Credit Rating
Learning Objectives
After studying the chapter, you should be able to understand:
Meaning of Credit Rating
Benefits of credit Ratings
Credit Rating Agencies in India
Problems of Credit Rating
INTRODUCTION
Credit rating is one of the important financial services provided by independent credit rating agencies. The credit rating agencies originated in 1900 in US when Joyn Moody founded Moody investor’s services and firstly rated “railroad securities”. In 1909 moody issued a publication known as “Manual of Railroad Securities” which was widely accessible. The expansion of credit rating agencies was witnessed in 1916 with the establishment of big three credit rating agencies. These companies are: Poor’s Publishing Company initiated in 1916, Standard Statistics Company in 1922 and the Fitch Publishing Company in 1924.
MEANING OF CREDIT RATING
Credit Rating is an assessment in terms of alphanumeric symbol to convey the creditworthiness of an individual, company financial instruments or a country. It is a simple and easily understood tool enabling the investor or lender the relative degree of risk associated with a loan amount on a debt instrument or a financial obligations.
C HAPTE R
CREDIT RATING
Credit rating is just an opinion about the creditworthiness about the instrument. However, it does not give any assurance of repayment of the rated instrument. The rating is representative of the financial history and current assets and liabilities of the rated instrument. A credit rating does not provide recommendation to buy, hold or sell a debt instrument. It just represents a guideline to help the investors or lenders for making an investment decision. A high credit rating represents a good investment with very low risk of non-payment on a loan, whereas a poor credit rating represents investments with high level of risk of default. Investors expect a risk return trade off. The investors who want high return invest in low rated instruments and get compensated for high risk involved with it.
Credit rating is not a permanent credit rate. It is a continuous review process and the rating keeps on changing periodically based on the availability of information. For example, recently reliance communication rating to its bonds was reduced with the information that company is unable to pay interest in time.
Credit rating is generally done for various debt instruments like bonds, debentures, fixed deposits, Bank loans, commercial paper and other.
SEBI defines credit rating as “an opinion regarding securities, expressed in the form of standard symbol or in any other standardized manner, assigned by a credit rating agency, it is mandatory for an issuer of such securities, to comply with a requirement specified by SEBI regulations and provide the credit rating as an information to the investors of the bonds”.
Credit Rating Agency
A credit rating agency is an entity or a body corporate engaged in assessing the ability and willingness of the issuer company for repayment of interest and principal on a debt instrument. Their main business is to rate the securities or instruments offered by way of public issue of bonds or debentures. Credit Rating Agencies helps in maintaining investor’s confidence by providing the information and also differentiating the risk among different debt instruments.
There is no pre-defined mathematical formula for the calculation of ratings. It is based on a comprehensive evaluation and in-depth study of company’s fundamentals (including quality of management, corporate strategy), industry as well as macro-economic outlook, socio and political environment. In India, Credit rating Agencies are regulated by SEBI. In 1999, SEBI had recommended an extensive set of regulations to be followed by regulatory agencies in India.
Credit rating Agencies need to disclose their methodology of computing the rating for the issuer.
A credit rating agency cannot rate an instrument issued by its promoters.
To avoid the conflict of interest SEBI has barred rating agencies to rate securities or instruments issued by borrower or subsidiary of promoter if it has a chairman, director, employee of any such firm.
SEBI has incorporated a clause in the listing agreement of stock exchange in order to promote transparency requiring companies to cooperate with rating agencies and provide correct information. Thus Refusal to provide correct information can lead to breach of contract between rating agencies and clients.
Credit rating agencies will have to disclose their shareholding patterns to enhance the investor confidence in its ability to manage the conflict of interest if any.
The minimum net worth of credit rating agency has been fixed at ` 5 crore.
The certificate of registration of credit rating agency issued by SEBI is valid for three years.
A credit rating agency shall observe a high standard of integrity and fairness while dealing with its clients.
SEBI has made compulsory to have dual rating for public and right issue of debt instruments of ` 100 crore or more.
SEBI has issued the new symbols and definitions given in annexures 1-6 to be used for rating by Credit Rating agencies.
BENEFITS OF CREDIT RATING
Credit ratings provide various benefits to different class of people including investors, issuers, banks, brokers and government. Some of the benefits are:
(A) Benefits to Investors:
(1) Protection against Bankruptcy: A credit rating agency helps in providing information about the financial strength of the company issuing instrument to the investors. The high rated instruments are less risky in nature and gives protection against bankruptcy.
