Credit Rating agenciesTerm Paper – Basic Finance

Submitted ToMs. Shikha Dhawan

Submitted ByAnand DhawanRA17B1A03

Lovely Professional University

Term paper

Credit Rating Agencies

A credit rating estimates the credit worthiness of an individual, corporation, or even a country. It is an evaluation made by credit bureaus of a borrower’s overall credit history. A credit rating is also known as an evaluation of a potential borrower's ability to repay debt, prepared by a credit bureau at the request of the lender (Black's Law Dictionary). Credit ratings are calculated from financial history and current assets and liabilities. Typically, a credit rating tells a lender or investor the probability of the subject being able to pay back a loan. However, in recent years, credit ratings have also been used to adjust insurance premiums, determine employment eligibility, and establish the amount of a utility or leasing deposit.

Objectives

It provides guidance to investors or creditors in determining a credit risk associated with debt instrument or credit obligation.

Establishes a link between risk and return. Helps investors in making investment decisions. Credit rating shows the exact worth of the organization To assist the regulators in promoting the transparency in the financial market.

Credit Rating Agencies in India

Credit Rating Information Services of India Limited (CRISIL) (1987) Investment Information and Credit Rating Agency of India (ICRA) (1991) Credit Analysis & Research Limited (CARE) (1994) Duff & Phelps Credit Rating India Private Ltd. (DCR India) (1996) ONICRA Credit Rating Agency of India Ltd.

Functions of Credit Rating Agencies

The credit rating agencies in India offer varied services like mutual consulting services, which comprises of operation up gradation, risk management. They have special sections to carry on research and development work of the industries. They provide training to the employees and executives of the companies for better management. They examine the risk involved in a new project, chalk out plans to fight with the problem successfully and thus ameliorate the percentage of risk to a great extent. For this they carry on thorough research into the respective industry. They have started offering services to the mutual fund sector through the application of fund utilization services. The major industries currently graded by the credit rating agencies include agriculture, health care industry, infrastructure, and maritime industry.

Range of Rating & Grading Services

Ratings awarded by major Credit Rating Agencies

Who uses Credit Rating?

Banks and FI ratings

Sub-sovereign ratings

Structured Finance Ratings

Insurance/ CPA ratings

Infrastructure ratings

Corporate Governance ratings

Corporate ratings

Services

Construction GradingGrading of MFI

Fund credit Quality rating

SME/SSI ratingsIPO Grading

Issuer Rating

Investors

In absence of credit rating system, risk evaluation depends on “name recognition”.

Credit rating helps investors in selecting appropriate instrument from broad spectrum of investment options.

Banks use ratings of other banks for decisions regarding interbank lending, swap agreements, etc.

Credit rating agencies also provides services like industry reports, corporate reports, seminars and open access to the analysts of the agencies.

Issuers

Compared to unrated securities, issuers of rated securities have access to much wider investor base & more faith is placed.

Investor confidence enables issuers of highly rated instruments to access market even under adverse market conditions.

Intermediaries

Merchant bankers use rating for planning, pricing, underwriting, placement.

Brokers and dealers in securities use rating as an input for their monitoring of risk exposures.

Regulators

Restrict entry to market of new issues rated bellow a particular grade.

Prohibit investors from purchasing or holding of instruments rated bellow a particular level.

What can be Credit Rated ?

INDIVIDUAL

CORPORATE

SOVEREIGN (i.e. A Country)

FINANCIAL INSTRUMENTS

Bonds

Bank Deposits

Commercial Paper

Term Loans

Preference Shares

Secured Debt

Unsecured Debt

Securities

 

The Rating Process

CARE

CARE is a full service rating company that offers a wide range of rating and grading services across sectors. It 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.

Some important points about CARE

Registered with SEBI under the Securities & Exchange Board of India (Credit Rating Agencies) Regulations, 1999.

CARE’s Ratings are recognized by Govt. of India and all regulatory authorities like RBI and SEBI.

CARE is a founder member of Association of Credit Rating Agencies in Asia (ACRAA).

FINDINGS

Quality of Ratings

Independent & Renowned External Rating Committee

Impressive Track Record of more than 15 years

Leader in bank ratings

Developing rating methodologies for new segments like Cooperatives, Service sector, trading etc.

Core Competency

CARE believes in independence in rating decisions and has an external rating committee that decides each rating.

It consists of members who are reputed professionals from various industries like IDBI Ltd, Reserve Bank of India, Hindustan Lever Ltd, etc.

CRISIL

CRISIL was set up in the year 1987 in order to rate the firms and then entered into the field of assessment service for the banks. Highly skilled members manage the agency. Ms. Roopa Kudva who acts as the Managing Director and Chief Executive Officer of the company heads it. The company has set up large number of committees to look after dispersal of various services offered by the company for example, investor grievance committee, investment committee, rating committee, allotment committee, and compensation committee and so on.

Some important points about CARE

CRISIL Ratings plays a leading role in the development of the debt markets in India.

CRISIL Ratings provides technical know-how to clients worldwide.

CRISIL Ratings is India's largest rating agency, having rated more than 24,541 debt instruments.

CRISIL Ratings has a 70 per cent penetration in the domestic debt market.

