Credit Rating

An assessment of the credit worthiness of individuals and corporations. It is based

upon the history of borrowing and repayment, as well as the availability of assets
and extent of liabilities. A credit rating agency is a company that rates the ability of
a person or company to pay back a loan. The rating given by a credit rating agency
is important because it affects the perceived risk element incorporated into interest
rates that are applied to loans.
Interest rates are not the same for everyone, but instead are based on risk based
pricing, a form of price discrimination based on the different expected costs of
different borrowers, as set out in their credit rating.
efinition
!" A published ranking, based on detailed financial analysis by a credit bureau, of
one#s financial history, specifically as it relates to one#s ability to meet debt
obligations. The highest rating is usually AAA, and the lowest is . $enders use this
information to decide whether to approve a loan.
An estimate of the amount of credit that can be extended to a company or person
without undue risk.
%" Credit rating is a &ualified assessment and formal evaluation of company's credit
history and capability of repaying obligations. It measures the default
probability of the borrower, and its ability to repay fully and timely its
financial debt obligations.
The main purpose of credit rating is to provide investors with comparable
information on credit risk based on standard rating scale, regardless of specifics of
companies, separate sector of the economy and country as a whole.
Credit rating has proven itself to be effective instrument of risk assessment in
countries with advanced economy since it demonstrates transparency of an
enterprise. Credit rating reflects financial, sectorial, operational, legal and
organi(ational sides of companies, which characteri(e ability and willingness duly
and in full amount to repay obligations.
In world practice, credit rating can be assigned to sovereign governments, regional
and local executive bodies, corporations, financial organi(ations and etc.
Investment companies for the internal use and for the purpose of providing
information to its clients can assign internal credit ratings.
)enerally, international rating agencies assign short*term and long*term credit
ratings.
+hort*term rating gives the benchmark of the likelihood of borrower's
default within one year.
$ong*term rating evaluates the likelihood of default over longer time ,up to
the lifetime of the securities issued".
All credit ratings are revised and monitored on an ongoing basis by rating agencies.
According to the results, the agency can downgrade, upgrade or confirm previously
assigned credit rating.
Credit Rating -unction
!" Credit rating plays an important role in developed and developing capital
markets throughout the world.
%" The use of ratings fosters growth in local and international markets, and
streamlines their functioning.
." Capital markets currently include bonds and other bond*like instruments
guaranteeing a fixed income amounting to an aggregate total of over /01
trillion.
2" Ratings serve a wide array of players in the capital market.
3" The service is designed first and foremost to provide reliable ratings to fulfill
the needs of investors interested in obtaining a reliable, independent estimate
of a company's credit risk, of issuers and borrowers seeking flexible sources of
financing on the capital market and brokering entities en4oying this service
namely5 savers, governments, economists, the financial media and other
observers.
Rating 6rocess
7idroog offers its customers two main rating tracks5
!. Indicative Rating5 Indicative rating 8 a one time, confidential rating for an
enterprise to examine a possible issue and which does not re&uire long*term
monitoring.
%. Comprehensive Rating5
6reliminary5
A preliminary rating of existing series in circulation, new series or a rating of the
issuer. If the repayment priorities of the different series are identical, the series and
the issuer will be assigned identical ratings. If there are series with different
priorities, they will be assigned higher or lower ratings accordingly, in relation to
the rating of the issuer.
7onitoring5
9nce a year, 7idroog will publish a monitoring report re*examining the ratings that
it has assigned. In addition, whenever there is a new issue, the issuer:series will be
evaluated in light of the new issue.
;atchlist Review5
<vents sometimes occur in a rated concern or in its sector, which may affect the
concern's rating. 7idroog's regular procedure in these cases is to consider whether
the event is significant enough to warrant a review of the concern's rating, and
whether an announcement should be issued that the rating is being reviewed and
put on the ;atchlist. If the decision is yes, 7idroog will notify the party being
reviewed accordingly. It must also immediately publish that the rating has been put
on a ;atchlist, and explain the reasons for it. 7idroog hopes that a rating review
will take no longer than three months from the day that the concern being reviewed
is informed of the rating committee's decision, but it could take longer.
