is communicated to the issuer's
top management for acceptance. Non-accepted Ratings are not disclosed and
complete confidentiality is maintained on them unless such disclosure is required
under any laws/regulations.
6. Review of Ratings:
If the issuer does not find the Rating acceptable, it has a right to appeal for a review.
Such reviews are usually taken up if the issuer provides certain fresh inputs. During a
review, the issuer's response is presented to the Rating Committee. If the inputs and/or
fresh clarifications so warrant, the Rating Committee would revise the initial Rating
decision.
7. Mandatory Surveillance:
As part of a mandatory surveillance process, ICRA monitors all accepted Ratings over
the tenure of the Rated instruments. The Ratings are generally reviewed once every
year, unless the circumstances of the case warrant an earlier review. The Rating
outstanding may be retained or revised (that is, upgraded or downgraded) on
surveillance.
CARE Rating Process
CARE rating process largely depends on the flow of information from client. Rating
decisions are made by rating committee. The CARE rating process includes the
following steps:
1. Request for Rating and Assignment of Rating Team:
The client requests the agency for rating and after signing of agreement between both
a rating team is assigned for the purpose by the rating agency.
2. Analysis of Information:
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The client is required to submit information and detailed schedules and proper
analysis of that information is done by the agency.
3. Interaction with the Client:
After the analysis of data by the rating team, the team interacts with the client, and the
client responds to the queries raised by the team and provides the additional data as
required by the team. Further, the team undertakes the site visits and analyzes the
additional data submitted by the client.
4. Assignment of Rating:
The internal committee of rating agency reviews the analysis and then the Rating
committee assigns rating to the client. The rating so assigned is communicated to the
client. The client may then accept the rating or it may ask for review of rating in
which case the client has to furnish additional information for the purpose.
5. Publishing of Rating:
In case the client accepts the rating then the rating agency will give the notification
about such rating in the press, otherwise CARE will not publish the rating.
6. Review of Rating:
Each rating is then reviewed formally at least once a year when the analyst of rating
agency meets the issuer's management.
FITCH Rating Process
The FITCH rating process includes the following steps:
1. Rating Agreement Signed:
The rating agreement is signed between the rating agency and the entity wanting to
get its instrument rated.
2. Review of Publicly Available Information:
FITCH‟s analysis and rating decisions are based on information received from
sources known to it and believed by FITCH to be relevant to the analysis and rating
decision. This includes publicly available information on the issuer, such as company
financial and operational statistics, reports filed with regulatory agencies, and industry
and economic reports. In addition, the rating process may incorporate data and insight
gathered by analysts in the course of their interaction with other entities across their
sector of expertise.
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3. Questions Sent to Issuer:
In addition to review of publicly available information the rating agency needs to ask
certain special questions from the issuer in order to get out the information (that is not
available otherwise) about the instrument. The issuers are required to reply within the
stipulated period and that too before the management meeting.
4. Management Meeting:
After having received the replies from the issuers, the rating agency conducts the
meeting with the management to discuss the relevance of information collected about
particular instrument.
5. Further Analysis:
After having discussions in the management meeting the rating agency goes for
further detailed analysis about the product or instrument to be rated.
6. Credit Committee Presentation and Draft Report:
The credit committee (which if formed specifically for the purpose) gives the
presentation of its analysis and a draft report is prepared for the same.
7. Rating Committee Review and Discussion:
After getting the draft report from the credit committee, the rating committee reviews
it. The rating committee considers the relevant quantitative and qualitative issues, as
defined in FITCH‟s established criteria and methodologies, to arrive at the rating that
most appropriately reflects both the current situation and prospective performance.
Then the rating decision is communicated to the company and the company accepts
that rating.
8. Preparation of Final Rating Report and Press Release:
Once the rating is communicated to the company, it passes comments on the rating
decision and after that a final rating report is prepared and rating is communicated to
the public through a press release and full rating report is made available to the
subscribers.
9. Ongoing Dialogues and Application of Rating to the New Issues:
After the completion of the rating process, the rating assigned is continuously
reviewed by the agency and the agency continues its dialogue with the company for
further rating of new issues.
Thus, almost similar steps are followed by all the rating agencies as the Rating
process is initiated on receipt of a formal request and it ends with the continuous
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review of ratings in all the cases. Rating decisions are made in accordance with the
criteria applicable to that sector.
The methodologies and criteria that determine rating levels are created and revised by
the analytical groups. Each of the analytical group considers the appropriateness of its
criteria and models as individual transactions are rated. As far as rating methodology
is concerned almost similar parameters are considered by all the agencies under study.
Moreover, these agencies rate similar types of instruments and products with only few
differences in them. However, during the period 2001-09, the maximum number of
instruments, i.e., 16,762 have been rated by CRISIL. This is followed by CARE,
ICRA and FITCH with 3075, 2929 and 1475 instruments respectively during the
period.
Thus, for better understanding of how RATING METHODOLOGY has effects on
rating of various products and instruments we would consider and compare the Data
from CRISIL only as it has rated maximum number of instruments among the major 4
Agencies so as to have a clear and better understanding.
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7. BOND RATING METHODOLOGY
Objective
The main objective of the paper is to assess the consistency in rating methodology of
rating agencies by verifying some of the common factors which determine the bond
ratings. Consistency in rating methodology of each individual rating agency is
assessed by taking companies belonging to same rating class (within group) including
AAA, AA, A and BBB as sample.
Methodology And Data Collection
The study is based on the Secondary Data. It is a study of four old SEBI recognized
rating agencies including CRISIL, ICRA, CARE and FITCH. The time period of the
study is from April 2001 to March 2006. Bond rating methodology has been analyzed
corresponding to eight variables, viz. four liquidity as well as solvency ratios and four
profitability ratios.
The short-term liquidity ratios considered are Current ratio and Quick ratio whereas
long-term solvency ratios include Debt-equity ratio and Interest Coverage ratio.
Further the profitability ratios selected include Return on Capital Employed, Return
on Net Worth, Profit after tax/Total Income (PAT/TI), and Profit before depreciation,
interest and tax/Total Income (PBDITA/TI). These financial ratios are selected as
these are commonly used by all the credit rating agencies and some of the previous
studies also support these ratios. The data regarding various rating grades has been
collected from the reports of the rating agencies including various issues of CRISIL
Rating Scan, ICRA Rating Profile and CARE Rating View, websites of these rating
agencies. Further, the data relating to various financial ratios relating to the given
period has also been collected from various sources available online.
For all the rating grades F-values using Analysis of Variance (ANOVA) is calculated
for all the eight financial ratios selected. 25 per cent of the total number of
manufacturing and trading companies whose debentures and bonds are rated by each
rating agency during the time period 2001-02 to 2005-06 are taken as sample.
Companies selected for each rating agency are further divided into four groups viz.
AAA, AA, A and BBB. These rating categories have been chosen in the light of the
fact that majority of rated companies fall under these rating classes. The main
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core of the analysis is that in case of within group sample companies, variance in
mean values of ratios should be minimum. All calculations are done with the help of
Statistical Package for Social Sciences (SPSS) version .
Limitations
1.The data taken, has been drawn on convenience and judgment basis & also
secondary in nature. Thus, It may vary from the actual result
2. Different quantitative and qualitative factors are considered by various rating
agencies while assigning a rating grade, whereas in the present study only quantitative
factors including eight financial ratios have been used to assess the consistency in
rating methodology. Therefore, the results of the study should be interpreted with
caution.
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Results
A) Comparison of AAA Rated Companies ‘AAA’
Table 1 : Consistency in Bond Rating Methodology in case of AAA Rating Grade
RATIOS
CRISIL
F
ICRA
Sig.
Values
F
CARE
Sig.
F Values
FITCH
Sig.
Values
F
Sig.
Values
Current Ratio
1.14
0.35
0.17
0.85
0.94
0.48
1.81
0.31
Quick Ratio
0.52
0.61
0.67
0.55
1.73
0.32
0.90
0.50
Debt-Equity
1.32
0.30
1.29
0.34
0.80
0.53
0.51
0.64
1.52
0.26
1.07
0.40
0.39
0.71
0.95
0.48
on 1.31
0.31
1.11
0.39
0.80
0.53
0.41
0.69
Return on Net 1.43
0.28
0.49
0.64
0.16
0.86
0.25
0.79
after 0.08
0.93
1.68
0.26
58.189*** 0.00
0.16
0.86
0.70
0.51
1.49
0.30
2.13
0.16
0.87
Ratio
Interest
Coverage Ratio
Return
Capital
Employed
Worth
Profit
Tax/Total
Income
PBDITA/Total
0.27
Income
*** denotes Significant at 1 per cent level.
"AAA" ratings denote the highest credit quality. The rated instrument carries the
lowest expectation of credit risk. The above table mentions the F-values of eight
financial ratios of different companies which were assigned AAA rating grade by
CRISIL, ICRA, CARE and FITCH respectively. It is clear from the table that as far as
companies rated by CRISIL,ICRA & FITCH. are concerned, none of the financial
ratios have significant F-values. Thus, the methodology adopted by all 3 Agencies
while assigning AAA rating grade was consistent as similar ratios were considered
while assigning equivalent rating grade.
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Whereas, companies rated by CARE are concerned, the table highlights that the Fvalue for Profit after tax/Total income is significant while F-values for all other ratios
are not significant. It implies that the Profit after tax/Total income ratio of various
companies which were assigned AAA rating by CARE significantly differ from each
other whereas all other ratios do not vary significantly from each other.
B) Comparison of AA Rated Companies
Table 2 : Consistency in Bond Rating Methodology in case of AA Rating Grade
RATIOS
CRISIL
F
ICRA
Sig.
Values
F
CARE
Sig.
Values
F
FITCH
Sig.
Values
F
Sig.
Values
Current Ratio
3.43
0.07
0.68
0.54
1.37
0.38
0.71
0.56
Quick Ratio
5.144** 0.02
0.27
0.77
0.90
0.50
0.33
0.74
Debt-Equity
1.55
0.25
0.12
0.89
0.72
0.56
1.51
0.35
Interest Coverage 2.00
0.18
1.04
0.41
0.39
0.71
1.30
0.39
0.10
1.16
0.38
0.40
0.70
2.18
0.26
Net 2.28
0.15
0.07
0.93
0.32
0.75
1.57
0.34
after 1.73
0.22
1.71
0.26
0.03
0.97
0.63
0.59
0.29
2.22
0.19
0.72
0.56
0.10
0.91
Ratio
Ratio
Return on Capital 2.85
Employed
Return
on
Worth
Profit
Tax/Total Income
PBDITA/Total
1.37
Income
**Significant at 5 per cent level
It is clear from the table that in case of CRISIL, only quick ratio has significant Fvalue. It means the Quick Ratio of different sets of companies which were assigned
"AA" rating grade by CRISIL is different from each other, while as far as all other
ratios are concerned CRISIL had considered similar ratios while assigning AA rating.
While, F-values of the eight financial ratios of the companies which were assigned
AA rating by ICRA,CARE & FITCH are significant. It implies that there is no
significant difference between the values of various ratios of the companies which
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were assigned . Thus there was consistency in rating methodology while assigning
AA rating grade to different companies during the given period.
C) Comparison of A Rated Companies
Table 3 : Consistency in Bond Rating Methodology in case of A Rating Grade
RATIOS
CRISIL
F
Values
ICRA
Sig.
F
CARE
Sig.
Values
F
FITCH
Sig.
Values
F
Sig.
Values
Current Ratio
0.56
0.59 1.22
0.36
1.02
0.46
0.58
0.62
Quick Ratio
1.01
0.39 2.03
0.21
1.09
0.44
0.44
0.68
Debt-Equity
0.90
0.43 0.19
0.83
0.59
0.61
0.11
0.90
1.36
0.30 1.52
0.29
3.11
0.19
1.21
0.41
on 1.09
0.37 1.27
0.35
3.33
0.17
0.57
0.62
Return on Net 0.74
0.50 0.69
0.54
3.77
0.15
0.52
0.64
after 0.97
0.41 1.16
0.37
3.85
0.15
0.73
0.56
0.17
0.85 1.73
0.26
2.39
0.24
7.34
0.07
Ratio
Interest Ratio
Return
Capital
Employed
Worth
Profit
Tax/Total
Income
PBDITA/Total
Income
The Table 3 points out that the F-values of all the ratios are not significant in case of
A rated companies by CRISIL, CARE & FITCH as which means that there is no
significant difference in the similar ratios of A rated companies. Thus, Thus, the
methodology adopted all 3 above while assigning A rating grade was consistent as
similar ratios were considered while assigning similar rating grade. As far as the Fvalues of different ratios of various A rated companies by FITCH are concerned, it is
visible from the table that all the ratios have in-significant F-values. Thus it is clear
that methodology used by FITCH to assign rating grade A is consistent over the
period of the study.
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D) Comparison of BBB Rated Companies
Table 4 : Consistency in Bond Rating Methodology in case of "BBB" Rating Grade.
RATIOS
CRISIL
F
ICRA
Sig.
Values
F
CARE
Sig.
Values
F
FITCH
Sig.
Values
F
Sig.
Values
Current Ratio
1.63
0.24
0.26
0.78
2.42
0.24
0.40
0.70
Quick Ratio
2.05
0.17
0.26
0.78
3.60
0.16
0.32
0.75
Debt-Equity
0.26
0.77
0.44
0.67
1.61
0.34
1.06
0.45
3.24
0.08
0.95
0.44
1.07
0.45
2.67
0.22
on 3.31
0.07
2.13
0.20
1.21
0.41
2.44
0.24
Return on Net 3.33
0.07
2.22
0.19
1.53
0.35
4.40
0.13
after 2.07
0.17
3.00
0.13
0.97
0.47
1.67
0.33
1.30
0.31
0.72
0.53
0.74
0.55
6.55
0.06
Ratio
Interest Ratio
Return
Capital
Employed
Worth
Profit
Tax/Total
Income
PBDITA/Total
Income
The F-values are not significant for any of the ratios belonging to BBB rated
companies by CRISIL,ICRA, CARE & FITCH. This highlights that during the period
of study, the financial]ratios of the companies belonging to similar BBB rating are not
significantly different from each other. This depicts the consistency in rating
methodology of all 4 during the period under study.
CONCLUSION :
It has been assessed from the above analysis that all the rating agencies use consistent
methodology while assigning a particular rating grade as there is no significant
difference in the value of all the ratios which belong to different sets of similarly rated
companies. The only exception to this is PAT/TI ratio of AAA rated companies by
CARE and quick ratio of AA rated companies by CRISIL as there is significant
difference in these ratios.
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8. IPO GRADING PROCESS
Introduction
IPO grading is the grade assigned by a Credit Rating Agency registered with SEBI, to
the initial public offering (IPO) of equity shares or any other security which may be
converted into or exchanged with equity shares at a later date. The grade represents a
relative assessment of the fundamentals of that issue in relation to the other listed
equity securities in India. Such grading is generally assigned on a five-point point
scale with a higher score indicating stronger fundamentals and vice versa as below.
IPO grading has been introduced as an endeavor to make additional information
available for the investors in order to facilitate their assessment of equity issues
offered through an IPO.
IPO grading can be done either before filing the draft offer documents with SEBI or
thereafter. However, the Prospectus/Red Herring Prospectus, as the case may be, must
contain the grade/s given to the IPO by all CRAs approached by the company for
grading such IPO.
The company desirous of making the IPO is required to bear the expenses incurred for
grading such IPO.
IPO grading is not optional. A company which has filed the draft offer document for
its IPO with SEBI, on or after 1st May, 2007, is required to obtain a grade for the IPO
from at least one Credit Rating Agency.
IPO grade/s cannot be rejected. Irrespective of whether the issuer finds the grade
given by the rating agency acceptable or not, the grade has to be disclosed as required
under the DIP Guidelines. However the issuer has the option of opting for another
grading by a different agency. In such an event all grades obtained for the IPO will
have to be disclosed in the offer documents, advertisements etc
No other country in the world carries out IPO grading and therefore it is necessary to
see the usefulness of the process. Initial Public Offering, also referred to simply as a
"public offering," is the first sale of stock by a private company to the public. A
company can raise money by issuing either debt or equity. If the company has never
issued equity to the public, it's known as an IPO. IPOs can be a risky investment for
investors.
Therefore, for the individual investor, it is tough to predict what the stock will do on
its initial days of trading and in the near future since there is often little historical data
with which to analyze the company. Also, mostly IPOs are done by the companies
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which are going through a transitory growth period, and they are therefore subject to
uncertainty regarding their future value.
IPO Grading Symbols
CRISIL ICRA
5/5
Grade 5
Grade 4
Grade 3
Grade 4(ind) of the issuers concerned
Grade 3(ind) issuers concerned
IPO Grade CARE IPO FITCH IPO Below average fundamentals
2
1/5
Grade 5(ind) issuers concerned
IPO Grade CARE IPO FITCH IPO Average fundamentals of the
3
2/5
EXPLANATION
IPO Grade CARE IPO FITCH IPO Above average fundamentals
4
3/5
FITCH
IPO Grade CARE IPO FITCH IPO Strong Fundamentals of the
5
4/5
CARE
Grade 2
Grade 2(ind) of the issuers concerned
IPO Grade CARE IPO FITCH IPO Poor
1
Grade 1
fundamentals of the
Grade 1(ind) issuers concerned
Accordingly, IPO Grading methodology examines the following key fundamentals:
Business and Competitive Position ‐The alignment between industry opportunities the
company's strategy and objectives
Financial Position and Prospects ‐ Forward looking assessment of key
financial indicators such as ROE, EPS, P/E, growth in profit, relevant
for
an equity investor.
Management Quality – An evaluation of the ability of the management to
handle uncertainty in terms of capitalizing on future business opportunity
and mitigating the impact of contingencies
Corporate
Governance
practices
–
An
evaluation
of
the
company’s
governance architecture to determine if it is structured such that the risks and
rewards of business are equally available to all shareholders.
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Normally, grading is done looking at roughly a three year time horizon and would
involve an in‐depth assessment of the various quantitative and qualitative parameters
of the issuer
IPO grading is a onetime assessment done prior to the IPO issue and relies
significantly on the draft prospectus filed with SEBI. Normally, grading is done
looking at roughly a three-year time horizon and would involve an in‐depth
assessment of the various quantitative and qualitative parameters of the issuer. While
growth prospects of the industry and financial strength are some of the quantitative
parameters, qualitative parameters such as management capability also provide
critical input in determining a grade
SEBI’s guidelines for IPO grading
The Securities and Exchange Board of India (SEBI) had first experimented IPOs
grading on optional basis. But on the other hand, none of the promoters and lead
managers voluntarily chose to be graded even at no cost to the companies concerned.