(2) Alternative investment opportunities: Credit rating of various instruments done by credit rating agencies assist investors to compare and contrast a wide variety of alternative instruments at a particular point of time in the capital market.
(3) Risk identification: Credit rating agencies provide alphanumeric symbols to express the credit worthiness of the respective instrument of the issuer company. This helps investor to make a wiser decision of investment based on the symbol of the instrument.
(4) Saving in time and cost: An investor makes his decision based in the information provided by the credit rating agencies. This relieves him from the making an in-depth analysis of fundamentals of the company, management details, economic environment and others. This results in saving in time and money of the investors.
(5) Credible information: Credit rating agencies shall observe a high standard of integrity and provide credible and fair information on risk component of the instruments. The rating agencies are the independent agencies and have no relationship with the issuer company. Thus the investor can easily rely on the informed opinion of the neutral credit rating agencies.
(6) Quick decision: The rating symbols are easily understandable by the investor and this facilitates the investor to take independent quick decisions.
(B) Benefits to the Issuers/company: The company which issues the instruments and get its instruments rated by a credit rating agency are also benefited in following ways:
(1) Lower cost of borrowing: A high rated instrument has the opportunity to raise funds at a lower rate of interest in market. The investor with low risk preference will invest in high rated and safe securities though yielding lower rate of interest. Thus credit rating agencies help in informed financial decisions.
(2) Wider access to capital market: The high rate instruments have an advantage to maximize the access to market even in difficult times. Thus credit rating helps issuers to attract investors by considering the significance of timely payment of interest and principal on instruments with better ratings.
(3) Goodwill enhancement: Better credit rating motivates the issuers for growth and establishes a reputation in market. This further helps the issuer to access or borrow funds from banks at reasonable rates.
(4) Self discipline: The issuer companies becomes symbol conscious. Companies try to become self discipline over financial issues and try to improve their performance for a better credit rating.
(5) Rating as a marketing tool: The issuers companies consider the high rating as a marketing tool for dealing with the customers and enhanc-
ing their market image. The customer feels confident in utilizing the product produced by the companies of the high rated instruments.
(C) Benefits to Financial Intermediaries: High rated instruments convince investors to invest in the safe and highly liquid instruments. This leads the financial intermediaries save lot of time, money and energy. The credit rating also provides information about various investment opportunities available which helps brokers to improve their business. The investors are self motivated to invest in high rated investments and rating make easy to invest in profitable investments. The brokers have an advantage of credit rating as it helps them in planning, pricing and placement of securities.
(D) Benefits to Country/government: Credit rating motivates and equips investors with information to invest in debt market for the development of growth of trade and industry. It also facilitates access to funds from foreign countries in form of foreign direct investments. Further, the burden for the responsibility on the government is also reduced as credit rating agencies protect the interest of the investors.
CREDIT RATING AGENCIES IN INDIA
The important credit rating agencies in India are:
1. Credit Rating Information Services of India Limited (CRISIL)
2. Investment Information and Credit Rating Agency of India (ICRA)
3. Credit Analysis and Research (CARE)
4. Fitch Rating India Pvt Ltd.
5. Onicra Credit Rating Agency of India Limited (ONICRA)
6. SME rating Agency of India Limited (SMERA)
Credit Rating Information Services of India Limited (CRISIL)
The process of credit rating in India was started by CRISIL in 1987. It has been promoted by Industrial Credit and Investments Corporation of India ltd. (ICICI), Unit Trust of India Ltd (UTI), Asian Development Bank (ADB), Life Insurance Corporation of India (LIC), General Insurance Corporation (GICs), and various nationalized banks as a public limited company. CRISIL has been India’s leading rating agency with over a 60% share of the Indian Rating Market.
CRISIL has been fourth largest in the world and offers comprehensive range of rating services like long-term rating, fixed deposit rating, credit quality rating, real estate projects and corporate credit rating. Its rating is mostly
useful for corporations, brokers, merchant bankers and regulatory authorities and investors. CRISIL is listed on stock markets NSE and BSE for trading.
Investment Information and Credit Rating Agency of India (ICRA)
ICRA started in 1991 and has been one of the independent and professional credit rating agencies. It was promoted by Industrial Finance Corporation of India (IFCI). UTI, LIC, GIC, UCO bank, Bank of Baroda, State Bank of India and other financial institutions also promoted ICRA. ICRA Ltd. has been listed on BSE and NSE for trading.