Rating 9utlook5
Another indicator is usually assigned to investment grade companies 8 a rating
outlook, resulting from any occurrence taking place or likely to develop over a
period of up to !0 months. 7idroog will express its opinion on the =reasonable
direction> of the firms' rating as =positive>, =stable> or =negative> using this
indicator.
An outlook rating can only be changed by a rating committee team meeting.
A rating outlook does not re&uire a modification of the firm's overall rating or a
rating review.
Rating Report5
7idroog will deliver the rating report to the concern being rated for approval, and
will then distribute the report to its subscribers.
6ublic Announcement5
7idroog will deliver the public announcement regarding its main rating
considerations to the party being rated for its approval, and will then distribute the
announcement to the various communication media.
;hat is credit rating agencies
A credit rating agency is a company that rates the ability of a person or company to pay back a
loan. The rating given by a credit rating agency is important because it affects the perceived risk
element incorporated into interest rates that are applied to loans.
Interest rates are not the same for everyone, but instead are based on risk based pricing, a form
of price discrimination based on the different expected costs of different borrowers, as set out in
their credit rating.
Ratings awarded by major credit rating agencies:
AAA - : Highest Safety
AA - :
High Safety
A - :
Adequate Safety
BBB - : Moderate Safety
BB - : Sub -moderate Safety
B - : Inadequate Safety
C - : Substantial Risk
D - : Default
CRI+I$ is India#s leading rating agency, and is the fourth largest in the world.
;ith over a ?1@ share of the Indian Ratings market, CRI+I$
Ratings is the agency of choice for issuers and investors.
;ith over Rs. A.0 trillion of debt, 3,?11 issues and .,111 issuers rated to date,
CRI+I$ continues to play a key role in the development of India#s debt markets.
. CRII! is acronym for Credit Rating Information ervices of India !imited. CRII! is India"s
leading Ratings, #inancial $ews, Risk and %olicy Advisory company. ince &'() when CRII!
was incorporated, CRII! has played an integral role in India"s development milestones.
CRII!"s ma*ority shareholder is tandard + %oor"s, the world"s foremost provider of independent
credit ratings, indices, risk evaluation, investment research and data. CRII!"s association with
tandard + %oor"s, a division of The ,c-raw./ill Companies, dates back to &''0 when both
companies started working together on rating
methodologies and *oint pro*ects.
CRII! Ratings is the only ratings agency in India to operate on the basis of sectoral
specialisation. CRII! Ratings plays a leading role in the development of the debt markets in
India. CRII! has also spearheaded the formation of the CariCRI, the world"s first regional credit
rating agency.

ICRA

ICRA Limited (an Assoiate of Moody!s In"estors Ser"ie# $as
inor%orated in &''& as an inde%endent and %rofessional om%any(
ICRA is a leading %ro"ider of in"estment information and redit rating
ser"ies in India( ICRA)s ma*or shareholders inlude Moody!s In"estors
Ser"ie and leading Indian finanial institutions and banks( +ith the
gro$th and globalisation of the Indian a%ital markets leading to an
e,%onential surge in demand for %rofessional redit risk analysis- ICRA
has been %roati"e in $idening its ser"ie offerings- e,euting
assignments inluding redit ratings- equity gradings- s%eialised
%erformane gradings and mandated studies s%anning di"erse
industrial setors( In addition to being a leading redit rating ageny
$ith e,%ertise in "irtually e"ery setor of the Indian eonomy- ICRA
has broad-based its ser"ies for the or%orate and finanial setors-
both in India and o"erseas- and urrently offers its ser"ies under the
follo$ing banners.
ICRA assigns A!B rating to the commercial paper programme of ICICI
Come -inance Company $imited
ICRA assigns A!B rating to short term debt programme ,including
Commercial 6aper" of -irst India Credit Corporation $imited
ICRA assigns A!B rating to the enhanced short*term debt of +DI -actors E
Commercial +ervices 6rivate $imited
ICRA assigns highest credit &uality ratings to long*term debt programme of
Infrastructure evelopment -inance Company $imited
C

I++F<R RATIG)+
Background
ICRA has been providing investors with independent, professional and reliable rating opinions on
debt instruments since &''&. 1ased on the feedback received from the market and to extend its
Rating coverage to corporate entities who do not have firm or immediate debt issue plans, ICRA
has launched the Issuer Rating services in India.