This has led SEBI to make IPO grading compulsory for all.
The important features of SEBI's decision on IPO grading are as follows:
The grading exercise will exclude the issue price from its scope;
It will be carried out by recognized credit rating agencies;
The grading will be on a 5-point scale, the lowest grade to be indicated by 1 and the
highest by 5.
The issuing company will be allowed to choose the rating agency for grading its IPO.
Is IPO Grading Necessary?
Given that no other capital market in the world practices such a grading scheme, what
is unique about India’s capital market that calls for IPO grading? To assess the
necessity, it is prudent to first look at the views of the various stakeholders. The
primary stakeholders in this context are SEBI, the rating agencies, the firms aspiring
to issue an IPO, and the investors.
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SEBI’s View
An investor may find it challenging to appropriately assess, on the basis of the
information available on the prospectus, a firm’s business prospects and risks. SEBI’s
belief is that an IPO grade provides an additional input to investors, in arriving at an
investment decision. In recent times, with the stock market participation of new and
foreign investors increasing in India, SEBI contends that there is need for greater
value‐added information on companies tapping the capital market and their intrinsic
quality. In this context, IPO grades, being simple, objective indicators of the relative
fundamental positions of the issuers concerned, helps in both widening and deepening
the market.
SEBI believes that it has taken a pioneering role in safeguarding investors’ interest by
increasing disclosure levels by entities seeking to access equity markets for
funding. This has caused India to be amongst one of the more transparent and
efficient markets in the world.
A majority of retail investors do not read the offer document (prospectus) and even
when they do, they may not fully disseminate or comprehend the implications of the
disclosures made. Therefore, SEBI’s belief is that there is a vital need to rate equity
offerings, helping investors separate good floats from risky ones
SEBI has further said that as the IPO grading does not take into consideration the
pricing of the security, it is not an investment recommendation. Rather it is only one
of the inputs for the investor to aid in the decision making process. To that effect,
SEBI’s view is that all other things remaining equal, a security with stronger
fundamentals would command a higher market price.
SEBI believes that it has taken a pioneering role in safeguarding investors’ interest by
increasing disclosure levels by entities seeking to access equity markets for
funding. This has caused India to be amongst one of the more transparent and
efficient markets in the world.
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Rating Agencies’ View
Until now, research has been available to equity investors only in the form of
investment advice (buy/sell/hold recommendations). Rating agencies contend that an
IPO grade brings an independent, unbiased assessment of the fundamentals of the IPO
issuing firm. The fundamentals, as stated earlier, can be looked at in terms of factors
such as competence of management, competitive edge, operating efficiency and
profile of promoters.
One of the rating agencies, CRISIL, believes that grading helps if investors know
where exactly it belongs in their investment decision process. CRISIL further states
that the investment decision making is a three‐step process as outlined in figure:
1) Analysis of Fundamentals. (Addressed by IPO Grade)
2)Analysis Of Returns. (Is the Security being offered at the right price)
3)Investor's Preference. (Is this the right Investment of me?)
All these factors leads to Investment decision.
.
The rating agencies compare the fundamentals of the IPO firm to those of other listed
firms in the primary and the secondary market. This is done with an understanding
that if IPO grading is to meet investors’ needs, the relative comparison set of potential
IPO companies must include all companies that are potential investment equity
options for the investor. Doing so benefits the issuer company by benchmarking itself
with its peers.
The Process of Obtaining an IPO Grade
To initiate the process of obtaining an IPO grade, the company first contacts one of
the grading agencies. The steps involved in the grading process are as follows:
Step I:
The issuer shares the required information with the grading team of the rating agency
Step II: Rating agency follows up with detailed management meetings with the CEO,
CFO, and the Board of directors, and further follows up with subsequent
site visits
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Step III:
The grading team prepares a detailed note and grading committee assigns the grade
Step IV:
Grading agency publishes a rationale outlining the reasons for the reason
for the assigned grade
Step V:
Grading agency sends the grading report to SEBI, stock exchanges, and to the
company The issuing company then discloses the IPO grade on the prospectus that it
files with the ROC (Registrar of Companies).
Assessment Of An IPO Grading Process.
The concept of IPO grading being a unique one, while analyzing the concept of IPO
grading I observed worthwhile differences between IPO grading and credit rating.
1). While credit rating is assigned based on past data and the obligation of debt
payment along with its future prospects, IPO grade is assigned based solely on
fundamentals and on assessment of the future performance.
2). Companies that are likely to raise far more equity than they need in an IPO hence
suffer a depressed return on equity (ROE) are likely to be assessed unfavorably in the
IPO grading exercise; However, they are likely to be assessed more favorably in a
credit rating exercise, as more equity lowers the debt to equity(D/E) ratio and
provides cushion to acquire more debt in the process.
3). The focus while assigning an IPO grade would be projected in ROE, EPS, and
growth in profits, while the focus while assigning a credit rating would be on
projected cash flows in relation to debt .
4). Credit rating is assigned based on a promise to pay a fixed sum at regular intervals
regardless of the performance of the project for which the funds were borrowed, On
the other hand, IPO in grading the investor's
returns are dependent on the
performance of the project being financed.
5). Credit ratings are used for the valuation of buy/sell/hold recommendations on
bonds, where as IPO grading has no bearing on buy/sell/hold recommendations
of equity.
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Thus, IPO Grading System is relevantly different and new from other Rating process
and
introduced by SEBI in the year 2007. It still has a long way to go in order to
have total acceptability among the investors group. It needs to evolve according to the
needs & convenience of the Investors which would further
will be able to
compliment their investment decisions.
Findings :
1. It is a onetime assessment and has no ongoing validity thus it makes it difficult for an
investor to totally rely on it.
2. IPO grading totally ignores the valuation aspect of the company's IPO.
3. The main criticism against SEBI's is that it excludes the issue price from the scope of
grading. The critics have argued that the issue price is a crucial factor in determining
the worth of an IPO from the investor's viewpoint to include it.
4. SEBI Initially the cost of the grading would be borne by the Investor Protection Funds
administered by the stock exchanges, or by Investor Education Protection Funds (IPF)
administered by the Ministries of Companies Affairs. However, the bearing the cost
of
obtaining
the
grade
has
since
been
transferred
to
the
companies
themselves. without any justification for having shifted the cost responsibilities from
IPF to the companies. This has led to an increase in the cost of raising funds in the
capital market.
5. The grading does not aim to indicate the likely returns from the IPO to the investor for
his investment thus an investor cannot fully rely on the grading system to take his
investment decisions
6. The IPO grading also does not take into account market factors such as liquidity,
demand, supply situation of the scrip, the market sentiment at the time of the IPO
issue are not taken into consideration and the very purpose of protecting the interest
of the investors is defeated. This is mainly because pricing of the issue is the most
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Rizvi Institute of Management Studies & Research
crucial determinant of returns to the investors and it is not included in the grading
process.
Recommendations
1) SEBI has made it mandatory to get IPO grading done, the parameters and grades are
not standardized so it's important for SEBI to standardized parameters. This will
enable investors to make proper investment decision by analyzing several options.
2) Even though it grades the IPO & gives its opinion after several Qualitative &
Quantitative Analysis, it should be able to determine the loopholes an IPO may
possess.
3) SEBI can grant powers to them in order to be able to detect the frauds in an IPO
through the grading process which could further strengthen their position. This would
enable
to
protect
the
investors
interest.
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Rizvi Institute of Management Studies & Research
8.1 IPO GRADING - RATNAKAR BANK
Ratnakar Bank is latest in the news to go for an IPO in the coming months backed by
the Strong Election mandate and Positives Signs of recovery of the Economy. We
tried to analyze the potential of the bank by giving it an IPO Grade in order to give
an opinion to the Investor's.
Company's Background - Established in 1943, RBL is a Kolhapur based small sized
old private sector bank. It was granted the status of scheduled commercial bank in
1959. The business of RBL is primarily concentrated in Maharashtra and North
Karnataka.
Branches - It has 120 branches across the country with 140 ATMs. The bank has
presence in Maharashtra, Karnataka, Gujarat, Tamil Nadu and Delhi - NCR. By the
next year, the bank should have close to 200 branches.
No of Employees - over 1700.
ManagementThe board is totally independent with Indian professionals from top American Banks
taking over Operations .
Subhash Kutte - Chairman.
Vishwavir Ahuja - MD & CEO, Mr. Ahuja joined Ratnakar Bank in 2010. He is the
former CEO of Bank of America in India.
Naresh Karia - CFO.
No. of shares - 21.5 Cr Shares as of FY12. HDFC owns a 3.94% stake ~ 8.8 million.
Faering's stake is below 4%.
Business - Ratnakar Bank makes one-third of its loans to farmers, small businesses
and low-income consumers. The bank is using the deposits it takes from urban
customers and extending loans to rural borrowers.
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Rizvi Institute of Management Studies & Research
Segments 1. Retail Banking
2. Agriculture Financing & Financial Inclusion : ( Covering 500 villages & 30,000
clients directly and support over 3,00,000 financial inclusion clients indirectly in the
last 18 months)
3. Commercial Banking
4. Corporate & Institutional Banking
Financial Highlights
Particulars
FY 2011
FY 2012
FY 2013
Deposits (Cr.)
2042
4739
8340
Advances (Cr.)
1905
4132
6376
Net Interest Income (Cr.)
105.15
186.79
257.56
Net Interest Margin(%)
4.62
4.34
3.32
Net Profit (Cr.)
12.22
65.73
90.47
Gross NPA(%)
1.12
0.80
0.40
Net NPA(%)
0.36
0.20
0.11
Net worth (Cr.)
1074
1130
1594
Total Assets (Cr.)
3229
7205
12963
BV/ share (Rs.)
49.99
52.62
63.03
ROE(%)
1.71
5.90
6.73
EPS(%)
0.96
3.06
4.19
CAR (%)
56.41
23.20
17.11
The Bank’s deposits increased from `4,739.33 crores , as on March 31, 2012, to
8,340.52 crores, as on March 31, 2013, registering a growth of 75.99%. While the
RBI softened policy rates, the economy’s high liquidity deficit prevented the deposit
rates from decreasing as much, particularly till the end of third quarter of FY13.
The banks NPA has reduced over 3 years from 1.12 to 0.40 % which shows its strong
position. These results were achieved through proper management of credit as well as
aggressive and focused efforts on NPA management and recovery.
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Rizvi Institute of Management Studies & Research
In FY11, the bank's profit took a hit, mainly due to pension plan, enhancement of
gratuity limits & payments of arrears otherwise the bank has shown phenomenal
increase in its profits till FY 2013. Though it NII shows a YOY (year on year) growth
which depicts its stability.
Even though the banks NPA was decreasing its NIM was not increasing as it must.
Till 31st march of 2014 the bank had approx 11,600 crores in deposits out of which
they plan to have 20 % as CASA ,which is the cheapest source of money for the
banks as it gives very low rate of interest rates. Concerted efforts at increasing the
CASA Balances have helped to increase the Bank’s CASA deposit balances by
61.32% during FY13. However, CASA percentage reduced from 21.51% in FY12 to
19.72% in FY13 owing to relatively higher increase in term deposits.
The Bank’s earning capacity increased with its EPS touching 4.19 per share in
FY13 from 3.06 per share in FY12 & 0096 on FY11.Book value per share registered
a growth of 19.79%, from 49.99 in FY 11 to 52.62 in FY12 to 63.03
in FY13.
The Bank's CAR Reduced from 56.21% to 23.20% as Bank’s business has grown
significantly during the year which has helped the Bank in the
efficient deployment of capital. and further reduced to 17.11 in FY 2013 as the Bank
raised equity capital to the tune of 376 crores excluding shares issued on exercise of
equity stock options to employees. This has helped the Bank to attain a high CAR.
The shares were subscribed to by high-quality institutional and private equity
investors
These ratios reflect increased shareholder’s value in return for their investment.
Strengths
Strong Rural & Semi- Urban presence.
Healthy Financials, Underleveraged balance sheet.
Strong management led by Vishwavir Ahuja.
The under penetration of banking services in rural India (which accounts for about 68
% of total households),high potential growth rates ,a conservative regulator & high
entry barriers for new entrants makes Bank like Ratnakar a compelling investment
case.
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Concerns
Company's original staff is unionized & Can create problems
To fund its loans, Ratnakar pays high deposit rates 5.5 % on savings accounts,
compared with 4 % at most Indian banks, & its total deposit cost averages 8.9 %,
compared with the industry average of 6%.
Also Ratnakar's operating expense of 2.67 % of average assets is higher than the
industry average of 1.7 %.This should come down as the Bank Scales up.
Recent Developments
2010
In 2010, Ratnakar raised Rs.720 Cr ($130 million) from HDFC & other PE funds
including Faering, Gaja cap, Norwest Venture Partners, Samara Cap, Beacon India
Private Equity Fund & Cartica Cap at 67 Rs/share.
Reliance Capital Asset Management (RCAM) & SBI Mutual Fund had signed a
distribution agreement with Ratnakar Bank for the distribution of mutual fund
schemes.
Raised Tier-I capital of over 700 crores , taking the total capital base to around
1,100crore, from HDFC, Gaja Capital, Norwest Venture Partners, Samara Capital,
Beacon Capital, Faering Capital, TVS Shriram and Cartica Capital
2011
ICRA granted Ratnakar Bank’s Certificate of Deposit programme an A1+ rating - its
highest rating for short-term instruments
Launched ATM cards, pre-paid cards and internet banking; obtained an authorized
dealer license to commence Foreign Exchange and International Trade business
Implemented Core Banking System (CBS) across all rural and semi-urban branches,
thus ensuring 100% of the branches are CBS enabled.
Agri Banking and Financial Inclusion verticals introduced Ratna Group Loans, a
focused credit product for small and marginal farmers, artisans and women borrowers
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Rizvi Institute of Management Studies & Research
2012
Upgraded core banking system to Finacle, a product from Infosys, which holds a
leadership position in the market
Revamped the IT infrastructure with significant investments to ensure security and
integrated operations
Established call centre services to enhance the customer service experience
Launched debit cards
Added Corporate Internet Banking to the internet banking suite.
2013
Implemented Phase I of the Core Banking System – Finacle
Raised Tier-I capital of over ` 376 crores taking the total capital base to around `
1,600 crores, from
International Finance Corporation, Ascent Capital, Aditya Birla Private Equity,
Faering Capital, IDFC ,SPICE Fund, ICICI’s Emerging India Fund
Opened the first branch in the state of Andhra Pradesh at Hyderabad ,Chennai, Tamil
Nadu
Bestowed with the honour of being India’s Best Bank (Growth) in the mid-sized
banks segment by Business Today and KPMG and also ranked 5th overall for the year
2012
Ratnakar Bank took over RBS Banking, credit cards & Mortgage portfolios in India.
It will absorb RBS's Employees along with 1,20,000 customers as part of the deal.
Ratnakar Bank did not have any Credit Card portfolio, but through acquisition from
RBS it now has a customer base of 89,000.
The retail branches agriculture business portfolio increased by 65% during FY13
2014
IPO planned in 2014/2015, as the Net worth of the Bank moves closer to Rs. 2000 Cr,
it would be 41st Bank to be listed.
The Bank is set to raise Rs. 330 Cr ($55 million), an investment that will help it
prepare for an IPO next year from a group of domestic & global private equity
investors by issuing 3 million new shares, pegging its value @ Rs. 2500 Cr. The
Investors Includes some of the top names such as Aditya Birla PE, ICICI's Emerging
India Fund, IDFC Spice, Faering Cap etc. Faering, promoted by Aditya Parekh (son
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Rizvi Institute of Management Studies & Research
of HDFC chairman Deepak Parekh) is the only existing investor increasing its stake in
the bank. After the investment, Faering stake will increase to 5%.
Conclusion
After going through various aspects of the bank in the last 3 years, Ratnakar Bank has
the potential to get an IPO GRADE 4- Above average fundamentals as its the 1st
IPO offering since Punjab & Sind bank raised 480 crore in the year 2010, the markets
is optimistic about the bank's IPO given its range of network it operating in and its
potential to capture large market share.. The bank serves the small trading
businessman and farming communities An IPO is a litmus test for the bank and will
be critical in changing the banks perception towards the customers.
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Rizvi Institute of Management Studies & Research
9. CONCLUSION
Credit Rating is thus the need of the time since investors should be equipped with
easy methods to make their investment decisions. If ratings are assigned in a proper,
systematic, transparent way, then it will be a boon for investors and will go a long
way in making the investment world a safe place.
It is an undisputed fact that CRAs play a key role in financial markets by helping to
reduce the informative gap between lenders and investors, on one side, and issuers on
the other side, about the creditworthiness of companies (corporate risk) or countries
(sovereign risk). An investment grade rating can put a security, company or country
on the global radar, attracting foreign money and boosting a nation's economy.
Indeed, for emerging market economies, the credit rating is the key to showing their
worthiness of money from foreign investors. Credit rating helps the market regulators
in promoting stability and efficiency in the securities market. Ratings make markets
more efficient and transparent.
Practical Problems With Credit Rating
There is often a possibility of biased ratings and misrepresentation on account of the
lack of accountability in the process
Rating only represents the past and present performances of the company and
therefore future events may alter the nature of the rating.
Rating is based on the material provided by the company and therefore, there is
always a risk of concealment of information on the part of the latter.
Rating of a debt instrument is not a guarantee as to the soundness of the company.
Since the rating agencies receive a sizable fee from the companies for awarding
ratings, a tendency to inflate the ratings may develop.
The time factor greatly affects rating & gives misleading conclusions. a company
which adverse conditions temporarily will be given a low rating judged on the basis of
temporary phenomenon.
Investment which have the same rating may not have identical investment quality.
The information is obtained from issuers, underwriters, etc. and is usually not checked
for accuracy or truth. Thus ratings may change on account of non-availability of
information or unavailability of adequate information.
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Changes in market considerations may result in loss that will not be reflected in Credit
Rating.