CRISIL is divided in two main categories

CRISIL LTD. CRISIL INFRASTRUCTURES.

There are three sections under CRISIL Ltd viz, Ratings, Research, Advisory.

Rating Methodology

Different for different sectors such as

Corporate/Manufacturing Finance Infrastructure Structured Finance Funds Governance & Value Creation Real Estate Developers/Project Rating Maritime Grading Microfinance Institutions Grading SME Criteria for Small and Medium Enterprises

FINDINGS

The level of secrecy is high

Rating validity

All information gathered is only from the company

Companies are monitored even after its rated

A company is rated only if it’s clear in all aspects

ICRA

ICRA was established in the year 1991 by the collaboration of financial institutions, investment companies, and banks. The company has formed the ICRA group together with its subsidiaries. The company is headed by Mr. Piyush G. Mankad and offers products like short-term debt schemes, Issue-specific long-term rating and offers fund based as well as non-fund based facilities to its clients.

Some important points about CARE

ICRA Limited is in Alliance with ‘Moody's Investors Service’ and ICRA’s largest

shareholder. It is a public limited company with an authorized share capital of Rs.10 crore, Rs. 5

crore is paid up.

ICRA’s major shareholders IFCI (26%), and the balance by UTI, LIC, GIC, PNB, Central Bank of India, Bank of Baroda, UCO Bank and banks (SBI).

FINDINGS

Alliance with Moody’s Investor Services has given them Brand name and it provides high value Technical services.

It benefits ICRA’s in-house research capabilities and access to Moody’s global research base.

Core Competency

Dedicated teams for Monetary, Fiscal, Industry and Sector Research.

Fees are received in advance.

Challenges faced

Authenticity and credibility of data.

Fraud cannot be detected as its based on annual reports.

Investigation is not possible.

Difficulty in getting secondary data in case of small scale industries and family owned businesses.

Fees and manpower rates are high.

Business model

Value Proposition

The services are offered in order to solve customer problems like unbiased independent assessment, comparisons, risk identification.

The products offered are the grading, advisory and ratings provided.

The source credibility and the brand name of the agencies are the values that the customers get.

Customers Relationship

The Investors, Issuers, intermediaries are the customers.

The CRA’s are customer centric and cater to their needs.

A level of secrecy is maintained.

The customers have an access to the management.

Value chain structure

CRISIL

Market leader position with a 70% share. Research credibility. Brand name. Innovation. Employees.

ICRA

Global technical support. Research base. Brand name.

CARE

Large number of well qualified and multi-faceted professionals from diverse backgrounds such as; financial analysts, economists, sector specialists, chartered accountants.

Position in value network

CRISIL- market leader, an S & P’s company, acquisition of IREVNA.

ICRA- alliance with Moody’s which gives them a global edge.

CARE- CARE is a founder member of Association of Credit Rating Agencies in Asia.

Challenges faced by the Credit Rating agencies in India

Now-a-days Credit Rating Agencies (CRAs) are required to rate companies from growth sectors like Life Insurance, Bio technology, IT/ITES etc apart from earlier rated mature sectors.

Higher management risk.

Besides rating well-known listed entities, CRAs are now rating trading and partnership/proprietorship firms where there is less transparency in their accounts.

With market for complex products evolving, CRA’s in India are exposed to different kinds of structures with varied complexities.

Apart from basic risks, legal implications are also significant

  

Future of credit rating agencies in India

With developing secondary market securities, rating agencies will always have growing business.

However, with banks to follow standardized approach in the medium term, ratings under Basel II may reduce as banks will use their internal ratings and not require rating from external agencies for bank facilities.

CRISIL Grading

CRISIL launched MFI (Micro Finance Institutes) grading in 2002.

World’s first credit rating agency to develop a separate methodology and scale to assess MFIs.

Since then, CRISIL has assessed around 150 MFIs and established itself as the leading rating agency in the Indian microfinance space.

In addition to MFI grading and risk assessment services, it rates MFIs’ bank facilities and securitization transactions.

It is India’s first rating agency to have rated bank loans of MFIs and securitization transactions involving microfinance loan receivables.

Benefits

For MFIs A MFI Grading is based on through analysis of your microfinance programme and the

grading report from CRISIL therefore carries weight with donors, investors and lenders, and can help you access cost effective funds in a timely manner.

The MFI would also receive a report from CRISIL, which would include rationale for the grading, summary of the performance across various parameters - Management, Institutional arrangement, Capital adequacy and asset quality, Resources, Operational Effectiveness and Scalability and Sustainability, summary of key financial and operational indicators.

The report will not only be helpful in fund raising but also in identifying the weaknesses that the MFI needs to address.

For Banks CRISIL's MFI Grading would help bankers to evaluate the functioning of the MFIs

and NGO-MFIs and increase their priority sector disbursements

Process of MFI Grading

CRISIL has developed the microfinance grading to meet the requirements of the constituents of the sector - apex MFIs, banks, MFIs and social investors.

Hence the MFI Grading is not a credit rating and does not indicate the credit worthiness of an MFI (obligor).

The MFI Grading cannot also be compared with the credit rating assigned to a debt instrument (fixed deposits, debentures, etc) of the same MFI.