ICRA has been one of the most experienced credit rating agencies in India. It provides wide range of rating services like Credit rating, equity and preference share, bonds, fixed deposits, commercial papers and certificate of deposit and debt instrument issued by companies and financial institutions. ICRA also rate some specialized performance grading advisory services and economic research outsourcing.
Credit Analysis and Research (CARE)
CARE initiated its operation in 1993. CARE is a rating and information service company that provides a wide range of rating and grading services in different sectors. It has been promoted by Industrial Development Bank of India (IDBI) and other financial institutions like Unit Trust of India (UTI), Canara Bank, Federal Bank Ltd. and finance companies.
Various services offered by CARE are: Rating of both long and short-term debt instruments, enabling availability of information on any company, local body, or a sector required by a business entity, research or studying the equity shares listed in the major stock exchange and grading them on the basis of the fundamentals affecting the industry, economy, and other relevant factors.
Onida Individual Credit Rating Agency (ONICRA)
ONICRA has been incorporated as India’s first individual credit rating company in 1993. It has been promoted by Onida Finance ltd. There was a dearth of individual credit rating firms in India. ONICRA has filled this gap and brought the international concept of individual credit rating especially for the lending institutions.
ONICRA helps the lending institutions by providing credit ratings for individual customers or loan applicants. Various services offered by ONICRA are: Credit rating, Employee screening, customer verification, SSI/SME rating, Associate training and banking information service.
The process of rating by ONICRA initiates at the request of a lending firm or a financial institution. ONICRA request the individual or the loan applicant to fill a form which is based on 100 point scale. ONICRA uses this scale to rate the individual on various parameters. This helps the lenders and other financial institutions to save time and concentrate on other core issues.
Fitch Rating India Private Ltd.
Fitch rating private ltd. is one of the leading global rating agencies. Their main aim is to provide accurate and timely credit opinion. FITCH has been recognized by RBI, SEBI and NHB. Fitch provides rating to a variety of entities like corporate issuers, sovereigns governments structured financings, debt and preference stock, bank loans and other financial guarantor.
Problems of Credit Rating
The various limitations or defects of credit rating are as follows:
1. The absence of accountability limits the process of credit rating. Lack of experienced and skilled staff may not do justice to their task and it may lead to inappropriate ratings.
2. There is a huge scope of biased rating as there is no fixed mathematical formula for the calculation of rating.
3. Rating does not guarantee any financial strength to the investors. It is changeable over the period of time.
4. Ratings are based on the past and present performances of a company and it may get altered by the future events of a company.
5. Investors may get confused as different rating agencies provide different ratings for the same financial instrument of the same entity.
6. The credit rating company charges a sizable fee from the companies to award rating to their instruments. This may result in misleading or inflated ratings.
7. The information for rating is always provided by the borrower or the issuer and this is subject to inaccuracy on the part of the company.
8. The credit rating agencies has been facing a problem of absence of widespread branch network which may lead to limited skills in rating.
ANNEXURE 1
I. Rating Symbols and Definitions for Long-Term Debt Instruments by the Securities and Exchange board of India.
Long-term debt instruments: The instruments with original maturity exceeding one year.
200
CREDIT RATING
Rating symbols should have CRA’s first name as prefix
AAA - Instruments with this rating are considered to have the highest degree of safety regarding timely servicing of financial obligations. Such instruments carry lowest credit risk.
AA - Instruments with this rating are considered to have high degree of safety regarding timely servicing of financial obligations. Such instruments carry very low credit risk.
A - Instruments with this rating are considered to have adequate degree of safety regarding timely servicing of financial obligations. Such instruments carry low credit risk.
BBB - Instruments with this rating are considered to have moderate degree of safety regarding timely servicing of financial obligations. Such instruments carry moderate credit risk.
BB - Instruments with this rating are considered to have moderate risk of default regarding timely servicing of financial obligations.
B - Instruments with this rating are considered to have high risk of default regarding timely servicing of financial obligations.
C - Instruments with this rating are considered to have very high risk of default regarding timely servicing of financial obligations.
D - Instruments with this rating are in default or are expected to be in default soon.
Modifiers {“+” (plus)/“-” (minus)} can be used with the rating symbols for the categories AA to C. The modifiers reflect the comparative standing within the category.