In India the chief problems in the context of CRAs arises on account of the fact that
they are not the independent and autonomous entities that their international
counterparts are. The three primary CRAs in India, viz., ICRA promoted by IFCI and
other financial institutions and banks, CRISIL, promoted by ICICI, Asian
Development bank and others, and CARE promoted by IDBI are all promoted by
lending institutions. Further most corporate borrowers are clients of these institutions
in terms of borrowing. Further, institutions like ICICI, IDBI also have stakes in such
client companies. Thus it is very important for these agencies to distance themselves
from their promoters if they want to gain credibility.
RECOMMENDATIONS
(A) For investors
Investors should not forget the Contract Law principle of ‘Caveat Emptor’. Caveat
Emptor means ‘let the buyer beware’. It should be forgotten that everything including
returns cannot be guaranteed and investments cannot be risk-free.
Investors should observe caution while investing their money and be aware
themselves before taking their investment decisions. Investors should self study the
facts and information available about the investment products and the creditability of
the issuers, before zeroing on their decisions.
It is equally important for individual investors to maintain their good credit history by
repaying loans on time and not breaching any rules of law in respect of investments,
taxation, etc. that will go a long way in making the individual’s future secure and
smooth.
Investors must understand that the objective of assessment for IPO Grading and
Credit Rating are very different; though the basis elements of the analysis are same.
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Rizvi Institute of Management Studies & Research
IPO Grading assesses factors from equity-holder's perspective and is a point in time
exercise, whereas Credit Rating assesses factors from debt-holders perspective and
usually requires recurring surveillance over the life of the instrument.
(B)For credit rating agencies
CRISIL, ICRA & CARE, the three major rating agencies are handling 90%-95% of
the business of credit rating promoted by financial institutions who while advancing
loans take the help of credit rating agencies to get the company rated. All these
agencies have continued to expand their activities in recent years. They must also be
updated about the reforms in the financial sector which can have a impact on the
businesses of these agencies as the market is volatile in nature especially in case of
debt instrument like bonds.
Another aspect is regarding the procedure or the methodology that these rating
agencies follow for rating. Sometimes companies not satisfied with rating of one
agency approach use another rating agency for better rating. For this purpose the
rating process or procedure followed for rating must be relevant and accurate. Rating
agencies should not only take into consideration past & present performance; the
projected future performance must not be ignored. This could be a Cost Saving
measure for both the parties.
The rating agencies make public only those ratings which are accepted by the issuer
companies. They should also publish even those ratings which are not accepted by the
given companies
The credit rating agencies also follow qualitative aspects for rating which may not be
more reliable and accurate. Therefore, they should lay more emphasis on quantitative
factors.
Besides the given factors considered by the credit rating agencies, they should also
take into consideration other issues regarding investment like, liquidity risk, prepayment risk, interest rate risk, taxation aspects, risk of securities market loss,
exchange loss risk, etc
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The Credit Rating Agencies is comparatively a Young industry . The variations
happens due to lack of proper control systems in place along with the readiness of the
company in disclosing their information. Thus, needless to say, the system of CRAs
needs some amount of relooking and overhauling in order to make it effective and
viable in the future. The industry has to continuously strive to improve the
professional capabilities and sustain credibility. The credit rating agencies today have
ample opportunities to play a unique role in strengthening the capital market and
building the investors' confidence in the financial system.
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10. BIBLIOGRAPHY
Website
www.crisil.com
www.icra.in
www.careratings.com
www.fitchindia.com
www.sebi.gov.in
www.rblbank.com
www.google.com
www.moneycontrol.com
Books
Mamta Arora, (2003), Credit Rating in India– Institutions, Methods and
Evaluation, New Century Publications, Delhi.
Research Paper
Sanjay Poudyal,(2008) Grading Initial Public Offerings (IPOs) in India’s Capital
Markets A Globally Unique Concept.
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81
A
Project report
On
A STUDY ON THE CREDIT RATING AGENCIES IN INDIA AND THEIR
RATING METHODOLOGY
In partial fulfilment of the requirements of
The Summer Internship of
Master of Management Studies
Through
Rizvi Institute of Management Studies and Research
Under the guidance of
Prof. Imran Kazi
Submitted by
Mohammed Maaz Kazi
MMS
Batch: 2013 – 2015
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Rizvi Institute of Management Studies & Research
CERTIFICATE
This is to certify that Mr. Mohammed Maaz Kazi, a student of Rizvi Institute of
Management Studies and Research, of MMS bearing Roll No. 55 and specializing in
Finance has successfully completed the project titled
“A STUDY ON THE CREDIT RATING AGENCIES IN INDIA AND THEIR
RATING METHODOLOGY”
under the guidance of Prof. Imran Kazi in partial fulfillment of the requirement of
Master of Management Studies by Rizvi Institute of Management Studies and
Research for the academic year 2013– 2015.
_______________
Prof. Imran Kazi
Project Guide
_______________
Prof. Umar Farooq
Academic Coordinator
_________________
Dr. Kalim Khan
Director
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PAGE
CHAPTER
No
TITLE
1
2
3
Introduction
5
History of Credit Rating Agency
6
Need for Credit Rating Agency
9
Importance
10
Benefits
10
Role
11
Features
12
3.1
3.2
3.3
3.4
Credit Rating in India
4
4.1
4.2
4.3
5.1
5.2
15
Conditions for setting up of Credit Rating Agency
17
Process of getting Certification
19
25
Conditions to be followed while assigning ratings
26
Restrictions on Ratings
26
Prominent Rating Agencies in India
28
Activities undertaken by them
33
Instruments Rated By Agencies
38
Rating Symbols
40
Methodology Adopted
46
Rating Process Adopted
58
6.1
6.2
6.3
6.4
6.5
7
8
Bond Rating Methodology
56
IPO Grading Process
62
Grading of Ratnakar Bank
8.1
9
10
24
Products & Instruments requiring mandatory rating
5.3
6
14
Determinants of Credit Ratings
Regulatory Framework
5
No
70
Conclusion
76
Bibliography
80
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EXCECUTIVE SUMMARY
Credit Rating is an symbolic indicator of the current opinion of the rating
agencies regarding the capability of Issuer of Debt Instrument. The
corporations with specialized functions namely, assessment of the likelihood
of the timely payments by an issuer on a financial obligation is known as
Credit Rating Agencies. With the increasing scope of Capital markets in
country like India, Credit Rating Agencies tends to play an important role of
strengthening the Capital Markets and building investors confidence in further
decision making process. Considering the importance of credit rating, the
project work has been undertaken to study the need for a Credit Rating System
in a economy, the regulatory environment affecting the credit rating activities
in India, to examine the operational performance of four SEBI recognized
credit rating agencies, viz. CRISIL, ICRA, CARE and FITCH, to assess the
consistency in their avenues like Bond rating methodology & IPO grading
process and to know how a Credit Rating Agency has an impact on the Indian
Capital Markets.
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1. INTRODUCTION
A credit rating is a measure used by creditors to determine how much they can trust a
certain borrower, whether the borrower is an individual, a corporation, or a country.
The credit rating is derived using past financial data or the borrower’s credit history.
There are several factors that can affect the credit rating of an individual including:
The person’s ability to pay a loan – Reflected by the person’s salary and other assets
The amount of credit in existence – This is what credit limits are for. If the person is
near his credit limit or has reached it is harder to get a loan. This also reflects whether
the person is in the habit of going into debt
Credit history – Shows whether the person makes payments on time. This also reflects
the persons spending and saving patterns.
According to the Moody’s, “A rating on the future ability and legal obligation of the
issuer to make timely payments of Principal and interest on a specific fixed income
security. The rating measures the probability that the issuer will default on the
security over its life, which depending on the instrument of the expected monetary
loss, should a default occur."
According to Standard & Poor’s, "it helps investors by providing an easily
recognizable, simple tool that couples a possibly Unknown issuer with an informative
and meaningful symbol of credit quality. "
According to ICRA, “Credit ratings are opinions on the relative capability of timely
servicing of corporate debt and obligations."
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2. HISTORY OF CREDIT RATING AGENCY
The World Scene
US has been the birth place of rating agencies as in the background of great financial
crisis of 1837 in USA the need was felt to predict the ability of merchants and traders
to pay their financial obligations. In this context, one of the pioneer professional
thinker, Louis Tappan established the first mercantile bank credit rating agency in
New York in 1841, which rated the debt paying ability of the merchants. This
mercantile rating agency was further acquired by Robert Dun, and its first rating guide
was published in 1859. Another similar agency was set up by John Bradstreet, a
financial analyst, in 1849, who published the analytical work done by it in its rating
book in 1857. The mercantile rating agency acquired by Robert Dun and agency set
up by John Bradstreet were merged together to form Dun & Bradstreet in 1933.
Corporate bond ratings were developed prior to World War-I in response to a
commercially viable need for independent and reliable judgment about the quality of
corporate bonds (Pogue and Soldofsky, 1969). As such in 1900 John Moody founded
Moody‘s Investors Service in US and in 1909 published his Manual of Railroad
Securities with comments on 200 major railroad companies by John Moody. Further,
utility and industrial bonds were rated by the Moody‘s in 1914 followed by bonds
issued by US cities and other municipalities in the early 1920s. Moody‘s also assigned
sovereign ratings to debt of various nations including Britain, Italy, Japan, China, etc.
Further, the Moody‘s started rating the debt of international issues in 1950 by rating
the Yankee bond issue of Canada and the World Bank.
The purpose of Moody‘s ratings is to provide the American investor with a simple
system of gradation by which the relative investment qualities of bonds may be noted.
Gradations of investment qualities are indicated by rating symbols representing a
group in which the quality of characteristics are broadly the same (Pogue and
Soldofsky, 1969). Thus, Moody‘s was the first to use the alphabetical symbols like
"Ass" ;"As" and so on in the credit rating system which became the base of modern
credit rating.
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Then in 1962, the Dun and Bradstreet which was formed in 1933, acquired the
Moody‘s Investor Services. Evidence of the application of credit rating to corporate
instruments for the first time is also traceable to the time when Henry Vernum Poor (a
journalist) and his son started a firm to publish Poor‘s Manual of Railroad of the
United States‘ in 1860s in USA. The manual reported financial and operating
statistics covering several years for most of the major American railroads. After John
Moody began his ratings of railroad bond in 1909, the Poor‘s company also entered
the bond rating business, by publishing its first ratings in 1916.
A new entrant in information and rating business by the name of Standard Statistics
Company also started its operations in 1922 followed by Fitch Publishing Company in
1924. The Poor‘s Publishing Company and Standard Statistics. Company merged
together in 1941 to form Standard and Poor‘s (S&P). S&P was further taken over by
McGraw-Hill, the publishing giant in 1966. The credit rating agencies expanded from
the 1970s through the 1990s, much as they did from 1909, when John Moody
introduced the concept, to the 1930s (Jutur, 2005). In the 1970s a number of rating
agencies started rating activities all over the world.
In 1972, Canadian Bonds Rating Service
was established followed by the
incorporation of Thomson Bank Watch in 1974, which was based in Toronto, Canada
and which was exclusively following financial institutions including banks, securities
firms and finance companies.
In 1975, Japanese Bond Rating Institute was incorporated by Japan Economic Journal.
The other rating agencies in Japan such as Japan Bond Research Institute, Japan
Credit Rating Agency, and Nippon Investor‘s Services came to be established soon
thereafter. In 1975, McCarthy Crisanti and Maffei was established in USA which was
acquired by Duff and Phelps in 1991. Dominion Bond Rating Service was established
in 1977 in Canada, and IBCA Limited in 1978. IBCA Ltd. was an independent and
privately owned international credit rating agency based in London (UK) and was
established with the objective of offering credit analysis of bonds in different
countries.
In 1980, Duff and Phelps Credit Rating Company was formed which is a major
source of credit information internationally. It rates all major types of fixed income
securities, long and short-term debts of corporations, sovereign nations and financial
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institutions. This company operates in Latin American countries and also in Asian
countries, viz. Pakistan and India. US is the originator of concept of credit rating but
now with the development of capital markets the world over, it is becoming a
universal phenomenon.
Now there are credit rating agencies operating in many other countries of the world
also including Malaysia, Bahrain, Bangladesh, China, Philippines, Mexico, Indonesia,
Israel, Pakistan, Cyprus, Korea, Thailand, Kazakhstan, Uzbekistan and Australia.
Reasons for the Origin of Credit Rating Agencies.
The increasing role of capital and money markets consequent to disintermediation.
Globalization of Credit market.
Continuing growth of Information Technology.
Growth of confidence in the efficiency of the open market mechanism.
Withdrawal of Government safety nets and the Trend towards Privatization.
GROWTH OF CREDIT RATING AGENCIES
1841- Mercantile Credit Agency(USA)
1900- Moody’s Investors Services (USA)
1916- Poor Publishing Company (USA)
1922- Standard Statistics Company (USA)
1924- Pitch Publishing Company (USA)
1941- Standard and Poor (USA)
1974- Thomson Bank Watch (USA)
1975- Japanese Bond Rating Institution (JAPAN)
1987- CRISIL by ICICI (INDIA)
1991- ICRA by IFCI (INDIA)
1994- CARE by IDBI (INDIA)
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3. NEED FOR CREDIT RATING
The credit rating system originated in the USA in seventies. The high levels of
default, which occurred after Great Depression, in the US capital markets, gave the
impetus for the growth of credit rating. The default of $82 million of commercial
paper by Penn Central in the year 1970 and the consequent panic of investor in
commercial papers, resulted in massive defaults and liquidity crisis.US made rating
Mandatory for institutions such as Government Pension funds, and Insurance
companies.
Regulatory Agencies started Stipulating that Government Pension funds and
Insurance companies could not buy securities rated below a particular level. The
growing awareness of the investors was also another factor for the growth of Rating
business. Moreover Underwriters, Merchant Bankers and other Intermediaries
involved in the debt market also found Rating useful for planning and pricing the
placement of debt instrument.
Besides the increasing level of defaults resulting from growing access to the financial
markets the following Developments led to a growing importance of Credit Rating
System around the world.
The emergence of the Capital market as the primary allocator of resources in the
economy has underlined the need for reliable information in order to facilitate the
flow of resources to the most productive uses .In search of Investment avenues,
investors use various sources of information in order to arrive at their investment
decisions. These includes Offer Document of the Issuers, Research Reports & Media
Reports.
In Addition to the above sources, in the developed capital markets of the world, Credit
Rating Agencies have come to occupy a leading position as information providers,
particularly for the credit related opinions in respect of Debt instruments. This Role of
information providers has been strengthened by the fact that their opinions are
Independent, Objectives well researched and Credible.
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3.1 IMPORTANCE OF CREDIT RATING
1.
A wide range of industries take advantage of credit scores to improve fairness,
effectiveness and efficiency.
2. Financial companies use credit scores to predict the risk of delinquencies and losses,
which enables them to better allocate costs.
3.
Insurance companies use specialized credit scores to make fairer underwriting
decisions.
4.
Credit scores even provide benefits at the macroeconomic level by helping small
enterprises attain the funds they need and by facilitating the securitization and sale of
financial products in the secondary markets, substantially increasing the influx of
capital into a country.
3.2 BENEFITS
To Investors :The central function of credit rating is to communicate to the investors the relative
ranking of the default loss probability for a given fixed income investment in
comparison with the other rated instruments. Credit Rating in that sense is essentially
an information service.
Even for an organized Institutional Investor, rating provides a low cost supplement to
its own in house appraisal system. Large investors may use credit rating for Portfolio
Diversification by electing appropriate instruments from a broad spectrum of
investment option where he can use the information provided by Rating changes, by
carefully watching upgrades and downgrades and altering its Portfolio.
Another benefits derives by investors is the other services provided by credit rating
agencies, like RESEARCH in the form of industry reports. CORPORATE REPORTS,
SEMINARS.
To Issuers
The benefit of credit rating for issuers stems from the faith placed by the market on
the opinions of credit rating, and the widespread use of ratings as a guide for
investment decisions. The issuers of rated securities are likely to have access to a
much wider investor base as compared to unrated securities as a large section of
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investors, not having the required resources and skills to analyze each and every
investment opportunity would prefer to rely on the opinion of the Credit Rating
Agency.
Opinion of a rating agency enjoying investor confidence could therefore enable the
issuers of highly rated instruments to access the market even under adverse market
conditions. Credit Rating provides a basis for determining the additional return which
investors must get over and above its risk free return and also to get compensated for
the additional risk they bear. This is useful benchmark for issue pricing and could lead
to significant cost savings for highly rated instruments.
To Intermediaries
Rating is a useful tool for Merchant Bankers and other capital market intermediaries
in the process of
planning, pricing, underwriting and placement of issues. The
intermediaries like brokers and dealers in securities could use ratings as an input for
their monitoring of risk exposures . Regulators in some countries specify capital
adequacy rules linked to credit rating of securities in a portfolio. The merchant
bankers are also using credit rating for pre packaging of issues by way of asset
securitization obligation.
To Regulatory Bodies
Credit Ratings are used not only by Investors, Issuers, Intermediaries, but also by
various
regulatory authorities in major capital and money market. Regulatory
Authorities in various countries have specified rules that restrict entry to the market
of new issues rated below a particular grade, that stipulate different margin
requirements for mortgage of rated and unrated instruments, that prohibit institutional
investors from purchasing or holding of instrument rated below a particular level and
so on.
3.3 Role Of Credit Rating
Credit rating establishes a link between Risk and Return. They thus provide a
yardstick against which to measure the risk inherent in any instrument. An investor
uses the ratings to assess the risk level and compares the offered rate of return with
this expected rate of return (for the particular level of risk) to optimize his risk-return
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trade-off. The risk perception of a common investor, in the absence of a credit rating
system, largely depends on his familiarity with the names of the promoters or the
collaborators. It is not feasible for the corporate issuer of a debt instrument to offer
every prospective investor the opportunity to undertake a detailed risk evaluation. It is
very uncommon for different classes of investors to arrive at some uniform conclusion
as to the relative quality of the instrument. Moreover they do not possess the requisite
skills of credit evaluation. Thus, the need for credit rating in today’s world cannot be
overemphasized. It is of great assistance to the investors in making investment
decisions. It also helps the issuers of the debt instruments to price their issues
correctly and to reach out to new investors. The analysis is based on an all-round
analysis of quantitative as well as qualitative factors like past performance, economic
environment, market positioning, quality of management and predictions about future,
and is thus as complete as can be. The increasing levels of default resulting from easy
availability of finance, has led to the growing importance of the credit rating. The
other factors are:
1) The growth of information technology.
2) Globalization of financial markets.
3) Increasing role of capital and money markets.
4) Lack of government safety measures.
5) The trend towards privatization.