ICRA's Issuer Ratings provide an opinion on the general creditworthiness of the rated entities in
relation to their senior unsecured obligations.ICRA offers its Credit Rating services to a wide
range of issuers, including 2
,anufacturing companies
1anks and financial institutions
/ousing #inance companies
Infrastructure sector companies
ervice companies
,unicipal and other local bodies
tate governments
$on.banking finance companies
The Benefits
#or lenders3investors, ICRA issuer ratings would2
%rovide an ob*ective, independent and reliable opinion on credit 4uality
#acilitate an informed investment decision
Assists in risk pricing and capital allocation
#acilitate portfolio management and monitoring
#or the rated entities, ICRA issuer ratings may help to2
Improve the comfort level with prospective3existing lenders3investors
$egotiate terms based on their inherent credit 4uality
Reduce the time involved in loan approvals
Access a broader investor base
Disclaimer and Copyright
ICRA!s Cor%orate /o"ernane Rating (C/R# is meant to indiate the relati"e le"el to $hih an
organisation ae%ts and follo$s the odes and guidelines of or%orate go"ernane %raties(
Cor%orate /o"ernane %raties %re"alent in a om%any reflet the distribution of rights and
res%onsibilities among different %artii%ants in the organisation suh as the 0oard- management-
shareholders and other finanial stakeholders and the rules and %roedures laid do$n and follo$ed
for making deisions on or%orate affairs( 1he em%hasis of ICRA rating is on or%orate!s business
%raties and quality of dislosure standards that addresses the requirements of the regulators and
is fair and trans%arent for its finanial stakeholders 1he "ariables- $hih are analysed for arri"ing at
the rating- are the shareholding struture- e,euti"e management %roesses- board struture and
%roesses- stakeholder relationshi%- trans%areny and dislosures and finanial disi%line( 2ah of
these "ariables is e"aluated $ith res%et to a set of attributes and a om%osite sore is om%uted
using a %ro%rietary model de"elo%ed by ICRA( 1he rating %roess also looks at om%liane $ith
statutory regulations as laid do$n in Clause 3' of the Listing Agreement( 1he fous- ho$e"er- is on
substane o"er form and om%liane $ith regulations is only the starting %oint( 1he ICRA o%inion- is
- ho$e"er not a ertifiate of statutory om%liane or a omment on om%any!s future finanial
%erformane- redit rating or stok %rie(
Credit Analysis + Research !td. 5CAR67, incorporated in April &''8, is a credit rating, information
and advisory services company promoted by Industrial 9evelopment 1ank of India 5I91I7,
Canara 1ank, :nit Trust of India 5:TI7 and other leading banks and financial services companies.
In all CAR6 has &; shareholders.
CAR6 assigned its first rating in $ovember &''8, and upto ,arch 8&, <==0, had completed 8&)>
rating assignments for an aggregate value of about Rs ><8& billion. CAR6"s ratings are
recognised by the -overnment of India and all regulatory authorities including the Reserve 1ank
of India 5R1I7, and the ecurities and 6xchange 1oard of India 561I7. CAR6 has been granted
registration by 61I under the ecurities + 6xchange 1oard of India 5Credit Rating Agencies7
Regulations,&'''.
The rating coverage has extended beyond industrial companies, to include public utilities,
financial institutions, infrastructure pro*ects, special purpose vehicles, state governments and
municipal bodies. CAR6"s clients include some of the largest private sector manufacturing and
financial services companies as well financial institutions of India. CAR6 is well e4uipped to rate
all types of debt instruments like Commercial %aper, #ixed 9eposit, 1onds, 9ebentures and
tructured ?bligations.
CAR6"s Information and Advisory services group prepares credit reports on specific re4uests
from banks or business partners, conducts sector studies and provides advisory services in the
areas of financial restructuring, valuation and credit appraisal systems. CAR6 was retained by
the 9isinvestment Commission, -overnment of India, for assistance in e4uity valuation of a
number of state owned companies and for suggesting divestment strategies for these
companies.