ANNEXURE 2
II. Rating Symbols and Definitions for Short-term debt instruments
Short-term debt instruments: The instruments with original maturity of upto one year
Rating symbols should have CRA’s first name as prefix
A1 - Instruments with this rating are considered to have very strong degree of safety regarding timely payment of financial obligations. Such instruments carry lowest credit risk.
A2 - Instruments with this rating are considered to have strong degree of safety regarding timely payment of financial obligations. Such instruments carry low credit risk.
A3 - Instruments with this rating are considered to have moderate degree of safety regarding timely payment of financial obligations. Such instruments
carry higher credit risk as compared to instruments rated in the two higher categories.
A4 - Instruments with this rating are considered to have minimal degree of safety regarding timely payment of financial obligations. Such instruments carry very high credit risk and are susceptible to default.
D - Instruments with this rating are in default or expected to be in default on maturity.
Modifier {“+” (plus)} can be used with the rating symbols for the categories A1 to A4. The modifier reflects the comparative standing within the category.
ANNEXURE 3
III. Rating Symbols and Definitions for Long Term Structured Finance Instruments Long-term structured finance instruments:
The instruments with original maturity exceeding one year Rating symbols should have CRA’s first name as prefix.
AAA (SO) - Instruments with this rating are considered to have the highest degree of safety regarding timely servicing of financial obligations. Such instruments carry lowest credit risk.
AA (SO) - Instruments with this rating are considered to have high degree of safety regarding timely servicing of financial obligations. Such instruments carry very low credit risk.
A (SO) - Instruments with this rating are considered to have adequate degree of safety regarding timely servicing of financial obligations. Such instruments carry low credit risk.
BBB (SO) - Instruments with this rating are considered to have moderate degree of safety regarding timely servicing of financial obligations. Such instruments carry moderate credit risk.
BB (SO) - Instruments with this rating are considered to have moderate risk of default regarding timely servicing of financial obligations.
B (SO) - Instruments with this rating are considered to have high risk of default regarding timely servicing of financial obligations.
C (SO) - Instruments with this rating are considered to have very high likelihood of default regarding timely payment of financial obligations.
D (SO) - Instruments with this rating are in default or are expected to be in default soon.
Modifiers {“+” (plus)/“-” (minus)} can be used with the rating symbols for the categories AA (SO) to C (SO). The modifiers reflect the comparative standing within the category.
ANNEXURE 4
IV. Rating Symbols and Definitions for Short Term Structured Finance Instruments Short-term structured finance instruments:
The instruments with original maturity of upto one year Rating symbols should have CRA’s first name as prefix
A1(SO) - Instruments with this rating are considered to have very strong degree of safety regarding timely payment of financial obligation. Such instruments carry lowest credit risk.
A2(SO) - Instruments with this rating are considered to have strong degree of safety regarding timely payment of financial obligation. Such instruments carry low credit risk.
A3(SO) - Instruments with this rating are considered to have moderate degree of safety regarding timely payment of financial obligation. Such instruments carry higher credit risk as compared to instruments rated in the two higher categories.
A4(SO) - Instruments with this rating are considered to have minimal degree of safety regarding timely payment of financial obligation. Such instruments carry very high credit risk and are susceptible to default.
D(SO) - Instruments with this rating are in default or expected to be in default on maturity.
Modifier {“+” (plus)} can be used with the rating symbols for the categories A1(SO) to A4(SO). The modifier reflects the comparative standing within the category.
ANNEXURE
5
V. Rating Symbols and Definitions for Long Term Debt Mutual Fund Schemes Long-term debt mutual fund schemes:
The debt mutual fund schemes that have an original maturity exceeding one year. Rating symbols should have CRA’s first name as prefix.
AAAmfs - Schemes with this rating are considered to have the highest degree of safety regarding timely receipt of payments from the investments that they have made.
AAmfs - Schemes with this rating are considered to have the high degree of safety regarding timely receipt of payments from the investments that they have made.
Amfs - Schemes with this rating are considered to have the adequate degree of safety regarding timely receipt of payments from the investments that they have made.
BBBmfs - Schemes with this rating are considered to have the moderate degree of safety regarding timely receipt of payments from the investments that they have made.
BBmfs - Schemes with this rating are considered to have moderate risk of default regarding timely receipt of payments from the investments that they have made.
Bmfs - Schemes with this rating are considered to have high risk of default regarding timely receipt of payments from the investments that they have made.