6) Securitization of debt.
3.4 Features
Credit rating essentially indicates the credit worthiness of the borrowers and the
probability that the borrowers will pay the interest and principal on due dates. A credit
rating system is considered of good quality if debtors with a lower credit rating
default more often than debtors with a higher credit rating Here are some important
features/facts about credit rating:
(a)Rating can be revised.
(b) Rating is not based on audit.
(c) Rating only helps in investment decision-making.
(d) Rating is based on current information.
(e) Rating is assigned to specific instrument.
(f) Rating aims at guiding the investors.
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(g) Rating does not provide any recommendation to buy, hold or sell any instrument.
(h) Rating process is based on broad parameters of information supplied by the issuer
and collected from various other sources.
(i) The rating furnished by the agency does not provide any guarantee for the
completeness or accuracy of information on which it is based.
(j) In rating business, the users of the rating services such as investors, financial
intermediaries and other end users do not pay for it but the issuers, of the financial
instrument, who do not use rating, pay for it. This is one of the most peculiar feature
of credit rating.
(k) A key feature of rating is that they contain a limited number of categories. Hence,
equally rated bonds are not claimed to be of identical quality and rating cannot be
inverted into unique default probabilities.
Thus, Credit rating is expected to improve the quality consciousness in the market and
establish, over a period of time, a more meaningful relationship between the quality of
debt and the yield from it. Nowadays, the outlook of credit rating industry appears to
be positive but the industry has to continuously strive to improve the professional
capabilities and sustain credibility. The credit rating agencies today have ample
opportunities to play a unique role in strengthening the capital market and building
the investor's confidence in the financial system. Clearly, accurate assessment of the
credit worthiness of obligators is an important precondition for the stability of a
financial system since inadequately high exposure to credit risk has been one of the
leading sources for problems in financial institutions worldwide for many decades.
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4. CREDIT RATING IN INDIA
Credit ratings are playing an increasingly important role in financial markets. The
most significant change in the recent relates to emphasis on their accountability and
more important, the caution in regulators' use of ratings. In India, rating is a more
recent phenomenon, but the changing global perspectives on the subject do impact the
financial system. India was perhaps the first amongst developing countries to set up a
credit rating agency in 1988.
The function of credit rating was institutionalized when RBI made it mandatory for
the issue of Commercial Paper (CP) and subsequently by SEBI, when it made credit
rating compulsory for certain categories of debentures and debt instruments. In June
1994, RBI made it mandatory for Non- Banking Financial Companies (NBFCs) to be
rated. Credit rating is optional for Public Sector Undertakings (PSUs) bonds and
privately placed non-convertible debentures up to Rs. 50 million. Fixed deposits of
manufacturing companies also come under the purview of optional credit rating.
Rating agencies are constantly subject to scrutiny, evaluation and questioning by
investors, media and regulators. Since ratings are opinions, it is important that
markets are convinced about their robustness before acting on them. Rating agencies
therefore publish extensive data on rating default and transition statistics, and metrics
on predictive capability of ratings vis-a-vis macro- economic and corporate
performance.
Although Credit Rating has gained importance in the developing countries of the
world after it originated in the USA about 100 years back, in India the practice of
credit rating began in 1987 with the setting up of CREDIT RATING
INFORMATION SERVICES OF INDIA LIMITED (CRISIL).
Initially it rather played a subdued role presumably because the institutional investors
did not favor the wisdom of a rating agency. In the changed perspective of the
increased dependence of the corporate on the public, the removal of restrictions on
interest rates, opening up the economy to foreign investment and the stipulation of
mandatory credit rating since 1991 by the government /Securities and Exchange
Board of India (SEBI), Credit Rating has emerged as the critical element in the
functioning of the Indian Debt Market. In response to the ever -increasing role of
credit rating, two more agencies INVESTMENT INFORMATION AND CREDIT
RATING AGENCY OF INDIA (ICRA) and CREDIT ANALYSIS AND
RESEARCH LIMITED (CARE) were setup in 1991 and 1993 respectively.
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The first Private sector Credit Rating institution was set up as a joint venture between
JM Financials, Alliance Group and the International Rating agency Duffs and Phelps
in 1995; known as Duffs and Phelps Credit Rating PVT. Limited (DCR) which have
merged to form a new entity FITCH INDIA LTD, which is 100 percent subsidiary of
Fitch IBCA and is the only wholly-owned foreign operator.
The Indian Credit Rating Industry is next to USA in terms of number of ratings
issued and in the number of agencies. Between the 4 Rating Agencies in India over
5,000 ratings have been issued for around 1,400 issuers. CRISIL is the market leader
in credit rating agency with a 65% market share. The regulators support played an
important role in the development of the credit rating industry. In 1992, for the first
time, the Reserve Bank introduced the requirement of rating for commercial papers.
SEBI followed up by introducing mandatory ratings of bonds.
The other growth drivers of the credit rating industry were declining interest rates, a
shift towards market borrowings from bank loans and a steep increase in the state
government borrowings through special purpose vehicles. Besides these factors the
growth in the private placement market of debt increased business volume in the
credit rating industry.
4.1 Determinants Of Credit Ratings
Credit rating is a symbolic indicator of the current opinion of a rating agency of the
willingness and relative of an issuer debt instrument to pay interest and repay
principal as per the terms of the contract. A rating agency assigns quality ratings that
measures the default risk of a security and sells rating to their subscribers. The default
risks primarily determined by the amount of work available to the issuer relative to
the amount of funds to be paid to the security holders. The ability to pay is evaluated
by financial ratios. Ratio analysis is done to analyze the present and future earning
power of the company issuing the security. Ratio analysis of the issuer’s financial
statements yields insights about the strength and weaknesses of the company. The
credit rating agencies have written guidelines about what values particular ratios
should have in order to earn each different quality ratings.
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Credit rating appraises the default risk which is a combination of business risk and
financial risk.
Business Risk:
Business risk relates to the market position of the company, operating efficiency and
management quality. The key factor taken into consideration are: the nature of the
industry the company is in, the demand-supply position, cyclical/ seasonal factors and
government policies vis-à-vis the industry; and the competition its facing within the
industry.
Market Position: The market share the company enjoys, it is competitive advantages
and selling and distribution arrangements.
Operating Efficiency: Locational advantages, labor relationships, cost structure,
technological and manufacturing efficiency as compared to its competitors.
Legal Position: Terms of prospectus, systems for timely payment, and for protection
against fraud.
Financial Risk:
Financial risk is a function of the profitability, debt leverage flexibility and adequate
cash flow. The assessment of financial risk is done on the basis of:
Financial analysis, including accounting quality: accuracy of statement of profit,
auditors comments, valuation and depreciation policies.
Earnings protection: Sources of future earning growth, profitability ratios and
earnings in relation to fixed income charges.
Adequacy of cash flow: Sustainability of cash flows and working capital
management.
Financial flexibility: Ability to raise funds.
Management: An evaluation of the management, which is qualitative in nature and
imparts certain amount of subjective element is done on the basis of track record of
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the management; planning and control system, depth of managerial talent, succession
plans. Evaluation of capacity to meet adverse situations, goals, philosophy and
strategies.
Environment:
An analysis of environment covering regulatory and operating environment, national
economic outlook, pending litigation and unpaid taxes are also attempted.
Rating thus is not based on a predetermined formula which specifies the relevant
variables and as well as weights attached to each one of them. Further the emphasis
on different aspects varies from agency to agency. Broadly the rating agencies assures
itself that there is good congruence between assets and liabilities of a company and
downgrades the rating if the quality of the assets depreciates.
The rating agencies employ qualified professionals to ensure consistency and
reliability. The agencies also ensure the integrity of rating by insulating rating from
conflicts of interest.
4.2 Conditions For Setting Up A Credit Rating Agency
1. Eligibility Criteria:
Certain conditions have been prescribed by SEBI, for granting certificate of
registration to the body corporate, which must be fulfilled by the body corporate in
order to get the certificate. These conditions include the following:
The body corporate must be registered as a company under the Companies Act, 1956.
The Rating activity must be specified as one of its main object in the Memorandum of
Association by the Body Corporate.
The Body Corporate must have adequate infrastructure so that it can provide rating
services in accordance with the provisions of the act.
The Body Corporate must have a minimum net worth of rupees five crore but the
Body Corporate set up before the commencement of these regulations and having net
worth less than Rupees Five crore must be allowed to increase its net worth to the
required amount within a period of three years from such commencement.
The Body Corporate and its promoters must have professional competence, financial
soundness and general reputation of fairness and integrity in business transactions.
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The Body Corporate, its promoters or directors might not be convicted of any offence
involving moral turpitude or any economic offence, any time in the past.
The Body Corporate, its promoters or directors might not be involved in any legal
proceedings connected with the securities market, which may have an adverse impact
on the interest of the investors.
The employees of the Body Corporate must have an adequate professional and
relevant experience to the satisfaction of the board.
The Body Corporate in all respects must be fit and proper for the grant of a certificate.
The grant of certificate must be in the interest of the investors and securities market.
The Body Corporate or any of its associates must not, in the past, be refused by the
board to grant a certificate under these regulations and they must not have
contravened the act or any of rules or regulations made under the act`.
2. Promoters of a Body Corporate:
The Body Corporate, wanting to get the certificate of registration as a Credit Rating
Agency must be promoted by the persons, which include the following:
A public financial institution, as defined in section 4A of the Companies Act, 1956.
A scheduled commercial bank included in the second schedule to the Reserve Bank of
India Act, 1934.
A foreign credit rating agency recognized by law in force in the country of its
incorporation and having at least five years experience in rating securities.
Any company or a body corporate having continuous net worth of minimum rupees
one hundred crore as per its audited annual accounts for previous five years prior to
filing application with the board for the grant of certificate.
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4.3 Process Of Getting Certificate Of Registration
1. Application for Grant of Certificate:
The body corporate which fulfils the required eligibility criteria and which wants to
commence activities as a credit rating agency shall make an application to SEBI for
the grant of certificate of registration. The application shall be accompanied with the
application fees of Rs. 50,000 being paid by way of a bank draft in favour of
“Securities and Exchange Board of India” payable at Mumbai. Any person/ body
corporate already working as a credit rating agency, on the date of commencement of
the SEBI (Credit Rating Agencies) Regulations, 1999 is also required to apply for the
grant of certificate of registration within a period of three months from such
commencement (the time period may be extended up to six months by SEBI in special
cases) failing to which they said credit rating agency shall cease to carry on the rating
activities.
The application to be filled, for the grant of certificate of registration, shall contain the
following particulars
Particulars of the Applicant:
1) The application should contain the following information of the applicant:
2) Name of the applicant
3) Telephone Number and Fax Number
4) Address of the registered office
5) Address of the branch office, if any
6) Name of the contact person of the company
7) The date of incorporation of the applicant company
8) The objects of the applicant company, including both main and ancillary
9) The authorized, issued, subscribed and paid-up capital of the company
10) The category to which the applicant company belongs, i.e., Limited company
(Public or Private) or Unlimited company
11) If the company is listed then the names of Stock Exchanges and the latest
share prices should be specified
12) Whether the applicant company belongs to the category of companies already
undertaking rating activities or whether the company is proposing to undertake
rating activities.
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Eligibility Criteria:
The applicant company should specify the category to which their promoter(s) belong
to, which include :
A public financial institution
A scheduled commercial bank
A foreign bank
A foreign credit rating agency
In case the promoter is the company with continuous net worth of Rupees one
hundred crore for previous 5 years, a certificate by a Chartered Accountant certifying
the same shall be enclosed.
Particulars of Directors/ Key Personnel:
The application should contain the following particulars regarding Directors:
Name
Qualification
Experience
Shareholding in the company
Directorship in the company.
The particulars regarding Key Personnel should include:
Name
Designation in the company
Qualification
Previous position held
Experience
Date of appointment in the company
Functional areas.
Information regarding Infrastructure: The application should contain following
details regarding infrastructure:
Computing facilities
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Facilities for research and database available with the company
Whether existing infrastructure is adequate to carry on rating activities
Any further plan for addition/ improvement of infrastructure.
List of Major Shareholders:
This should contain the following:
Name of the shareholder
Number of the shares held in the company
Percentage of total paid up capital.
Particulars of Associate Concerns:
The application should contain the details of associate companies/ concerns including:
Name
Address
Type of activity handled
Nature of interest of applicant company in associate
Nature of interest of promoter(s) of applicant company in associate.
Details of Business Information of the Applicant:
The application should contain the following details regarding business information of
Major events and present activities
Details of experience in credit rating and other activities
The projected volume of activities if the company is proposing to engage in credit
rating activities The details of securities rating activities handled by the company
during last three years including – Name of the client, type of security, size of the
issue, year of issue, security/ instrument rated and whether they are listed or unlisted.
Details of Financial Information of the Applicant:
The details of Financial Information of the applicant should include:
Details of net worth
The audited annual reports for the last three years should be enclosed
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Name and address of the principal bankers of the applicant company should be
specified
Name and address of the auditors should also be specified.
Any Other Relevant Information:
The application should also contain the details regarding:
All pending litigations against the applicant company, directors and employees
specifying the nature of dispute, name of the party and status.
Indictment or involvement in any fraud or economic offences by the applicant or any
of its Directors or key managerial personnel in the last three years.
Declaration by the Directors:
The application shall contain a declaration regarding the truth of the information
given in the application signed by atleast two directors.
2. Clarification Regarding Application:
SEBI, if not satisfied with the filled application may ask the applicant to furnish such
information or clarification as SEBI may consider necessary for the purpose of
processing of the application. SEBI may also ask the applicant or its authorized
representative to appear for personal clarification in connection with the grant of a
certificate.
3. Conditions for Grant of Certificate of Registration:
The grant of certificate by SEBI shall be subject to the following conditions:
The credit rating agency shall comply with the provisions and regulations of the act
and the guidelines, directions, circulars and instructions issued by the Board from
time to time on the subject of credit rating.
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The credit rating agency shall inform the Board in writing in case any information/
particulars furnished by credit rating agency are found to be false or misleading on a
particular matter or if that information has undergone a subsequent change.
4. Registration Fees, Grant of Certificate of Registration and its Validity:
After being satisfied by the eligibility criteria of the applicant/ corporate body
regarding the grant of certificate of registration, SEBI shall grant a certificate but this
grant of certificate is subject to the payment of registration fees of Rs. 5,00,000 being
paid by way of bank draft drawn in favour of “Securities and Exchange Board of
India” and payable at Mumbai. This certificate of registration carries the registration
code and the period of validity of certificate which shall be three years.
5. Application for Renewal of Certificate:
As the validity of the certificate of registration as given above is three years, so the
credit rating agency must apply to SEBI for renewal of certificate at least three
months before the expiry of the period of validity. This application for renewal of
certificate of registration must be accompanied by the desired renewal fee of Rs.
10,00,000 being paid by way of bank draft drawn in favour of “Securities and
Exchange Board of India” and payable at Mumbai. This application shall be dealt
with in the same manner as if it were an application for the grant of a fresh certificate.
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5. REGULATORY FRAMEWORK
SEBI:SEBI issued regulations for credit rating agencies in 1999. These regulations
are called as Securities
and Exchange board of India. (Credit Rating Agencies)
Regulations, 1999.
1) Only commercial banks, public financial institutions, foreign banks operating
in India, foreign credit rating agencies, and companies with a minimum net
worth of Rs 100 crore as per its audited annual accounts for the previous five
years are eligible to promote rating agencies in India.
2) Rating agencies are required to have a minimum net worth of Rs 5 crore.
3) Rating agencies cannot assess financial instruments of their promoters who
have 10 % stake in them.
4) Rating agencies cannot rate a security issued by an entity, which is
a borrower of its promoter.
a subsidiary of its promoter.
an associate of its promoter, if
(i) there are common chairman, directors between credit rating agency and these
entities
(ii) there are common employees
(iii) there are common chairman, directors, employees on the rating committee.
1) Rating agencies cannot rate a security issued by its associated or subsidiary, if the
credit rating agency or its rating committee has a chairman, director or employee, who
is also a chairman, director or employee of any such entity.
2) Rating agencies can choose their methodology of operation but self regulatory
mechanism will give a better maturity status for agencies.
3) Period of validity of registration shall be 3 years.
4) Sebi has decided to incorporate a clause in the listing agreement of stock exchanges
requiring companies to corporate with agencies by providing correct information.
Refusal to do so many lead to breach of contract between rating agency & client.
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A penalty of suspension of the certificate of registration or a penalty of cancellation of
registration may be imposed on the rating agency if it fails to comply with the
condition or contravenes any of the provisions of the Act
SEBI:
As per the regulations of SEBI, a public issue of debentures and bonds
convertible/redeemable beyond a period of 18 months, needs credit rating.
RBI:
According to the guidelines of RBI, one of the conditions for issuance of commercial
paper in India is that the issue must have a rating not below the P2 grade from
CRISIL/A2 grade from ICRA/PR2 from CARE.
5.1 Products / Instruments Requiring Mandatory Rating Before Issuance
Sr.No
Instrument
Regulator
1
Public/Rights/Listed
issue
of SEBI
bonds
2
IPO Grading
SEBI
3
Capital protection-oriented funds
SEBI
4
Collective Investment Schemes of SEBI
plantation companies
5
Commercial Paper
RBI
6
Bank loans
RBI (Basel-II capital computation for
banks)
7
Security Receipts
8
Securitized
instruments
Through Certificates)
9
RBI (For NAV declaration)
(Pass RBI (Basel-II capital computation for
banks)
Fixed Deposits by NBFCs & RBI
HFCs
10
LPG/SKO Rating
Ministry of Petroleum and Natural Gas
11
Maritime Grading
Directorate General of Shipping
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5.2 Conditions To Be Followed While Assigning Ratings
SEBI has prescribed certain conditions for credit rating agency, which must be
fulfilled during the process of rating:
1). Every credit rating agency shall specify a particular rating process, copy of which
should be filed with the board for record and any further modifications or additions
should also be intimated to the board.
2). Every credit rating agency shall appoint adequately qualified and knowledgeable
persons and form a professional rating committee to assign a rating. All the rating
decisions including the decisions regarding changes in rating shall be taken by the
committee.
3). Adequately qualified analysts shall be appointed by every credit rating agency for
carrying out a rating assignment.
4). Every credit rating agency shall inform the board about new rating instruments or
symbols introduced by it but a credit rating agency shall not change the rating
definition or structure of a particular rating product without prior information to the
board.