CAR6"s Credit Rating is an opinion on the relative ability and willingness of an issuer to make
timely payments on specific debt or related obligations over the life of the instrument. CAR6 rates
rupee denominated debt of Indian companies and Indian subsidiaries of multinational companies.
CAR6 undertakes credit rating of all types of debt and related obligations. These include all types
of medium and long term debt securities such as debentures, bonds and convertible bonds and
all types of short term debt and deposit obligations such as commercial paper, inter.corporate
deposits, fixed deposits and certificates of deposit.
CAR6 also rates 4uasi.debt obligations such as the ability of insurance companies to meet
policyholders obligations. CAR6"s preference share ratings measure the relative ability of a
company to meet its dividend and redemption commitments.
CAR6 has a strong structured finance team and has been instrumental in developing rating
methodologies for innovative asset backed securities in the Indian capital market. The term
"structured financing" refers to securities where the servicing of debt and related obligations is
backed by some sort of financial assets and3 or credit support from a third party to the
transaction. The securities are termed "structured" because through specific choices relating to
the type and amount of assets and particular structural features, these securities may be
structured to achieve a desired rating level. CAR6 assigns the suffix 5?7 to denote that the
rating has been achieved by suitably structuring the transaction to enhance the credit 4uality of
the securities and not on the basis of the credit 4uality of the issuer alone.
Symbols Definition
CARE 1 6xcellent debt management capability. uch companies will normally
be characterised as leaders in the respective industries.
CARE 2 @ery good debt management capability. uch companies would be
regarded as close to those rated CAR6.&, but with a lower capability
to withstand changes in assumptions.
CARE 3 -ood capability for debt management. uch companies are
considered medium gradeA assumptions that do not materialise may
impair debt management capability in future.
CARE 4 1arely satisfactory capability for debt management. The capacity to
meet obligations is likely to be adversely affected by short. term
adversity or less favourable conditions.
CARE 5 %oor capability for debt management. uch companies are in default
or are likely to default in meeting their debt obligations.
-re&uently Asked Huestions
;hat is credit ratingI
Credit rating is, essentially, the opinion of the rating agency on the relative ability
and willingness of the issuer of a debt instrument to meet the debt service
obligations as and when they arise.
;hy do rating agencies use symbols like AAA, AA, rather than give marks or
descriptive credit opinionI
The great advantage of rating symbols is their simplicity, which facilitates universal
understanding. Rating companies also publish explanations for their symbols used
as well as the rationale for the ratings assigned by them, to facilitate deeper
understanding.
;hy is credit rating necessary at allI
Credit rating is an opinion expressed by an independent professional organisation,
after making a detailed study of all relevant factors. +uch an opinion will be of great
assistance to investors in making investment decisions. It also helps the issuers of
debt instruments to price their issues correctly and to reach out to new investors.
Regulators like Reserve Dank of India ,RDI" and +ecurities E <xchange Doard of
India ,+<DI" often use credit rating to determine eligibility criteria for some
instruments. -or example, the RDI has stipulated a minimum credit rating by an
approved agency for issue of Commerce 6aper. In general, credit rating is expected
to improve &uality consciousness in the market and establish, over a period of time,
a more meaningful relationship between the &uality of debt and the yield from it.
Credit Rating is also a valuable input in establishing business relationships of
various types.
oes credit rating constitute an advice to the investors to buyI
It does not. The reason is that some factors, which are of significance to an investor
in arriving at an investment decision, are not taken into account by rating agencies.
These include reasonableness of the issue price or the coupon rate, secondary
market li&uidity and pre*payment risk. -urther, different investors have different
views regarding the level of risk to be taken and rating agencies can only express
their views on the relative risk.
;hat kind of responsibility or accountability will attach to a rating agency if an
investor, who makes his investment decision on the basis of its rating, incurs a loss
on the investmentI
A credit rating is a professional opinion given after studying all available
information at a particular point of time. Gevertheless, such opinions may prove
wrong in the context of subse&uent events. -urther, there is no privity of contract
between an investor and a rating agency and the investor is free to accept or re4ect
the opinion of the agency. Gevertheless, rating is essentially an investor service and a
rating agency is expected to maintain the highest possible level of analytical
competence and integrity. In the long run, the credibility of a rating agency has to
be built, brick by brick, on the &uality of its services.
o rating companies undertake unsolicited ratingsI
Got in India, at least not yet. There is however, a good case for undertaking
unsolicited ratings. It will be relevant to mention here that any rating based entirely
on published information has serious limitations and the success of a rating agency
will depend, to a great extent, on its ability to access privileged information. Co*
operation from the issuers as well as their willingness to share even confidential
information are important pre*re&uisites. 9n its part, the rating agency has a great
responsibility to ensure confidentiality of the sensitive information that comes into
its possession during the rating process.