Cmfs - Schemes with this rating are considered to have very high risk of default regarding timely receipt of payments from the investments that they have made.
Modifiers {“+” (plus)/“-” (minus)} can be used with the rating symbols for the categories AAmfs to Cmfs. The modifiers reflect the comparative standing within the category.
ANNEXURE 6
VI. Rating Symbols and Definitions for Short Term Debt Mutual Fund Schemes Short-term debt mutual fund schemes:
The debt mutual fund schemes that have an original maturity of upto one year. Rating symbols should have CRA’s first name as prefix
A1mfs - Schemes with this rating are considered to have very strong degree of safety regarding timely receipt of payments from the investments that they have made.
A2mfs - Schemes with this rating are considered to have strong degree of safety regarding timely receipt of payments from the investments that they have made.
A3mfs - Schemes with this rating are considered to have moderate degree of safety regarding timely receipt of payments from the investments that they have made.
A4mfs - Schemes with this rating are considered to have minimal degree of safety regarding timely receipt of payments from the investments that they have made.
Modifier {“+” (plus)} can be used with the rating symbols for the categories A1mfs to A4mfs. The modifier reflects the comparative standing within the category.
SUMMARY
The credit rating agencies originated in 1900 in US when Joyn Moody founded Moody investor’s services and firstly rated “railroad securities”. The expansion of credit rating agencies was witnessed in 1916 with the establishment of big three credit rating agencies. These companies are: Poor’s Publishing Company initiated in 1916, Standard Statistics Company in 1922 and the Fitch Publishing Company in 1924.
Credit rating is just an opinion about the creditworthiness about the instrument. However, it does not give any assurance of repayment of the rated instrument. Credit rating is generally done for various debt instruments like bonds, debentures, fixed deposits, Bank loans, commercial paper and other. In India, Credit rating Agencies are regulated by SEBI. In 1999, SEBI had recommended an extensive set of regulations to be followed by regulatory agencies in India.
REVIEW QUESTIONS
Q. 1. Explain Credit Rating in India (B.com Hons, 2014)
Q. 2. What is credit rating? How credit Rating of a company is helpful in making investment decisions?
Q. 3. Explain the need and importance of credit rating. (B.com Hons, 2015)
Q. 4. Define the term credit rating and discuss how it is used as an indicator for making an investment decision.
Q. 5. Discuss the factors contributing to the success of the rating system in India.
Q. 6. What are the benefits of credit ratings? Who are the beneficiaries of the rating services? Are Indian credit ratings credible?
PRACTICAL EXERCISE
Q. 1. Prepare a project on the role of Credit rating agencies in financial markets. List out top 5 blue chip companies listed on NSE and analyze their credit rating agencies in India.
FINANCIAL MARKETS & INSTITUTIONS
AUTHOR : MANMEET KAUR BAWA, VINOD KUMAR
PUBLISHER : TAXMANN
DATE OF PUBLICATION : JULY 2024
EDITION : 3RD EDITION
ISBN NO : 9789357784825
NO. OF PAGES : 256
BINDING TYPE : PAPERBACK
DESCRIPTION
This book provides an up-to-date analysis of policy changes and regulatory updates from SEBI, IRDA, and RBI, equipping students with fundamental knowledge of India's financial markets and institutions. This book is helpful for the following:
• B.Com. (Hons.) Paper DSE 3.2 & B.Com. Paper DSE 5.2 (University of Delhi)
• NCWEB & SOL students (University of Delhi)
• Commerce & Management students in Central Universities
• BBA/MBA and management courses
The Present Publication is the 3rd Edition, authored by Dr Vinod Kumar & Dr Manmeet Kaur, with the following noteworthy features:
• [What's New in the 3rd Edition]
o Financial Systems – New market indicators
o Money Markets – Introduction of FIMMDA
o Secondary Markets – Expanded global indices (DOW Jones, NASDAQ)
o Commercial Banking – Updates on MUDRA financing, NPAs, Insolvency and Bankruptcy Code
o Venture Capital & Private Equity – Detailed processes
o Financial Stability – Stages of financial crises, emerging challenges
• [Pedagogical Features]
o Simple Language – Accessible to beginners
o Updated Content – Aligned with UGCF
o Learning Tools – Learning outcomes, summaries, exercises
o Visual Aids – Figures, tables, graphs
o Practical Cases – Real-life examples from various financial sectors
• [Student-focused]
o Developed from classroom interactions and teaching experience
o Incorporates student feedback