5). Due diligence must be exercised by credit rating agency while rating a security to
ensure that the rating assigned is fair and appropriate.
6). A credit rating agency shall not rate the securities issued by it.
7). The ratings assigned to the securities of a client including the changed ratings,
shall be disclosed to the concerned stock exchange through press release and websites
for general investors by the credit rating agency.
5.3 Restrictions On Ratings
Certain restrictions have been placed by SEBI on rating of securities issued by
promoters or by certain other persons. These include:1). No credit rating agency shall rate the securities issued by its promoter, here
promoter means a person who hold 10 per cent or more, of the shares of credit rating
agency.
2). Securities issued by a person who is a chairman, director or employee of a credit
rating agency or its rating committee, shall not be rated by such credit rating agency.
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This regulation is enforceable within three months from the date of commencement of
SEBI regulations.
3). Any credit rating agency shall not rate a security issued by an entity which is
either a borrower, a subsidiary or an associate of its promoter and if there are common
Chairman, Director and Employees between credit rating agency and these entities.
4). A credit rating agency can rate a security issued by its associate having a common
independent Director with it or rating committee, if such person does not participate
in the discussion in rating decisions and disclosure regarding this thing should be
made in the rating announcements of such associate company.
5). None of the above restrictions shall apply to securities, whose rating has already
been done by a credit rating agency before the commencement of these regulations
and as such these securities shall, subject to various other provisions of these
regulations, continue to be rated.
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6. PROMINENT RATING AGENCIES IN INDIA
CRISIL: - Credit Rating Information Services of India Limited.
ICRA: - Investment Information and Credit Rating Agency of India Limited.
CARE: - Credit analysis and Research Limited.
FITCH Ratings India Private Limited.
CREDIT RATING INFORMATION SERVICES OF INDIA LTD. (CRISIL)
CRISIL is India's leading rating, research, risk and policy advisory company, and is
the fourth largest in the world. It was incorporated in 1987 and was promoted by
Industrial Credit and Investment Corporation of India Ltd. (ICICI) and Unit Trust of
India (UTI). It commenced its operations of rating in 1987-88. CRISIL has its
association with internationally recognized rating agency Standard and Poor's (S&P)
since 1996. CRISIL‟s majority shareholder is Standard and Poor's which is a
subsidiary of The McGraw-Hill Companies. The latter is the world's foremost
provider of independent credit ratings, indices, risk evaluation, investment research
and data. CRISIL has been recognized by SEBI under the Securities & Exchange
Board of India (Credit Rating Agencies) Regulations, 1999.
CRISIL is a group of businesses which offers the following diversified services:
Rating and Risk Assessment,
Infrastructure Advisory, and
Business Research.
CRISIL's services include credit ratings and risk assessment; research on India‟s
economy, industries and companies; financial research and analytics outsourcing;
fund services; risk management and infrastructure advisory services. Through its IPO
Grading initiative, CRISIL has also established a presence in the equity research
domain. It provides all these services through its different subsidiaries.
1.1 CRISIL Ratings
It is the only rating agency in India to operate on the basis of sectoral specialization.
It rates different kinds of organizations, including industrial companies, banks, SMEs,
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non-banking financial institutions, insurance providers, mutual funds, infrastructure
entities, state governments, and urban local bodies. It also rates securitized papers.
1.2 CRISIL Fund Services
CRISIL Fund provides fund evaluation services and risk solutions to the mutual fund
industry through use of various benchmarks and analytical tools.
1.3 CRISIL Research
CRISIL Research is India's largest independent integrated research house which
provides research, analysis and forecasts on the Indian economy, industries and
companies across financial, corporate, consulting and public sectors.
1.4 The CRISIL Centre for Economic Research
The CRISIL Centre for Economic Research was set up in April 2002. It provides
research offerings to different financial players, corporates and policy-makers. It
offers products and services based on economic analysis to external clients, both
independently and in collaboration with other group businesses.
1.5 Irevna
CRISIL entered in equity research business by acquiring Irevna. Irevna is a division
of CRISIL which provides customized equity research and analytics, and knowledge
process outsourcing, to the world's leading financial institutions, investment banks,
private equity firms and consulting companies. CRISIL transferred its advisory and
risk consulting business into a 100 per cent subsidiary CRISIL Risk and Infrastructure
Solutions Limited (CRIS) with effect from April 01, 2007. CRIS is engaged in the
areas of infrastructure policy and transaction advisory services; integrated risk
management services and consulting to banks and corporates, through its divisions
CRISIL Infrastructure Advisory and CRISIL Risk Solutions.
1.6 CRISIL Risk and Infrastructure Solutions Limited (CRIS) CRISIL Infrastructure
Advisory works extensively in the areas of policy-making and economic
development. Its range of activities include undertaking complex feasibility studies,
creation of appropriate policy frameworks, sector reforms, regulatory support and
project structuring for various large and complex projects.
CRISIL Risk Solutions business provides risk management solutions and advice to
banks and corporates in the areas of credit and market risk.
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INVESTMENT INFORMATION AND CREDIT RATING AGENCY OF
INDIA LTD. (ICRA)
ICRA is a full-service credit rating agency but besides Ratings, Group ICRA offers
Consulting services, IT-based services, Information services, and Outsourcing
services. Thus, along with the ICRA Limited, Group ICRA has three wholly-owned
subsidiaries which together form the ICRA Group of Companies (Group ICRA).
These are:
ICRA Management Consulting Services Limited (IMaCS);
ICRA Techno Analytics Limited (ICTEAS);
ICRA Online Limited (ICRON).
2.a ICRA Limited (formerly Investment Information and Credit Rating Agency of
India Limited)
It was incorporated in 1991 and was jointly sponsored by Industrial Finance
Corporation of India (IFCI) and other Financial Institutions and banks as an
independent and professional investment information and credit rating agency. ICRA
is an associate of the international rating agency Moody's Investors Services which is
ICRA‟s largest shareholder. Moody's assists ICRA in organizing formal training
programmes and it gives advice to ICRA on rating-products strategy and the ratings
business in general. ICRA has been granted registration with SEBI under the
Securities & Exchange Board of India (Credit Rating Agencies) Regulations, 1999.
ICRA provides information products, ratings and solutions to different businesses and
investors.
2.b ICRA Management Consulting Services Limited (IMaCS)
It is a wholly-owned subsidiary of ICRA Limited and offers consulting services in
strategy, risk management, regulation and reform, transaction advisory, development
consulting and process re- engineering. IMaCS clientele includes banks and financial
service companies, corporate entities, institutional investors, governments, regulators,
and multilateral agencies. IMaCS provides management consulting services to clients
based in India and abroad through five Business Groups: infrastructure, energy,
banking and insurance, corporate advisory, and government.
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2.c ICRA Techno Analytics Limited (ICTEAS)
It is a wholly-owned subsidiary of ICRA Limited, and offers Information Technology
(IT) solutions to meet the dynamic needs of present-day businesses. The services
range from the traditional development of client-server, web-centric and mobile
applications to the generation of cutting-edge business intelligence applications and
analytics solutions. ICTEAS has two subsidiaries, ICRA Sapphire Inc. (ICSAP) and
Axiom Technologies Limited (AXIOM).
ICSAP is a wholly-owned subsidiary of ICTEAS and is based in Connecticut, USA. It
provides business analytics and software development services backed by offshore
teams.
AXIOM is also a wholly-owned subsidiary of ICTEAS and it operates in Kolkata,
India. AXIOM provides various customization and implementation services on the
Oracle E-Business Suite.
2.d ICRA Online Limited (ICRON) I
It is a wholly-owned subsidiary of ICRA Limited. ICRON was incorporated in
January 1999 and is providing software and outsourcing solutions since then. ICRON
has a wholly-owned subsidiary M-Serve Business Solutions Private Limited, a KPO
services company which is headquartered in Kolkata, India. ICRON has two Strategic
Business Units.
The Knowledge Process Outsourcing Division (KPO Division)
ICRON diversified into the Knowledge Process Outsourcing (KPO) business in April
2004, with focus on the banking, financial services and insurance as well as on retail,
healthcare and pharmaceuticals sectors. The KPO Division of ICRON offers
Knowledge Process Outsourcing services by translating data and information into
structured business inputs.
The Information Services and Technology Solutions Division (MFI Division)
The MFI Division serves the Mutual Fund Industry through Research, Analytics and
Mutual Fund Ranking. Besides, the company provides several innovative products to
meet the varied needs of its clients.
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CREDIT ANALYSIS & RESEARCH LTD. (CARE)
Credit Analysis & Research Ltd. was incorporated in 1993 by consortium of
Banks/financial institutions in India. The three largest shareholders of CARE are IDBI
Bank, Canara Bank and State Bank of India. CARE‟s Ratings are recognized by
Govt. of India and all regulatory authorities like RBI and SEBI. CARE has been
granted registration with SEBI under the Securities & Exchange Board of India
(Credit Rating Agencies) Regulations, 1999. CARE is a founder member of
Association of Credit Rating Agencies in Asia (ACRAA). CARE is set up with two
divisions:
3.a CARE Ratings
CARE Ratings offers a wide range of rating and grading services across sectors.
Types of debt instruments rated by CARE Ratings include commercial paper, fixed
deposit, bonds, debentures, hybrid instruments, structured obligations, preference
shares, loans, etc. CARE Ratings provide investors and risk managers with credit
opinions based on detailed in-depth research, which encompasses detailed analysis of
risks that affect credit quality of an issuer.
3.b CARE Research and Information Services
CARE Research & Information Services is an independent division of CARE. The
research division undertakes two activities, i.e., providing an in-house support to the
ratings division and providing sectoral research to financial intermediaries, corporates
, analysts, policy-makers, etc. as an aid to their decision-making process. CARE
Research & Information Services offers both subscription based reports and also
customized reports on request.
Sector Research
Sector Research includes an in-depth analysis of business environment of industry,
trends, future direction, coverage on sectors in India, including updates at regular
intervals for a year forward.
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Customized Research
Customized Research involves business analysis and position in the market, financial
analysis, future outlook, etc. which helps the clients to make better credit/investment
decisions.
FITCH RATINGS INDIA PRIVATE LTD. (FITCH)
Fitch Ratings India Private Ltd., formerly Duff and Phelps Credit Rating (India)
Private Ltd. (DCR), was established in 1996. Duff & Phelps India became whollyowned subsidiary of FITCH in November 2001. Fitch Ratings credit ratings provide
the agency's views regarding the future performance and the relative ability of an
entity to meet financial commitments, such as interest, preferred dividends, repayment
of principal, insurance claims or counterparty obligations. FITCH rates sovereigns,
financial institutions, insurance companies, corporates, municipalities, structured
finance obligations, etc. FITCH has been recognized by SEBI under the Securities &
Exchange Board of India (Credit Rating Agencies) Regulations, 1999.
6.1 Activities Undertaken By The Credit Rating Agencies
Credit rating agencies (subsequently denoted as CRAs) specialize in analyzing and
evaluating the creditworthiness of corporate and sovereign issuers of debt securities.
Credit rating agencies are expected to become more important in the wake of various
services/activities being undertaken by various credit rating agencies, along with the
rating services that provide information and guidance to institutional and individual
investors/creditors. These agencies enhance the ability of borrowers/issuers to access
the money market and the capital market for lapping a large volume of resources from
a wider range of the investing public. These services provided by the credit rating
agencies also assist the regulators in promoting transparency in the financial markets.
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Table 1
Activities Undertaken
Activities
CRISIL
ICRA
CARE
FITCH
Rating & Grading
Information
Research Services
Business
Advisory Services
Process
Outsourcing
Information
--
--
--
Technology Services
Rating and Grading Services
Credit rating is the symbolic indicator of the relative capability of the corporate entity
to timely service its debt obligations, whereas grading is done to assess the quality of
performance of that particular entity. Ratings may be changed, qualified, placed on
rating watch or withdrawn as a result of changes in, additions to, accuracy of,
unavailability of or inadequacy of information or for any related reason. Different
types of rating and grading services provided by all rating agencies are shown below
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Table 2
Activities Undertaken
Rating/Grading
CRISIL
ICRA
CARE
FITCH
debt
of
Corporate Governance rating
Structured Finance/ Obligation
Issuer credit rating
IPO Grading
Loan/ Bank Loan rating
Healthcare
Rating of Subsidiaries & Joint
Rating of long /medium-term
debt instrument
Rating
of
short-term
instrument
Claims
paying
ability
insurance company
rating
Grading of Mutual Funds/Bond
Funds
Grading of real estate/ Project
finance rating
Assessment
of
State
Governments/ Rating of Urban
Local Bodies
Micro Finance Institution(MFI)
Grading
Grading of Maritime Training
--
Course
Grading
of
--
--
--
--
Institutions
--
Ventures of MNCs in India
SSI/ SME rating
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Information and Advisory Services
The information and advisory services are the next very important activity being
undertaken by rating agencies, which include information services, advisory services,
project and infrastructure advisory services, investment and risk management
advisory, Financial Restructuring advisory, etc. as highlighted in Table 3
Table 3
Information and Advisory Services
Services
CRISIL
ICRA
CARE
FITCH
Information Services
Advisory Services
Project/ Infrastructure Advisory
Investment & Risk Management
---
--
Advisory
Financial Restructuring Advice
--
Credit Appraisal System
--
--
--
--
Research Activities
Some Indian credit rating agencies have set up research arms to complement their
rating activities. These arms carry out research on the economy, industries and
specific companies, and make the same available to external subscribers for a fee.
Research being done by various agencies present an in-depth analysis into the matter
being researched and helps various users to properly make use of that information in
future planning or some policy formulation. In addition, they disseminate opinions on
the performance of the economy or specific industries. The research is also used
internally by the rating agencies for arriving at their rating opinions.
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Table 4
Research Services
Services
CRISIL
ICRA
CARE
FITCH
Industry/ Sector Analysis
Corporate Analysis
Customized Research
-
Equity Research
-
-
Business Process Outsourcing
Business process outsourcing services are being provided by CRISIL as well as
ICRA. These agencies provide knowledge process outsourcing to various financial
institutions, investment banks, private equity firms and consulting companies at the
global level, and help them to achieve sustainable competitive advantage. The
outsourcing services being provided include financial modeling, data analysis
valuation, outsourced research, financial assets pricing, etc. CRISIL provides
knowledge process outsourcing through one of its divisions called „Irevna‟, whereas
ICRA is involved in this service through its subsidiary ICRA Online Limited.
Information Technology Services
Information and Technology services are provided by ICRA only through its
subsidiary ICRA Techno Analytics Limited (ICTEAS). ICTEAS provides IT products
and solutions along with engineering services. It provides onsite and offshore design
expertise in the areas like automotive, plant design, construction and instrumentation
space.
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6.2 Instruments And Products Rated By Rating Agencies
The primary focus of the rating exercise is to assess the adequacy to meet debt
obligations of a particular instrument in adverse conditions. Different types of
products and instruments are being rated by all the rating agencies as shown Below
Table 4 - Instruments & Products Rated
CRISIL
ICRA
Long & Medium
Long
Term Instruments
Instruments
Term Long
Debentures Debenture
Bonds
Preference Preference shares Bonds
Obligations
Certificates
Loans/Bank
Structured
Obligations
of
Convertible
Short-Term
Short-Term
Preference Shares
Instruments
Instruments
Loans/Bank Loan
Short-term deposits
Loans
Loans/Bank Loans
of Medium-Term
Notes
Fixed deposits
Certificates
of
Deposit
Preference Shares
Redeemable
Commercial Papers Commercial
Bonds
Deposit
Deposit
Debentures
Fixed deposits
of Fixed deposits
Deposit
Term
Instruments
Debentures
Medium-Term
deposits Instruments
Certificates
Medium Long
Certificates
Structured
Fixed
&
Non-convertible
Bonds
Bank Loans
FITCH
Term Instruments
shares
CARE
Commercial
Papers
Preferred Stock
Papers
Short-Term
Loans
Instruments
Loans
Commercial Papers
Loans
IPOs
Others
Mutual
IPOs
Funds
Mutual funds
Others
Others
IPOs
IPOs
Mutual funds
Mutual funds
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Rating Fees:
In the credit rating business, the users of rating service, such as investors, financial
intermediaries and other end- users, do not pay for it. The issuer of the financial
instrument pays fees to the credit rating industry and this is the major source of
revenue to the rating agency. Today issuer’s fees constitute 95% of the total revenues
of the rating agencies. In India rating agencies charge 0.1 % of the instrument size as
rating fees. They also charge an annual surveillance fees at a rate of 0.03% to monitor
the instrument during his life.
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6.3 Rating Symbols
Rating agencies use symbols such as AAA, AA, BBB, B, C, D, to
convey the safety grade to the investor. Ratings are classified into three grades:
High Investment Grades
Investment Grades
Speculative Grades.
In all ratings is classified into 14 or 15 categories. Signs “+” or “-” are used to show
the certainty of timely payment. The suffix + or – may be used to indicate the
comparative position of the instrument within the group covered by the symbol. Thus
FAA- lies one notch above FA+. To provide finer gradations, rating industry attach +
or – to their ratings. The rating symbols for different instruments of the same
company need not necessarily be the same.
High Investment Grades
AAA: - Triple A denotes highest safety in terms of timely payment of interest and
principal. The issuer is fundamentally strong and any adverse changes are not going to
affect it.
AA: - Double A denotes high safety in terms of timely payment of interest and
principal. The issuer differs in safety from AAA issue only marginally.
Investment Grades
A : - denotes adequate safety in terms of timely payment of interest and principal.
Changes in circumstances can adversely affect such issues.
BBB: - Triple B denotes moderate safety in terms of timely payment of interest and
principal speculative grades.
Speculative Grades
BB: - Double B denotes inadequate safety terms of timely payment of interest and
principal. Uncertain changes can lead to inadequate financial capacity to make timely
payments in the immediate future.
B: - denotes high risk. Adverse changes could lead to inability or unwillingness to pay
timely payment.
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C: - denotes substantial risk. Issue rated is vulnerable to default.
D: - denoted default in terms of timely payment of interest and principal.
These symbols are just a current opinion of an agency and they are not
recommendations to invest or not to invest. The rating assigned applies to a particular
instrument of the company and is not a general evaluation of the company.