Cow reliable and consistent is the rating processI Cow do rating agencies eliminate
the sub4ective element in ratingI
To answer the second &uestion first, it is neither possible nor even desirable, to
totally eliminate the sub4ective element. Rating does not come out of a pre*
determined mathematical formula, which fixes the relevant variables as well as the
weights attached to each one of them. Rating agencies do a great amount of number
crunching, but the final outcome also takes into account factors like &uality of
management, corporate strategy, economic outlook and international environment.
To ensure consistency and reliability, a number of &ualified professionals are
involved in the rating process. The Rating Committee, which assigns the final rating,
consists of professionals with impeccable credentials. Rating agencies also ensure
that the rating process is insulated from any possible conflicts of interest.
Is it customary to have the same issue rated by more than one rating agencyI o the
ratings for the same instrument vary from agency to agencyI
The answer to both the &uestions is yes. In the well*developed capital markets, debt
issues are, more often than not, rated by more than one agency. And, it is only
natural that the opinions given by two or more agencies will vary, in some cases. Dut
it will be very unusual if such differences are very wide. -or example, a debt issue
may be rated 9FD$< A 6$F+ by one agency and 9FD$< A or 9FD$< A
7IGF+ by another. It will indeed be unusual if one agency assigns a rating of
9FD$< A while another gives a TRI6$< D.
;hy do rating agencies monitor the issues already ratedI
A rating is an opinion given on the basis of information available at a particular
point of time. As time goes by, many things change, affecting the debt servicing
capabilities of the issuer, one way or the other. It is, therefore, essential that as a part
of their investor service, rating agencies monitor all outstanding debt issues rated by
them. In the context of emerging developments, the rating agencies often put issues
under creditwatch and upgrade or downgrade the ratings as and when necessary.
Gormally, such action is taken after intensive interaction with the issuers.
Are all ratings publishedI
In India, ratings are undertaken only at the re&uest of the issuers and only those
ratings, which are accepted by the issuers, are published. Dut there is a view that the
rating agencies should publish all ratings, even those found unacceptable by the
issuers. This is a matter for further discussion, so that a generally acceptable
industry practice emerges. 9nce a rating is accepted, it will be published and
subse&uent changes emerging out of the monitoring by the agency will be published
even if such changes are not found acceptable by the issuers.
o issuers have a right of appeal against a rating assignedI
Jes. In a situation where an issuer is unhappy with the rating assigned, he may
re&uest for a review, furnishing additional information, if any, considered relevant.
The rating agency will, then, undertake a review and thereafter indicate its final
decision. Fnless the rating agency had overlooked critical information at the first
stage, ,which is unlikely", chances of the rating being changed on appeal are rare.
Cow much time does rating takeI
The rating process is a fairly detailed exercise. It involves, among other things,
analysis of published financial information, visits to the issuers offices and works,
intensive discussion with the senior executives of issuers, discussions with auditors,
bankers, creditors, etc. It also involves an in*depth study of the industry itself and a
degree of environment scanning. All this takes time and a rating agency may take six
to eight weeks or more to arrive at a decision. The time taken may be somewhat less
say, three or four weeks, for rating short term instruments like commercial paper, as
the focus will be more on short term li&uidity rather than on long term
fundamentals. It is of paramount importance to rating companies to ensure that
they do not, in any way, compromise on the &uality of their analysis, under pressure
from issuers for &uick results. Issuers would also be well advised to approach the
rating agencies sufficiently in advance so that issue schedules can be adhered to.
Is it possible that not satisfied with the rating assigned by one rating agency, an
issuer approaches another, in the hope of getting a better resultI
It is possible, but rating companies do not and should not indulge in competitive
generosity. Any attempt by issuers to play one agency against another will have to be
discouraged by all the rating companies. It may, however, be pointed out here that
two rating companies may, and often do, arrive at different conclusions on the same
issue. This is only natural, as perceptions differ.