Table 1
Rating Symbols for Long-term Instruments
CRISIL
ICRA
CARE
FITCH
EXPLANATION
AAA
LAAA
CARE
AAA (ind) Highest Safety
AAA
AA
LAA
CARE AA
AA (ind)
High Safety
A
LA
CARE A
A (ind)
Adequate Safety
BBB
LBBB
CARE
BBB (ind)
Moderate Safety
BBB
BB
LBB
CARE BB
BB (ind)
Inadequate Safety
B
LB
CARE B
B (ind)
High Risk (ICRA Risk Prove)
C
LC
CARE C
C (ind)
Substantial Risk (ICRA Poor
Credit Quality)
D
LD
CARE D
D (ind)
Default (ICRA Lowest Credit
Note :1) AAA to BBB fall in investment grade
2) BB and below fall in speculative grade
3) For CRISIL, High Investment Grade, Viz. AAA And AA; Investment Grade, Viz. A
and BBB; and Speculative Grade, Viz. BB To D
4) ICRA uses prefix of letter "L" in every symbol, CARE uses as prefix the word
"CARE" symbol, whereas FITCH uses suffix "(ind)" in every symbol.
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Table 2
Rating Symbols for Medium-term Instruments
CRISIL
ICRA
CARE
FAAA
MAAA CARE
FITCH
AAA tAAA
(FD)/(CD)
FAA
MAA
EXPLANATION
Highest safety
(ind)
CARE
AA tAA (ind)
High safety
(FD)/(CD)
FA
MA
CARE A (FD)/(CD)
--
--
CARE
tA (ind)
BBB --
(FD)/(CD)
--
--
Adequate safety
Sufficient
safety(CARE
only)
CARE BB (FD)/(CD
--
Inadequate
safety(CARE
only)
FB
MB
CARE B (FD)/(CD
tB (ind)
Inadequate
safety(CARE
susceptible to default)
FC
MC
CARE C (FD)/(CD
tC (ind)
High risk
FD
MD
CARE D (FD)/(CD
tD (ind)
Default
NOTE :
1) 'F'
= fixed deposits of companies
2) 'M' = medium-term instruments
3) 'FD' = fixed deposits
4) 'CD' = certificates of deposit
Table 3
Rating Symbols for Short-term Instruments
CRISIL ICRA
CARE
FITCH
EXPLANATION
P1
A1
PR1
F1 (ind)
Highest credit quality /safety
P2
A2
PR2
F2 (ind)
Above average
credit
quality/Strong
safety.
P3
A3
PR3
F3 (ind)
Adequate credit quality/ safety
P4
A4
PR4
F4 (ind)
Risk prone/Highly uncertain
P5
A5
PR5
F5 (ind)
Lowest credit quality/Default
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Table 4
Rating Symbols Used for Claims Paying Ability of Insurance Company
CRISIL ICRA
CARE
FITCH
EXPALNATION
AAA
CARE
AAA
Highest ability to repay policyholder's
AAA(In)
(ind)
claims
CARE
AA (ind) High ability to repay policyholders
AA
iAAA
iAA
AA(In)
A
iA
CARE A(In)
claims
A (ind)
Adequate
ability
to
repay
to
repay
to
repay
policyholders claims
BBB
BB
iBBB
iBB
CARE
BBB
Moderate
BBB(In)
(ind)
policyholders claims
CARE
BB (ind)
Inadequate
BB(In)
B
iB
CARE B(In)
ability
ability
policyholders claims
B (ind)
Weak ability to repay policyholders
claims
C
IC
CARE C(In)
C (ind)
Lowest/poor
ability
to
repay
policyholders claims
D
--
CARE D(In)
D (ind)
Default to repay policyholders claims
Table 5
Rating Symbols Used for Mutual Funds Grading
CRISIL ICRA
CARE
FITCH
EXPLANATION
AAAf
CARE AAAf
AAA
Minimal Credit Risk
mfAAA
(ind)
AAf
mfAA
CARE AAf
AA (ind)
Very Low Credit Risk
Af
mfA
CARE Af
A(ind)
Low Credit Risk
BBBf
mfBBB
CARE BBBf
BBB
Moderate Credit Risk
(ind)
BBf
mfBB
CARE BBf
BB (ind)
High Credit Risk
Bf
mfB
CARE Cf
B (ind)
Very High Credit Risk
Cf
mfC
CARE Df
C (ind)
Extremely Higher Credit Risk
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Table 5
IPO Grading Symbols
CRISIL ICRA
5/5
Grade 5(ind) issuers concerned
Grade 4
Grade 4(ind) of the issuers concerned
Grade 3
Grade 3(ind) issuers concerned
IPO Grade CARE IPO FITCH IPO Below average fundamentals
2
1/5
Grade 5
IPO Grade CARE IPO FITCH IPO Average fundamentals of the
3
2/5
EXPLANATION
IPO Grade CARE IPO FITCH IPO Above average fundamentals
4
3/5
FITCH
IPO Grade CARE IPO FITCH IPO Strong Fundamentals of the
5
4/5
CARE
Grade 2
Grade 2(ind) of the issuers concerned
IPO Grade CARE IPO FITCH IPO Poor
1
Grade 1
fundamentals of the
Grade 1(ind) issuers concerned
These are the main Sector in which Credit Rating Agencies gives rating to various
Products & Instruments involved. Rating symbols used by all agencies vary from each
other in one way or the other in order to differentiate the symbols of all the agencies
from one another.
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Table 6
Micro Finance Institutions Grading Symbols
CRISIL ICRA CARE FITCH
EXPLANATION
mfR1
M1
MF1
F1
Highest ability to manage activities
mfr2
M2
MF2
F2
High ability to manage activities
mfR3
M3
MF3
F3
Moderate ability to manage activities(CRISIL
adequate ability)
mfR4
M4
MF4
F4
Below
average
ability
to
manage
activities(CRISIL- sufficient ability)
mfR5
M5
MF5
F5
Weak ability to manage activities(CRISILbelow average ability
mfR6
--
--
--
Poor ability to manage activities(CRISIL only)
mfR7
--
--
--
Very poor ability to manage activities(CRISIL
only)
mfR8
--
--
--
Poorest ability to manage activities(CRISIL
only)
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6.4 METHODOLOGY ADOPTED
Rating methodology is concerned with the use and appreciation of the tools in rating
process. Both qualitative as well as quantitative factors are considered by the agencies
before assigning any rating
CRISIL Rating Methodology:
CRISIL assesses all the factors that could affect credit worthiness of the borrowing
company and then assigns rating to debt instruments. The key factors, considered for
rating assessment are:
1) Business Analysis:
Every relevant piece of information concerning the business is evaluated by assessing
industrial risk, market position of the company within industry, operating efficiency
and legal position.
2) Financial Analysis:
Under financial analysis, all relevant aspects connected with the business and
financial position of the company are assessed. The profitability, solvency and
liquidity ratios are taken into consideration. Thus, CRISIL considers Growth rate of
PAT, PAT/OI, PBIT/Net Worth, Earnings on Capital Employed, PBDITA/TI, Current
Ratio, Quick Ratio, Debt to Equity Ratio, Interest Coverage Ratio, Pre-tax Coverage
Ratio, Earnings on Assets to Capital Employed, etc.
3) Management Evaluation:
Judgment of management performance based on past operating and financial results,
planning and control system of management, depths of managerial talents are
considered.
4) Regulatory and Competitive Environment:
CRISIL evaluates structure and regulatory framework of financial system in which it
works.
5) Fundamental Analysis: It covers aspects on liquidity management (capital structure),
asset quality, economic as well as industrial analysis of that particular entity to take
the rating decision accordingly.
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ICRA Rating Methodology:
While assigning ratings ICRA considers all relevant factors that have a bearing on the
future cash generation of the issuer. A detailed analysis of the past financial
statements is made and estimates of future earnings under various scenarios are drawn
up, over the tenure of the instrument being rated. The other factors considered are:
1)Industry Characteristics:
Industrial features are evaluated by ICRA by taking into account various success
factors, demand and supply position, structure of industry and Government policies
related to that particular entity.
2)Competitive Position:
The competitive position of the issuer is evaluated by considering various factors
including nature and basis of competition, competitive advantage through marketing
and distribution, strength, weaknesses and opportunities available to the issuer in
comparison to the competitors.
3) Financial Risk Analysis:
Under this, ICRA considers various accounting policies, debt servicing track record,
cash flow position, profitability position and capital structure of the issuer. The ratios
considered specifically for the purpose include: Profit after Tax /Total Income, Profit
Before Depreciation Interest and Tax/Total Income, Earnings Before Depreciation
Interest and Tax/ Interest and Fixed Charges, Return on Capital Employed, Return on
Net Worth, Total Debt/ Net Worth, Current Ratio, Quick Ratio, Cash Accrual Ratio
and so on.
4) Operational Efficiency:
Operational efficiency of the company is assessed by evaluating the price or cost
advantage availability, cost and quality of raw material, availability of labour and
labour relations prevalent in the organization.
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5) Management Quality:
The quality of the management is evaluated by observing the goals and philosophies
of the management, and its strategies and abilities to overcome adverse situations.
6)Commitment to New Projects:
ICRA also evaluates the company's commitment to new projects by estimating its
progress in the initial stages and from past performance on similar projects.
7) Funding Policies of the Issuer:
The funding policies of the issuer are also evaluated to get the deep knowledge of the
sources of funds of the issuer company and the uses to which these funds have been
put into.
CARE Rating Methodology:
CARE also takes into account various quantitative as well as qualitative factors while
assigning rating which include:
1)Economy and Industry Risk:
The factors assessed by CARE include the effect of economic cycle on industry,
business cycles, tariff structure, basis of competition, environmental as well as
political factors concerning the issuer's business.
2)Business Risks (Competitor's Assessment):
Factors considered under this are size of company and market share, supply of raw
material and marketing arrangements, bargaining power of issuers, suppliers as well
as customers, and location advantages and disadvantages available to the business of
the issuer.
3)Financial Risk:
It includes analysis of financial management, capital structure, cash flow adequacy
and profitability as well as liquidity position of the company. The financial risk is
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evaluated by CARE by considering various ratios including, Growth in total Income,
Profit after Tax/Total Income, Profit before Depreciation Interest and Tax/ Total
Income, Return on Capital Employed, Return on Net Worth, Debt-Equity Ratio,
Interest Coverage Ratio, Overall Gearing Ratio, Current Ratio, Quick Ratio and
Average Collection Period.
4)Management Assessment:
CARE makes complete assessment of the background and history of the issuer,
corporate strategy adopted, philosophy and quality of management and the strength of
management capabilities under stress.
5) Terms of Instrument: Rating also depends on such factors as maturity of
instrument, nature of security (whether secured or unsecured), repayment terms,
coupon rates, etc. So, CARE also considers all these things before the assignment of
rating.
FITCH Rating Methodology:
FITCH rating analysis involves the assessment of the following:
1)Past Years’ Rating Methodology:
While assigning ratings FITCH takes into account last few years "rating
methodology" on the basis of which rating was done.
2)Past Years’ Financial Data:
The ratios considered by FITCH while evaluating the past years‟ financial data
include, Profit Before Depreciation Interest and Tax/ Total Income, Profit after
Tax/Total Income, Return on Capital Employed, Return on Net Worth, Operating
Profit/ Profit after Tax, Working Capital Turnover Ratio, Average Collection Period,
Debt-Equity Ratio, Interest Coverage Ratio, Current Ratio and Quick Ratio.
3)Forecast of Future Performance:
It means how much the business will be able to earn in future which will be helpful in
repayment of principal amount borrowed and interest thereof.
4)Comparison of Company’s Performance with the Competitors:
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Under this the agency compares the performance of the company being rated with
that of the competitors in the field to properly assess the relative standing of the
company
5)Analysis of Company’s Ability to Generate Cash from Operations:
The Company's ability to generate cash in future is also assessed by the agency to
find out the relative capability of the business to repay its obligations in time.
6.5 RATING PROCESS ADOPTED
Rating is a multi-layered decision-making process which requires interactive dialogue
with the issuer. The rating process is a fairly detailed exercise that starts with a rating
request from the issuer, the signing of a rating agreement and continues up to the
surveillance of rating. It involves among other things, analysis of published financial
information, visits to issuer's offices and work places, and intensive discussions with
issuer's auditors, bankers, creditors, etc. It also involves an in-depth study of the
industry itself and a degree of environment scanning. The rating process of various
rating agencies is explained below:
CRISIL Rating Process
The process of rating starts with a rating request from the issuer, and the signing of a
rating agreement. CRISIL‟s rating process normally takes three to four weeks.
However, rating can be arrived at shorter timeframes, to meet urgent requirements.
The CRISIL rating process includes the following steps:
1. Request for Rating:
The rating process starts with the issuer's request for rating. Then the rating agreement
is signed between the client and the rating agency. The rating agency assigns a rating
team for the purpose, and the client provides the relevant information to the rating
team along with the rating fees.
2. Analysis of Information:
The rating team conducts the preliminary analysis of the information provided by the
client. The team also conducts the site visits for the purpose of analysis.
3. Meeting:
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Then the meetings between the rating team and management of the issuer are
conducted and the rating team does the final analysis of the information after
clarification of any doubts in the management meeting.
4. Assignment of Rating:
The rating team presents its analysis to the rating committee which assigns the rating
to the given instrument and communicates the same to the issuer. The rating is then
accepted by the issuer or the issuer may appeal the rating agency to further refine the
rating.
5. Dissemination of Rating:
In case the rating is accepted by the issuer it is disseminated to CRISIL's subscriber
base, and to the local and international news media. Rating information is also
updated on line on the website of rating agency.
6. Continuous Surveillance:
All ratings are kept under continuous surveillance throughout its validity by the rating
agency.
ICRA Rating Process
The Rating involves assessment of a number of qualitative factors with a view to
estimating the future earnings of the issuer. This requires extensive interactions with
the issuer's management, specifically on subjects relating to plans, outlook,
competitive position, and funding policies. Thus, the following steps are included in
the ICRA rating process:
1. Formal Request for Rating:
ICRA‟s rating process is initiated on receipt of a formal request (or mandate) from the
prospective issuer.
2. Setting of Rating Team and Analysis of Information:
A Rating team, which usually consists of two analysts with the expertise and skills
required to evaluate the business of the issuer, is involved with the Rating assignment.
An issuer is provided a list of information requirements and the broad framework for
discussions. Then the Rating team analyzes that information.
3. Interaction with the Management of the Issuer:
Then there are extensive interactions between Rating Team and the issuer's
management, specifically on subjects relating to plans, outlook, competitive position,
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and funding policies. In some cases where the agency finds it necessary, the site visits
may be done by the rating team for proper analysis of information.
4. Preparation of Rating Report:
After completing the analysis, a Rating Report is prepared by the Rating Team, which
is then presented to the ICRA Rating Committee. A presentation on the issuer's
business and management is also made by the Rating Team.
5. Assignment of Rating:
The Rating Committee which is the final authority for assigning Ratings assigns the
rating. The assigned Rating, along with the key issues, is communicated to the issuer's
top management for acceptance. Non-accepted Ratings are not disclosed and
complete confidentiality is maintained on them unless such disclosure is required
under any laws/regulations.
6. Review of Ratings:
If the issuer does not find the Rating acceptable, it has a right to appeal for a review.
Such reviews are usually taken up if the issuer provides certain fresh inputs. During a
review, the issuer's response is presented to the Rating Committee. If the inputs and/or
fresh clarifications so warrant, the Rating Committee would revise the initial Rating
decision.
7. Mandatory Surveillance:
As part of a mandatory surveillance process, ICRA monitors all accepted Ratings over
the tenure of the Rated instruments. The Ratings are generally reviewed once every
year, unless the circumstances of the case warrant an earlier review. The Rating
outstanding may be retained or revised (that is, upgraded or downgraded) on
surveillance.
CARE Rating Process
CARE rating process largely depends on the flow of information from client. Rating
decisions are made by rating committee. The CARE rating process includes the
following steps:
1. Request for Rating and Assignment of Rating Team:
The client requests the agency for rating and after signing of agreement between both
a rating team is assigned for the purpose by the rating agency.
2. Analysis of Information:
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The client is required to submit information and detailed schedules and proper
analysis of that information is done by the agency.
3. Interaction with the Client:
After the analysis of data by the rating team, the team interacts with the client, and the
client responds to the queries raised by the team and provides the additional data as
required by the team. Further, the team undertakes the site visits and analyzes the
additional data submitted by the client.
4. Assignment of Rating:
The internal committee of rating agency reviews the analysis and then the Rating
committee assigns rating to the client. The rating so assigned is communicated to the
client. The client may then accept the rating or it may ask for review of rating in
which case the client has to furnish additional information for the purpose.
5. Publishing of Rating:
In case the client accepts the rating then the rating agency will give the notification
about such rating in the press, otherwise CARE will not publish the rating.
6. Review of Rating:
Each rating is then reviewed formally at least once a year when the analyst of rating
agency meets the issuer's management.
FITCH Rating Process
The FITCH rating process includes the following steps:
1. Rating Agreement Signed:
The rating agreement is signed between the rating agency and the entity wanting to
get its instrument rated.
2. Review of Publicly Available Information:
FITCH‟s analysis and rating decisions are based on information received from
sources known to it and believed by FITCH to be relevant to the analysis and rating
decision. This includes publicly available information on the issuer, such as company
financial and operational statistics, reports filed with regulatory agencies, and industry
and economic reports. In addition, the rating process may incorporate data and insight
gathered by analysts in the course of their interaction with other entities across their
sector of expertise.
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3. Questions Sent to Issuer:
In addition to review of publicly available information the rating agency needs to ask
certain special questions from the issuer in order to get out the information (that is not
available otherwise) about the instrument. The issuers are required to reply within the
stipulated period and that too before the management meeting.
4. Management Meeting:
After having received the replies from the issuers, the rating agency conducts the
meeting with the management to discuss the relevance of information collected about
particular instrument.
5. Further Analysis:
After having discussions in the management meeting the rating agency goes for
further detailed analysis about the product or instrument to be rated.
6. Credit Committee Presentation and Draft Report:
The credit committee (which if formed specifically for the purpose) gives the
presentation of its analysis and a draft report is prepared for the same.
7. Rating Committee Review and Discussion:
After getting the draft report from the credit committee, the rating committee reviews
it. The rating committee considers the relevant quantitative and qualitative issues, as
defined in FITCH‟s established criteria and methodologies, to arrive at the rating that
most appropriately reflects both the current situation and prospective performance.
Then the rating decision is communicated to the company and the company accepts
that rating.
8. Preparation of Final Rating Report and Press Release:
Once the rating is communicated to the company, it passes comments on the rating
decision and after that a final rating report is prepared and rating is communicated to
the public through a press release and full rating report is made available to the
subscribers.
9. Ongoing Dialogues and Application of Rating to the New Issues:
After the completion of the rating process, the rating assigned is continuously
reviewed by the agency and the agency continues its dialogue with the company for
further rating of new issues.
Thus, almost similar steps are followed by all the rating agencies as the Rating
process is initiated on receipt of a formal request and it ends with the continuous
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review of ratings in all the cases. Rating decisions are made in accordance with the
criteria applicable to that sector.
The methodologies and criteria that determine rating levels are created and revised by
the analytical groups. Each of the analytical group considers the appropriateness of its
criteria and models as individual transactions are rated. As far as rating methodology
is concerned almost similar parameters are considered by all the agencies under study.
Moreover, these agencies rate similar types of instruments and products with only few
differences in them. However, during the period 2001-09, the maximum number of
instruments, i.e., 16,762 have been rated by CRISIL. This is followed by CARE,
ICRA and FITCH with 3075, 2929 and 1475 instruments respectively during the
period.
Thus, for better understanding of how RATING METHODOLOGY has effects on
rating of various products and instruments we would consider and compare the Data
from CRISIL only as it has rated maximum number of instruments among the major 4
Agencies so as to have a clear and better understanding.
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7. BOND RATING METHODOLOGY
Objective
The main objective of the paper is to assess the consistency in rating methodology of
rating agencies by verifying some of the common factors which determine the bond
ratings. Consistency in rating methodology of each individual rating agency is
assessed by taking companies belonging to same rating class (within group) including
AAA, AA, A and BBB as sample.
Methodology And Data Collection
The study is based on the Secondary Data. It is a study of four old SEBI recognized
rating agencies including CRISIL, ICRA, CARE and FITCH. The time period of the
study is from April 2001 to March 2006. Bond rating methodology has been analyzed
corresponding to eight variables, viz. four liquidity as well as solvency ratios and four
profitability ratios.
The short-term liquidity ratios considered are Current ratio and Quick ratio whereas
long-term solvency ratios include Debt-equity ratio and Interest Coverage ratio.
Further the profitability ratios selected include Return on Capital Employed, Return
on Net Worth, Profit after tax/Total Income (PAT/TI), and Profit before depreciation,
interest and tax/Total Income (PBDITA/TI). These financial ratios are selected as
these are commonly used by all the credit rating agencies and some of the previous
studies also support these ratios. The data regarding various rating grades has been
collected from the reports of the rating agencies including various issues of CRISIL
Rating Scan, ICRA Rating Profile and CARE Rating View, websites of these rating
agencies. Further, the data relating to various financial ratios relating to the given
period has also been collected from various sources available online.
For all the rating grades F-values using Analysis of Variance (ANOVA) is calculated
for all the eight financial ratios selected. 25 per cent of the total number of
manufacturing and trading companies whose debentures and bonds are rated by each
rating agency during the time period 2001-02 to 2005-06 are taken as sample.
Companies selected for each rating agency are further divided into four groups viz.
AAA, AA, A and BBB. These rating categories have been chosen in the light of the
fact that majority of rated companies fall under these rating classes. The main
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core of the analysis is that in case of within group sample companies, variance in
mean values of ratios should be minimum. All calculations are done with the help of
Statistical Package for Social Sciences (SPSS) version .
Limitations
1.The data taken, has been drawn on convenience and judgment basis & also
secondary in nature. Thus, It may vary from the actual result
2. Different quantitative and qualitative factors are considered by various rating
agencies while assigning a rating grade, whereas in the present study only quantitative
factors including eight financial ratios have been used to assess the consistency in
rating methodology. Therefore, the results of the study should be interpreted with
caution.
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Results
A) Comparison of AAA Rated Companies ‘AAA’
Table 1 : Consistency in Bond Rating Methodology in case of AAA Rating Grade
RATIOS
CRISIL
F
ICRA
Sig.
Values
F
CARE
Sig.
F Values
FITCH
Sig.
Values
F
Sig.
Values
Current Ratio
1.14
0.35
0.17
0.85
0.94
0.48
1.81
0.31
Quick Ratio
0.52
0.61
0.67
0.55
1.73
0.32
0.90
0.50
Debt-Equity
1.32
0.30
1.29
0.34
0.80
0.53
0.51
0.64
1.52
0.26
1.07
0.40
0.39
0.71
0.95
0.48
on 1.31
0.31
1.11
0.39
0.80
0.53
0.41
0.69
Return on Net 1.43
0.28
0.49
0.64
0.16
0.86
0.25
0.79
after 0.08
0.93
1.68
0.26
58.189*** 0.00
0.16
0.86
0.70
0.51
1.49
0.30
2.13
0.16
0.87
Ratio
Interest
Coverage Ratio
Return
Capital
Employed
Worth
Profit
Tax/Total
Income
PBDITA/Total
0.27
Income
*** denotes Significant at 1 per cent level.
"AAA" ratings denote the highest credit quality. The rated instrument carries the
lowest expectation of credit risk. The above table mentions the F-values of eight
financial ratios of different companies which were assigned AAA rating grade by
CRISIL, ICRA, CARE and FITCH respectively. It is clear from the table that as far as
companies rated by CRISIL,ICRA & FITCH. are concerned, none of the financial
ratios have significant F-values. Thus, the methodology adopted by all 3 Agencies
while assigning AAA rating grade was consistent as similar ratios were considered
while assigning equivalent rating grade.
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Whereas, companies rated by CARE are concerned, the table highlights that the Fvalue for Profit after tax/Total income is significant while F-values for all other ratios
are not significant. It implies that the Profit after tax/Total income ratio of various
companies which were assigned AAA rating by CARE significantly differ from each
other whereas all other ratios do not vary significantly from each other.
B) Comparison of AA Rated Companies
Table 2 : Consistency in Bond Rating Methodology in case of AA Rating Grade
RATIOS
CRISIL
F
ICRA
Sig.
Values
F
CARE
Sig.
Values
F
FITCH
Sig.
Values
F
Sig.
Values
Current Ratio
3.43
0.07
0.68
0.54
1.37
0.38
0.71
0.56
Quick Ratio
5.144** 0.02
0.27
0.77
0.90
0.50
0.33
0.74
Debt-Equity
1.55
0.25
0.12
0.89
0.72
0.56
1.51
0.35
Interest Coverage 2.00
0.18
1.04
0.41
0.39
0.71
1.30
0.39
0.10
1.16
0.38
0.40
0.70
2.18
0.26
Net 2.28
0.15
0.07
0.93
0.32
0.75
1.57
0.34
after 1.73
0.22
1.71
0.26
0.03
0.97
0.63
0.59
0.29
2.22
0.19
0.72
0.56
0.10
0.91
Ratio
Ratio
Return on Capital 2.85
Employed
Return
on
Worth
Profit
Tax/Total Income
PBDITA/Total
1.37
Income
**Significant at 5 per cent level
It is clear from the table that in case of CRISIL, only quick ratio has significant Fvalue. It means the Quick Ratio of different sets of companies which were assigned
"AA" rating grade by CRISIL is different from each other, while as far as all other
ratios are concerned CRISIL had considered similar ratios while assigning AA rating.
While, F-values of the eight financial ratios of the companies which were assigned
AA rating by ICRA,CARE & FITCH are significant. It implies that there is no
significant difference between the values of various ratios of the companies which
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were assigned . Thus there was consistency in rating methodology while assigning
AA rating grade to different companies during the given period.
C) Comparison of A Rated Companies
Table 3 : Consistency in Bond Rating Methodology in case of A Rating Grade
RATIOS
CRISIL
F
Values
ICRA
Sig.
F
CARE
Sig.
Values
F
FITCH
Sig.
Values
F
Sig.
Values
Current Ratio
0.56
0.59 1.22
0.36
1.02
0.46
0.58
0.62
Quick Ratio
1.01
0.39 2.03
0.21
1.09
0.44
0.44
0.68
Debt-Equity
0.90
0.43 0.19
0.83
0.59
0.61
0.11
0.90
1.36
0.30 1.52
0.29
3.11
0.19
1.21
0.41
on 1.09
0.37 1.27
0.35
3.33
0.17
0.57
0.62
Return on Net 0.74
0.50 0.69
0.54
3.77
0.15
0.52
0.64
after 0.97
0.41 1.16
0.37
3.85
0.15
0.73
0.56
0.17
0.85 1.73
0.26
2.39
0.24
7.34
0.07
Ratio
Interest Ratio
Return
Capital
Employed
Worth
Profit
Tax/Total
Income
PBDITA/Total
Income
The Table 3 points out that the F-values of all the ratios are not significant in case of
A rated companies by CRISIL, CARE & FITCH as which means that there is no
significant difference in the similar ratios of A rated companies. Thus, Thus, the
methodology adopted all 3 above while assigning A rating grade was consistent as
similar ratios were considered while assigning similar rating grade. As far as the Fvalues of different ratios of various A rated companies by FITCH are concerned, it is
visible from the table that all the ratios have in-significant F-values. Thus it is clear
that methodology used by FITCH to assign rating grade A is consistent over the
period of the study.
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D) Comparison of BBB Rated Companies
Table 4 : Consistency in Bond Rating Methodology in case of "BBB" Rating Grade.
RATIOS
CRISIL
F
ICRA
Sig.
Values
F
CARE
Sig.
Values
F
FITCH
Sig.
Values
F
Sig.
Values
Current Ratio
1.63
0.24
0.26
0.78
2.42
0.24
0.40
0.70
Quick Ratio
2.05
0.17
0.26
0.78
3.60
0.16
0.32
0.75
Debt-Equity
0.26
0.77
0.44
0.67
1.61
0.34
1.06
0.45
3.24
0.08
0.95
0.44
1.07
0.45
2.67
0.22
on 3.31
0.07
2.13
0.20
1.21
0.41
2.44
0.24
Return on Net 3.33
0.07
2.22
0.19
1.53
0.35
4.40
0.13
after 2.07
0.17
3.00
0.13
0.97
0.47
1.67
0.33
1.30
0.31
0.72
0.53
0.74
0.55
6.55
0.06
Ratio
Interest Ratio
Return
Capital
Employed
Worth
Profit
Tax/Total
Income
PBDITA/Total
Income
The F-values are not significant for any of the ratios belonging to BBB rated
companies by CRISIL,ICRA, CARE & FITCH. This highlights that during the period
of study, the financial]ratios of the companies belonging to similar BBB rating are not
significantly different from each other. This depicts the consistency in rating
methodology of all 4 during the period under study.
CONCLUSION :
It has been assessed from the above analysis that all the rating agencies use consistent
methodology while assigning a particular rating grade as there is no significant
difference in the value of all the ratios which belong to different sets of similarly rated
companies. The only exception to this is PAT/TI ratio of AAA rated companies by
CARE and quick ratio of AA rated companies by CRISIL as there is significant
difference in these ratios.
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8. IPO GRADING PROCESS
Introduction
IPO grading is the grade assigned by a Credit Rating Agency registered with SEBI, to
the initial public offering (IPO) of equity shares or any other security which may be
converted into or exchanged with equity shares at a later date. The grade represents a
relative assessment of the fundamentals of that issue in relation to the other listed
equity securities in India. Such grading is generally assigned on a five-point point
scale with a higher score indicating stronger fundamentals and vice versa as below.
IPO grading has been introduced as an endeavor to make additional information
available for the investors in order to facilitate their assessment of equity issues
offered through an IPO.
IPO grading can be done either before filing the draft offer documents with SEBI or
thereafter. However, the Prospectus/Red Herring Prospectus, as the case may be, must
contain the grade/s given to the IPO by all CRAs approached by the company for
grading such IPO.
The company desirous of making the IPO is required to bear the expenses incurred for
grading such IPO.
IPO grading is not optional. A company which has filed the draft offer document for
its IPO with SEBI, on or after 1st May, 2007, is required to obtain a grade for the IPO
from at least one Credit Rating Agency.
IPO grade/s cannot be rejected. Irrespective of whether the issuer finds the grade
given by the rating agency acceptable or not, the grade has to be disclosed as required
under the DIP Guidelines. However the issuer has the option of opting for another
grading by a different agency. In such an event all grades obtained for the IPO will
have to be disclosed in the offer documents, advertisements etc
No other country in the world carries out IPO grading and therefore it is necessary to
see the usefulness of the process. Initial Public Offering, also referred to simply as a
"public offering," is the first sale of stock by a private company to the public. A
company can raise money by issuing either debt or equity. If the company has never
issued equity to the public, it's known as an IPO. IPOs can be a risky investment for
investors.
Therefore, for the individual investor, it is tough to predict what the stock will do on
its initial days of trading and in the near future since there is often little historical data
with which to analyze the company. Also, mostly IPOs are done by the companies
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which are going through a transitory growth period, and they are therefore subject to
uncertainty regarding their future value.
IPO Grading Symbols
CRISIL ICRA
5/5
Grade 5
Grade 4
Grade 3
Grade 4(ind) of the issuers concerned
Grade 3(ind) issuers concerned
IPO Grade CARE IPO FITCH IPO Below average fundamentals
2
1/5
Grade 5(ind) issuers concerned
IPO Grade CARE IPO FITCH IPO Average fundamentals of the
3
2/5
EXPLANATION
IPO Grade CARE IPO FITCH IPO Above average fundamentals
4
3/5
FITCH
IPO Grade CARE IPO FITCH IPO Strong Fundamentals of the
5
4/5
CARE
Grade 2
Grade 2(ind) of the issuers concerned
IPO Grade CARE IPO FITCH IPO Poor
1
Grade 1
fundamentals of the
Grade 1(ind) issuers concerned
Accordingly, IPO Grading methodology examines the following key fundamentals:
Business and Competitive Position ‐The alignment between industry opportunities the
company's strategy and objectives
Financial Position and Prospects ‐ Forward looking assessment of key
financial indicators such as ROE, EPS, P/E, growth in profit, relevant
for
an equity investor.
Management Quality – An evaluation of the ability of the management to
handle uncertainty in terms of capitalizing on future business opportunity
and mitigating the impact of contingencies
Corporate
Governance
practices
–
An
evaluation
of
the
company’s
governance architecture to determine if it is structured such that the risks and
rewards of business are equally available to all shareholders.
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Normally, grading is done looking at roughly a three year time horizon and would
involve an in‐depth assessment of the various quantitative and qualitative parameters
of the issuer
IPO grading is a onetime assessment done prior to the IPO issue and relies
significantly on the draft prospectus filed with SEBI. Normally, grading is done
looking at roughly a three-year time horizon and would involve an in‐depth
assessment of the various quantitative and qualitative parameters of the issuer. While
growth prospects of the industry and financial strength are some of the quantitative
parameters, qualitative parameters such as management capability also provide
critical input in determining a grade
SEBI’s guidelines for IPO grading
The Securities and Exchange Board of India (SEBI) had first experimented IPOs
grading on optional basis. But on the other hand, none of the promoters and lead
managers voluntarily chose to be graded even at no cost to the companies concerned.
This has led SEBI to make IPO grading compulsory for all.
The important features of SEBI's decision on IPO grading are as follows:
The grading exercise will exclude the issue price from its scope;
It will be carried out by recognized credit rating agencies;
The grading will be on a 5-point scale, the lowest grade to be indicated by 1 and the
highest by 5.
The issuing company will be allowed to choose the rating agency for grading its IPO.
Is IPO Grading Necessary?
Given that no other capital market in the world practices such a grading scheme, what
is unique about India’s capital market that calls for IPO grading? To assess the
necessity, it is prudent to first look at the views of the various stakeholders. The
primary stakeholders in this context are SEBI, the rating agencies, the firms aspiring
to issue an IPO, and the investors.
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SEBI’s View
An investor may find it challenging to appropriately assess, on the basis of the
information available on the prospectus, a firm’s business prospects and risks. SEBI’s
belief is that an IPO grade provides an additional input to investors, in arriving at an
investment decision. In recent times, with the stock market participation of new and
foreign investors increasing in India, SEBI contends that there is need for greater
value‐added information on companies tapping the capital market and their intrinsic
quality. In this context, IPO grades, being simple, objective indicators of the relative
fundamental positions of the issuers concerned, helps in both widening and deepening
the market.
SEBI believes that it has taken a pioneering role in safeguarding investors’ interest by
increasing disclosure levels by entities seeking to access equity markets for
funding. This has caused India to be amongst one of the more transparent and
efficient markets in the world.
A majority of retail investors do not read the offer document (prospectus) and even
when they do, they may not fully disseminate or comprehend the implications of the
disclosures made. Therefore, SEBI’s belief is that there is a vital need to rate equity
offerings, helping investors separate good floats from risky ones
SEBI has further said that as the IPO grading does not take into consideration the
pricing of the security, it is not an investment recommendation. Rather it is only one
of the inputs for the investor to aid in the decision making process. To that effect,
SEBI’s view is that all other things remaining equal, a security with stronger
fundamentals would command a higher market price.
SEBI believes that it has taken a pioneering role in safeguarding investors’ interest by
increasing disclosure levels by entities seeking to access equity markets for
funding. This has caused India to be amongst one of the more transparent and
efficient markets in the world.
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Rating Agencies’ View
Until now, research has been available to equity investors only in the form of
investment advice (buy/sell/hold recommendations). Rating agencies contend that an
IPO grade brings an independent, unbiased assessment of the fundamentals of the IPO
issuing firm. The fundamentals, as stated earlier, can be looked at in terms of factors
such as competence of management, competitive edge, operating efficiency and
profile of promoters.
One of the rating agencies, CRISIL, believes that grading helps if investors know
where exactly it belongs in their investment decision process. CRISIL further states
that the investment decision making is a three‐step process as outlined in figure:
1) Analysis of Fundamentals. (Addressed by IPO Grade)
2)Analysis Of Returns. (Is the Security being offered at the right price)
3)Investor's Preference. (Is this the right Investment of me?)
All these factors leads to Investment decision.
.
The rating agencies compare the fundamentals of the IPO firm to those of other listed
firms in the primary and the secondary market. This is done with an understanding
that if IPO grading is to meet investors’ needs, the relative comparison set of potential
IPO companies must include all companies that are potential investment equity
options for the investor. Doing so benefits the issuer company by benchmarking itself
with its peers.