;ho rates the rating companiesI
Informed public opinion will be the touchstone on which the rating companies have
to be assessed and the success of a rating agency should be measured by the &uality
of the services offered, consistency and integrity.
Is the rating assigned for an instrument or for the Issuer CompanyI
The rating is for a particular issue and not for a company. It is, therefore, &uite
possible that two instruments issued by the same company carry different ratings,
particularly if maturities are substantially different or one of the instruments is
backed by additional credit reinforcements like guarantees. In many cases, short
term obligations, like commercial paper carry the highest rating even as the long
term debt of the same issuer may be assigned a rating several levels below the
highest rating. This is only natural, as the risk profile changes very dramatically for
longer maturities. It is, however, not unusual for lenders and business
counterparties to consider the long term bond rating as a rating of the issuer.
;hy are e&uity shares not ratedI
Dy definition, credit rating is an opinion on the issuers capacity to service debt. In
the case of e&uity, there is no pre*determined servicing obligation, as e&uity is in the
nature of venture capital. +o, credit rating in the conventional sense does not apply
to e&uity shares.
In what way is a credit rating different from an analysis by any financial analystI
Credit rating is essentially, business analysis, which has a much broader connotation
than financial analysis. 9ne significant factor, which adds value to the analysis of a
rating agency, is that the rating is normally done at the re&uest of and with the
active co*operation of the issuer. +o, the rating agency has access to unpublished
information and the discussions with the senior management of issuers give
meaningful insights into corporate plans and strategies. The rating agencies also
make necessary ad4ustments to published accounts for the purpose of their analysis
and 4uxtapose the issuer against the backdrop of the industry in &uestion and the
general economic environment. And, at the culmination of this detailed process, the
rating emerges as the well considered view of a do(en or more highly &ualified and
experienced professionals. The rating agencies (ealously safeguard their
independence and scrupulously avoid any conflict of interest with the various
players in the capital market. If any analyst or group of analysts is able to ensure all
these, we probably have another rating agency in the making.
Are rating standards specific for each countryI If CAR< gives AAA and if +E6
assigns AAA, are they at the same levelI
CAR< rates only Rupee denominated debt while +E6 rates debt of any currency. A
CAR< AAA rating indicates that the company's rupee debt stands in good
comparison to debt issued by the )overnment of India ,considered safest relatively"
and is considered to be of the best &uality. The sovereign ceiling, if any, does not
apply. Cowever, all +E6 ratings will have a cap in the form of the rating ceiling for a
particular currency denominated debt.
If a rating is downgraded, how would it KbenefitK ,or compensate " the investorI
A credit rating is a professional opinion on the ability and willingness of an issuer to
meet debt*servicing obligations. It is an opinion on future debt servicing capabilities
given on the basis, inter*alia, of past performance and all available information
,from audited financial statements, company management, banks and financial
institutions, statutory auditors, etc." at a particular time. ;hile rating agencies
make all possible efforts to pro4ect corporate business prospects, industry trends
and management capabilities, many events are unpredictable. Cence, such opinions
may prove wrong in the context of subse&uent events. 9n the occurrence of such an
event, a rating agency can only review and make appropriate changes in the rating.
7oreover, when there are recessionary trends in certain segments of the economy,
companies in such segments or with large exposures to such segments are adversely
affected and their credit ratings get downgraded. +uch downgradations are a
natural conse&uence of the recessionary trends. In other words, credit &uality ,and
credit rating" is dynamic, not static and all rating agencies review their ratings
periodically and make changes, wherever considered appropriate. +uch changes are
reported widely through the media. It is the experience of all rating agencies that
some instruments initially rated as investment grade fall below investment grade or
go into default, over a period of time.
-urther, it must be noted that there is no privity of contract between an investor or a
lender and a rating agency and the investor is free to accept or re4ect the opinion of
the agency. A credit rating is not an advice to buy, sell or hold securities or
investments and investors are expected to take their investment decisions after
considering all relevant factors and their own policies and priorities. A credit rating
is not a guarantee against future losses. 6lease also note that credit ratings do not
take into account many aspects which influence investment decisions. They do not,
for example, evaluate the reasonableness of the issue price, possibilities for capital
gains or take into account the li&uidity in the secondary market. Ratings also do not
take into account the risk of prepayment by issuer, or interest or exchange risks.