The Process of Obtaining an IPO Grade
To initiate the process of obtaining an IPO grade, the company first contacts one of
the grading agencies. The steps involved in the grading process are as follows:
Step I:
The issuer shares the required information with the grading team of the rating agency
Step II: Rating agency follows up with detailed management meetings with the CEO,
CFO, and the Board of directors, and further follows up with subsequent
site visits
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Rizvi Institute of Management Studies & Research
Step III:
The grading team prepares a detailed note and grading committee assigns the grade
Step IV:
Grading agency publishes a rationale outlining the reasons for the reason
for the assigned grade
Step V:
Grading agency sends the grading report to SEBI, stock exchanges, and to the
company The issuing company then discloses the IPO grade on the prospectus that it
files with the ROC (Registrar of Companies).
Assessment Of An IPO Grading Process.
The concept of IPO grading being a unique one, while analyzing the concept of IPO
grading I observed worthwhile differences between IPO grading and credit rating.
1). While credit rating is assigned based on past data and the obligation of debt
payment along with its future prospects, IPO grade is assigned based solely on
fundamentals and on assessment of the future performance.
2). Companies that are likely to raise far more equity than they need in an IPO hence
suffer a depressed return on equity (ROE) are likely to be assessed unfavorably in the
IPO grading exercise; However, they are likely to be assessed more favorably in a
credit rating exercise, as more equity lowers the debt to equity(D/E) ratio and
provides cushion to acquire more debt in the process.
3). The focus while assigning an IPO grade would be projected in ROE, EPS, and
growth in profits, while the focus while assigning a credit rating would be on
projected cash flows in relation to debt .
4). Credit rating is assigned based on a promise to pay a fixed sum at regular intervals
regardless of the performance of the project for which the funds were borrowed, On
the other hand, IPO in grading the investor's
returns are dependent on the
performance of the project being financed.
5). Credit ratings are used for the valuation of buy/sell/hold recommendations on
bonds, where as IPO grading has no bearing on buy/sell/hold recommendations
of equity.
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Rizvi Institute of Management Studies & Research
Thus, IPO Grading System is relevantly different and new from other Rating process
and
introduced by SEBI in the year 2007. It still has a long way to go in order to
have total acceptability among the investors group. It needs to evolve according to the
needs & convenience of the Investors which would further
will be able to
compliment their investment decisions.
Findings :
1. It is a onetime assessment and has no ongoing validity thus it makes it difficult for an
investor to totally rely on it.
2. IPO grading totally ignores the valuation aspect of the company's IPO.
3. The main criticism against SEBI's is that it excludes the issue price from the scope of
grading. The critics have argued that the issue price is a crucial factor in determining
the worth of an IPO from the investor's viewpoint to include it.
4. SEBI Initially the cost of the grading would be borne by the Investor Protection Funds
administered by the stock exchanges, or by Investor Education Protection Funds (IPF)
administered by the Ministries of Companies Affairs. However, the bearing the cost
of
obtaining
the
grade
has
since
been
transferred
to
the
companies
themselves. without any justification for having shifted the cost responsibilities from
IPF to the companies. This has led to an increase in the cost of raising funds in the
capital market.
5. The grading does not aim to indicate the likely returns from the IPO to the investor for
his investment thus an investor cannot fully rely on the grading system to take his
investment decisions
6. The IPO grading also does not take into account market factors such as liquidity,
demand, supply situation of the scrip, the market sentiment at the time of the IPO
issue are not taken into consideration and the very purpose of protecting the interest
of the investors is defeated. This is mainly because pricing of the issue is the most
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Rizvi Institute of Management Studies & Research
crucial determinant of returns to the investors and it is not included in the grading
process.
Recommendations
1) SEBI has made it mandatory to get IPO grading done, the parameters and grades are
not standardized so it's important for SEBI to standardized parameters. This will
enable investors to make proper investment decision by analyzing several options.
2) Even though it grades the IPO & gives its opinion after several Qualitative &
Quantitative Analysis, it should be able to determine the loopholes an IPO may
possess.
3) SEBI can grant powers to them in order to be able to detect the frauds in an IPO
through the grading process which could further strengthen their position. This would
enable
to
protect
the
investors
interest.
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Rizvi Institute of Management Studies & Research
8.1 IPO GRADING - RATNAKAR BANK
Ratnakar Bank is latest in the news to go for an IPO in the coming months backed by
the Strong Election mandate and Positives Signs of recovery of the Economy. We
tried to analyze the potential of the bank by giving it an IPO Grade in order to give
an opinion to the Investor's.
Company's Background - Established in 1943, RBL is a Kolhapur based small sized
old private sector bank. It was granted the status of scheduled commercial bank in
1959. The business of RBL is primarily concentrated in Maharashtra and North
Karnataka.
Branches - It has 120 branches across the country with 140 ATMs. The bank has
presence in Maharashtra, Karnataka, Gujarat, Tamil Nadu and Delhi - NCR. By the
next year, the bank should have close to 200 branches.
No of Employees - over 1700.
ManagementThe board is totally independent with Indian professionals from top American Banks
taking over Operations .
Subhash Kutte - Chairman.
Vishwavir Ahuja - MD & CEO, Mr. Ahuja joined Ratnakar Bank in 2010. He is the
former CEO of Bank of America in India.
Naresh Karia - CFO.
No. of shares - 21.5 Cr Shares as of FY12. HDFC owns a 3.94% stake ~ 8.8 million.
Faering's stake is below 4%.
Business - Ratnakar Bank makes one-third of its loans to farmers, small businesses
and low-income consumers. The bank is using the deposits it takes from urban
customers and extending loans to rural borrowers.
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Rizvi Institute of Management Studies & Research
Segments 1. Retail Banking
2. Agriculture Financing & Financial Inclusion : ( Covering 500 villages & 30,000
clients directly and support over 3,00,000 financial inclusion clients indirectly in the
last 18 months)
3. Commercial Banking
4. Corporate & Institutional Banking
Financial Highlights
Particulars
FY 2011
FY 2012
FY 2013
Deposits (Cr.)
2042
4739
8340
Advances (Cr.)
1905
4132
6376
Net Interest Income (Cr.)
105.15
186.79
257.56
Net Interest Margin(%)
4.62
4.34
3.32
Net Profit (Cr.)
12.22
65.73
90.47
Gross NPA(%)
1.12
0.80
0.40
Net NPA(%)
0.36
0.20
0.11
Net worth (Cr.)
1074
1130
1594
Total Assets (Cr.)
3229
7205
12963
BV/ share (Rs.)
49.99
52.62
63.03
ROE(%)
1.71
5.90
6.73
EPS(%)
0.96
3.06
4.19
CAR (%)
56.41
23.20
17.11
The Bank’s deposits increased from `4,739.33 crores , as on March 31, 2012, to
8,340.52 crores, as on March 31, 2013, registering a growth of 75.99%. While the
RBI softened policy rates, the economy’s high liquidity deficit prevented the deposit
rates from decreasing as much, particularly till the end of third quarter of FY13.
The banks NPA has reduced over 3 years from 1.12 to 0.40 % which shows its strong
position. These results were achieved through proper management of credit as well as
aggressive and focused efforts on NPA management and recovery.
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Rizvi Institute of Management Studies & Research
In FY11, the bank's profit took a hit, mainly due to pension plan, enhancement of
gratuity limits & payments of arrears otherwise the bank has shown phenomenal
increase in its profits till FY 2013. Though it NII shows a YOY (year on year) growth
which depicts its stability.
Even though the banks NPA was decreasing its NIM was not increasing as it must.
Till 31st march of 2014 the bank had approx 11,600 crores in deposits out of which
they plan to have 20 % as CASA ,which is the cheapest source of money for the
banks as it gives very low rate of interest rates. Concerted efforts at increasing the
CASA Balances have helped to increase the Bank’s CASA deposit balances by
61.32% during FY13. However, CASA percentage reduced from 21.51% in FY12 to
19.72% in FY13 owing to relatively higher increase in term deposits.
The Bank’s earning capacity increased with its EPS touching 4.19 per share in
FY13 from 3.06 per share in FY12 & 0096 on FY11.Book value per share registered
a growth of 19.79%, from 49.99 in FY 11 to 52.62 in FY12 to 63.03
in FY13.
The Bank's CAR Reduced from 56.21% to 23.20% as Bank’s business has grown
significantly during the year which has helped the Bank in the
efficient deployment of capital. and further reduced to 17.11 in FY 2013 as the Bank
raised equity capital to the tune of 376 crores excluding shares issued on exercise of
equity stock options to employees. This has helped the Bank to attain a high CAR.
The shares were subscribed to by high-quality institutional and private equity
investors
These ratios reflect increased shareholder’s value in return for their investment.
Strengths
Strong Rural & Semi- Urban presence.
Healthy Financials, Underleveraged balance sheet.
Strong management led by Vishwavir Ahuja.
The under penetration of banking services in rural India (which accounts for about 68
% of total households),high potential growth rates ,a conservative regulator & high
entry barriers for new entrants makes Bank like Ratnakar a compelling investment
case.
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Concerns
Company's original staff is unionized & Can create problems
To fund its loans, Ratnakar pays high deposit rates 5.5 % on savings accounts,
compared with 4 % at most Indian banks, & its total deposit cost averages 8.9 %,
compared with the industry average of 6%.
Also Ratnakar's operating expense of 2.67 % of average assets is higher than the
industry average of 1.7 %.This should come down as the Bank Scales up.
Recent Developments
2010
In 2010, Ratnakar raised Rs.720 Cr ($130 million) from HDFC & other PE funds
including Faering, Gaja cap, Norwest Venture Partners, Samara Cap, Beacon India
Private Equity Fund & Cartica Cap at 67 Rs/share.
Reliance Capital Asset Management (RCAM) & SBI Mutual Fund had signed a
distribution agreement with Ratnakar Bank for the distribution of mutual fund
schemes.
Raised Tier-I capital of over 700 crores , taking the total capital base to around
1,100crore, from HDFC, Gaja Capital, Norwest Venture Partners, Samara Capital,
Beacon Capital, Faering Capital, TVS Shriram and Cartica Capital
2011
ICRA granted Ratnakar Bank’s Certificate of Deposit programme an A1+ rating - its
highest rating for short-term instruments
Launched ATM cards, pre-paid cards and internet banking; obtained an authorized
dealer license to commence Foreign Exchange and International Trade business
Implemented Core Banking System (CBS) across all rural and semi-urban branches,
thus ensuring 100% of the branches are CBS enabled.
Agri Banking and Financial Inclusion verticals introduced Ratna Group Loans, a
focused credit product for small and marginal farmers, artisans and women borrowers
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Rizvi Institute of Management Studies & Research
2012
Upgraded core banking system to Finacle, a product from Infosys, which holds a
leadership position in the market
Revamped the IT infrastructure with significant investments to ensure security and
integrated operations
Established call centre services to enhance the customer service experience
Launched debit cards
Added Corporate Internet Banking to the internet banking suite.
2013
Implemented Phase I of the Core Banking System – Finacle
Raised Tier-I capital of over ` 376 crores taking the total capital base to around `
1,600 crores, from
International Finance Corporation, Ascent Capital, Aditya Birla Private Equity,
Faering Capital, IDFC ,SPICE Fund, ICICI’s Emerging India Fund
Opened the first branch in the state of Andhra Pradesh at Hyderabad ,Chennai, Tamil
Nadu
Bestowed with the honour of being India’s Best Bank (Growth) in the mid-sized
banks segment by Business Today and KPMG and also ranked 5th overall for the year
2012
Ratnakar Bank took over RBS Banking, credit cards & Mortgage portfolios in India.
It will absorb RBS's Employees along with 1,20,000 customers as part of the deal.
Ratnakar Bank did not have any Credit Card portfolio, but through acquisition from
RBS it now has a customer base of 89,000.
The retail branches agriculture business portfolio increased by 65% during FY13
2014
IPO planned in 2014/2015, as the Net worth of the Bank moves closer to Rs. 2000 Cr,
it would be 41st Bank to be listed.
The Bank is set to raise Rs. 330 Cr ($55 million), an investment that will help it
prepare for an IPO next year from a group of domestic & global private equity
investors by issuing 3 million new shares, pegging its value @ Rs. 2500 Cr. The
Investors Includes some of the top names such as Aditya Birla PE, ICICI's Emerging
India Fund, IDFC Spice, Faering Cap etc. Faering, promoted by Aditya Parekh (son
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Rizvi Institute of Management Studies & Research
of HDFC chairman Deepak Parekh) is the only existing investor increasing its stake in
the bank. After the investment, Faering stake will increase to 5%.
Conclusion
After going through various aspects of the bank in the last 3 years, Ratnakar Bank has
the potential to get an IPO GRADE 4- Above average fundamentals as its the 1st
IPO offering since Punjab & Sind bank raised 480 crore in the year 2010, the markets
is optimistic about the bank's IPO given its range of network it operating in and its
potential to capture large market share.. The bank serves the small trading
businessman and farming communities An IPO is a litmus test for the bank and will
be critical in changing the banks perception towards the customers.
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Rizvi Institute of Management Studies & Research
9. CONCLUSION
Credit Rating is thus the need of the time since investors should be equipped with
easy methods to make their investment decisions. If ratings are assigned in a proper,
systematic, transparent way, then it will be a boon for investors and will go a long
way in making the investment world a safe place.
It is an undisputed fact that CRAs play a key role in financial markets by helping to
reduce the informative gap between lenders and investors, on one side, and issuers on
the other side, about the creditworthiness of companies (corporate risk) or countries
(sovereign risk). An investment grade rating can put a security, company or country
on the global radar, attracting foreign money and boosting a nation's economy.
Indeed, for emerging market economies, the credit rating is the key to showing their
worthiness of money from foreign investors. Credit rating helps the market regulators
in promoting stability and efficiency in the securities market. Ratings make markets
more efficient and transparent.
Practical Problems With Credit Rating
There is often a possibility of biased ratings and misrepresentation on account of the
lack of accountability in the process
Rating only represents the past and present performances of the company and
therefore future events may alter the nature of the rating.
Rating is based on the material provided by the company and therefore, there is
always a risk of concealment of information on the part of the latter.
Rating of a debt instrument is not a guarantee as to the soundness of the company.
Since the rating agencies receive a sizable fee from the companies for awarding
ratings, a tendency to inflate the ratings may develop.
The time factor greatly affects rating & gives misleading conclusions. a company
which adverse conditions temporarily will be given a low rating judged on the basis of
temporary phenomenon.
Investment which have the same rating may not have identical investment quality.
The information is obtained from issuers, underwriters, etc. and is usually not checked
for accuracy or truth. Thus ratings may change on account of non-availability of
information or unavailability of adequate information.
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Rizvi Institute of Management Studies & Research
Changes in market considerations may result in loss that will not be reflected in Credit
Rating.
In India the chief problems in the context of CRAs arises on account of the fact that
they are not the independent and autonomous entities that their international
counterparts are. The three primary CRAs in India, viz., ICRA promoted by IFCI and
other financial institutions and banks, CRISIL, promoted by ICICI, Asian
Development bank and others, and CARE promoted by IDBI are all promoted by
lending institutions. Further most corporate borrowers are clients of these institutions
in terms of borrowing. Further, institutions like ICICI, IDBI also have stakes in such
client companies. Thus it is very important for these agencies to distance themselves
from their promoters if they want to gain credibility.
RECOMMENDATIONS
(A) For investors
Investors should not forget the Contract Law principle of ‘Caveat Emptor’. Caveat
Emptor means ‘let the buyer beware’. It should be forgotten that everything including
returns cannot be guaranteed and investments cannot be risk-free.
Investors should observe caution while investing their money and be aware
themselves before taking their investment decisions. Investors should self study the
facts and information available about the investment products and the creditability of
the issuers, before zeroing on their decisions.
It is equally important for individual investors to maintain their good credit history by
repaying loans on time and not breaching any rules of law in respect of investments,
taxation, etc. that will go a long way in making the individual’s future secure and
smooth.
Investors must understand that the objective of assessment for IPO Grading and
Credit Rating are very different; though the basis elements of the analysis are same.
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Rizvi Institute of Management Studies & Research
IPO Grading assesses factors from equity-holder's perspective and is a point in time
exercise, whereas Credit Rating assesses factors from debt-holders perspective and
usually requires recurring surveillance over the life of the instrument.
(B)For credit rating agencies
CRISIL, ICRA & CARE, the three major rating agencies are handling 90%-95% of
the business of credit rating promoted by financial institutions who while advancing
loans take the help of credit rating agencies to get the company rated. All these
agencies have continued to expand their activities in recent years. They must also be
updated about the reforms in the financial sector which can have a impact on the
businesses of these agencies as the market is volatile in nature especially in case of
debt instrument like bonds.
Another aspect is regarding the procedure or the methodology that these rating
agencies follow for rating. Sometimes companies not satisfied with rating of one
agency approach use another rating agency for better rating. For this purpose the
rating process or procedure followed for rating must be relevant and accurate. Rating
agencies should not only take into consideration past & present performance; the
projected future performance must not be ignored. This could be a Cost Saving
measure for both the parties.
The rating agencies make public only those ratings which are accepted by the issuer
companies. They should also publish even those ratings which are not accepted by the
given companies
The credit rating agencies also follow qualitative aspects for rating which may not be
more reliable and accurate. Therefore, they should lay more emphasis on quantitative
factors.
Besides the given factors considered by the credit rating agencies, they should also
take into consideration other issues regarding investment like, liquidity risk, prepayment risk, interest rate risk, taxation aspects, risk of securities market loss,
exchange loss risk, etc
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The Credit Rating Agencies is comparatively a Young industry . The variations
happens due to lack of proper control systems in place along with the readiness of the
company in disclosing their information. Thus, needless to say, the system of CRAs
needs some amount of relooking and overhauling in order to make it effective and
viable in the future. The industry has to continuously strive to improve the
professional capabilities and sustain credibility. The credit rating agencies today have
ample opportunities to play a unique role in strengthening the capital market and
building the investors' confidence in the financial system.
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10. BIBLIOGRAPHY
Website
www.crisil.com
www.icra.in
www.careratings.com
www.fitchindia.com
www.sebi.gov.in
www.rblbank.com
www.google.com
www.moneycontrol.com
Books
Mamta Arora, (2003), Credit Rating in India– Institutions, Methods and
Evaluation, New Century Publications, Delhi.
Research Paper
Sanjay Poudyal,(2008) Grading Initial Public Offerings (IPOs) in India’s Capital
Markets A Globally Unique Concept.
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