Although these are often related to the credit risk, the rating essentially is an
opinion on the relative &uality of the credit risk, based on the information available
at a given point of time.
$imitations of credit rating * rating downgrades
Rating agencies all across the world have often been accused of not being able to
predict future problems. In part, the problem lies in the rating process itself, which
relies heavily on past numerical data and standard ratios with relatively lower usage
of 4udgment and understanding of the underlying business or the country
economics. ata does not always capture all aspects of the situation especially in the
complex financial world of today. An excellent example of the meaningless over
reliance on numbers is the poor country rating given to India. 7a4or rating agencies
site one of the reasons for this as the low ratio India's exports to foreign currency
indebtedness. This completely ignores two issues 8 firstly, India gets a very high
&uantum of foreign currency earnings through remittances from Indians working
abroad and also services exports in the form of software exports which are not
counted as KmerchandiseK exports. These two flows along with other KinvisibleK
earnings accounted for almost F+/!!bn in -J LL. +econdly, since India has tight
control on foreign currency transactions, there is very little error possible in the
foreign currency borrowing figure. As against this, for a country like Morea, the
figure for foreign currency borrowing increased by F+/31bn after the exchange
crisis began. This was on account of hidden forward liabilities through swaps and
other derivative products.
In general, Indian rating agencies have lost some amount of their credibility in the
last two years due to their inability to predict defaults in many companies, which
they had rated &uite highly. +ometimes, some of the agencies had an investment
grade rating in place when the company in &uestion had already defaulted to some
of the fixed deposit holders. -urther, rating agencies resorted to mass downgrading
of 31*!11 companies as a reaction to public criticism, which further eroded their
credibility. The ma4or reasons for these downgrades are as follows
Corporate earnings fell very sharply due to persistent recessionary conditions
prevailing in the economy. 7any of the corporates are in commodity sectors where
fluctuations in selling prices of products can be very sharp * leading to complete
erosion of profitability. This problem was compounded by the Asian crisis, which led
to increased competition from cheap imports in many product categories.
Rating agencies substantially overestimated financial flexibility of corporates
especially from traditional corporate houses. 7uch of the financial flexibility was
implicit on raising money from new issues from the capital market, which has been
impossible in the last . years.
In the case of finance companies, widespread defaults like CRD and tightening of
regulations made it virtually impossible for them to raise money in any form. These
finance companies had been in the habit of investing in longer term, illi&uid assets
by borrowing shorter term fixed deposits. ;hen the flow of credit stopped, they
faced li&uidity problems. These were further compounded by defaults by some of
the companies to which they had on lent money.
The experience is no different from the international scenario where reputed and
highly experienced rating agencies like +tandard E 6oor ,+E6" and 7oody's were
unable to predict the Asian crisis and had to face the embarrassment of seeing the
credit rating of +outh Morea as a country go from AB to DDB in a short span of .
months.
Dy and large, the rating is a very good estimate of the actual creditworthiness of the
companyN however, it is not able to predict extreme situations such as the ones
described above, which are unlikely to have been predicted by most investors in any
case. Investors should reali(e that a credit rating is not sacrosanct and that one has
to do one's own due diligence and investigation before investing in any instrument.
They should use the rating as a reference and a base point for their own effort. 9ne
good way of doing this is examining the behavior of the stock price in case the stock
is listed. As a collective, the market is far smarter at predicting problems than any
credit rating agency. ;itness the sharp erosion in stock prices of companies much
before their credit ratings were downgraded. ;itness also the fact that foreign
currency bonds from Indian issuers trade at yields lower than countries which have
been rated higher by rating agencies.
Code of <thics to be followed by Rating Agencies followed by Rating
Agencies
7ember Credit Rating Agencies shall put in place systems and
pro 7ember Credit Rating Agencies shall put in place
systems and procedures to ensure cedures to ensure the
following 5 the following 5
!" !" The proceedings of a credit rating board : rating committee,
are The proceedings of a credit rating board : rating
committee, are kept kept confidential at all times, and not
revealed to any external part confidential at all times, and
not revealed to any external parties or agencies. If ies or
agencies. If any records of the proceedings are made, credit
rating agencies any records of the proceedings are made,
credit rating agencies must take steps must take steps to
keep such records properly safeguarded, except where
re&uired to keep such records properly safeguarded, except
where re&uired to be to be disclosed by the provisions of
laws or regulations. disclosed by the provisions of laws or
regulations.
%" %" ;hen the credit rating board decides on a rating, it
shall be an ;hen the credit rating board decides on a
rating, it shall be announced as a nounced as a 4oint
decision and the individual votes shall be kept
confidenti 4oint decision and the individual votes shall
be kept confidential, even if al, even if recorded. This
re&uirement of confidentiality shall apply to rat
recorded. This re&uirement of confidentiality shall
apply to rating board ing board members for their
own votes as well.
." ." ;hen and after a credit rating board : rating committee member o ;hen and
after a credit rating board : rating committee member or credit r credit rating
agency employee terminates his:her employment or work ass rating agency
employee terminates his:her employment or work association ociation with the
rating agency, the re&uirement of confidentiality with with the rating agency, the
re&uirement of confidentiality with respect to the respect to the information received
during the period of work association shall information received during the period
of work association shall continue as continue as information held in trust.
information held in trust
2" 2" A credit rating board : rating committee member does not
take un A credit rating board : rating committee member
does not take undue material due material advantage of
any confidential information received through his o
advantage of any confidential information received
through his or her r her participation in a credit rating
process. 6ersons involved in th participation in a credit
rating process. 6ersons involved in the ratings process e
ratings process should also be made vigilant to prevent
abuse of prior knowledge should also be made vigilant to
prevent abuse of prior knowledge of ratings of ratings
changes. changes.
Code of <thics to followed by concerened individuals
Individuals involved with the credit rating process at member
agencies shall agree to encies shall agree to and abide by the
following 5 and abide by the following 5
!" !" Credit Rating is a function of serious responsibility and any
an Credit Rating is a function of serious responsibility and
any and all persons d all persons exercising the function
shall view it as a matter of great trust exercising the function
shall view it as a matter of great trust.
%" %" 7embers of credit rating boards : rating committees and any
staf 7embers of credit rating boards : rating committees
and any staff member f member participating in any way in
the credit rating decision making, s participating in any way
in the credit rating decision making, shall always apply hall
always apply to the credit rating process the highest degree
of integrity, co to the credit rating process the highest degree
of integrity, competence, mpetence, ob4ectivity and
thoroughness, worthy of the trust the function r ob4ectivity
and thoroughness, worthy of the trust the function re&uires.
e&uires.
." ." Although Credit Rating is a matter of opinion, it shall be
reach Although Credit Rating is a matter of opinion, it shall
be reached through a ed through a formal and professional
process, which is supported by appropria formal and
professional process, which is supported by appropriate
ob4ective te ob4ective criteria and based on information
considered ade&uate and reliab criteria and based on
information considered ade&uate and reliable le by the
rating by the rating agency.
.
2" 2" The credit rating agency and its staff shall presume the
confide The credit rating agency and its staff shall presume
the confidentiality of the ntiality of the information
received by it in the course of the credit rating pr
information received by it in the course of the credit rating
process, and take all ocess, and take all possible
precautions towards this end. possible precautions towards
this end.
3" 3" In case of any possible conflict of interest situation, the
memb In case of any possible conflict of interest situation,
the member of the credit er of the credit rating board :
rating committee or the staff member concerned sh
rating board : rating committee or the staff member
concerned shall disclose alldisclosesuch conflict of interest
and shall not participate in any manne such conflict of
interest and shall not participate in any manner in
formulating r in formulating or arriving at a rating.
,Gevertheless, the person with a confli or arriving at a
rating. ,Gevertheless, the person with a conflict of interest
may ct of interest may be asked to be a resource person to
give information or opinions be asked to be a resource
person to give information or opinions useful for the
useful for the consideration of others, but such person
shall not participate i consideration of others, but such
person shall not participate in the voting n the voting
process itself". process itself".