Report On

“A STUDY ON CREDIT RATING”

“CRISIL v/s MOODY’S”

Submitted in partial fulfilment for award of the degree of

Masters of Management Studies (MMS)

(Under University of Mumbai)

Submitted By

Mr. Samson M Bishniki

(Roll. No.3158208)

Under the guidance of

Prof. Shrikesh Poojari

2021-2022

Pramod Ram Ujagar Tiwari

Saket Institute of Management

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 CERTIFICATE

This is to certify that project titled “ CREDIT RATING.” is successfully completed by Ms.
Samson M Bishniki during the III semester, in partial fulfilment of the Masters Degree in
Management Studies recognized by University of Mumbai for the Academic Year 2021-2022
through Pramod Ram Ujagar Tiwari Saket Institute of Management.

This project is original and not submitted earlier for award of any degree, diploma or
associateship of any other university or institute.

Name: Prof. Shrikesh Poojari

Date: (Signature of the Guide)

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 DECLARATION

I hereby declare that this Project Report submitted by me to Pramod Ram Ujagar Tiwari Saket
Institute of Management is a bonafide work undertaken by me and it is not submitted to any
other University or Institution for award of any degree, diploma/certificate or published any time
before.

Name: Mr. Samson M Bishniki

Roll. No.: 3158208 (Signature of the Student)

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 Acknowledgements

The success and final outcome of this project required a lot of guidance and assistance from
many people and I am extremely privileged to have got this all along the completion of my
project. All that I have done is only due to such supervision and assistance and I would not forget
to thank them.

I respect and thank Mr Saket Tiwari , for providing me an opportunity to do the project work in
Saket Gyanpeeth and giving me all support and guidance which made me complete the project
duly. I am extremely thankful to him for providing such a nice support and guidance, although he
had busy schedule managing the corporate affairs. I also thank Mrs. Shobha Nair the C.E.O of
Saket Gyanpeeth.

I owe my deep gratitude to my project guide Prof. Shrikesh Pujari, who took keen interest on our
project work and guided me all along, till the completion of our project work by providing all the
necessary information.

I am thankful to and fortunate enough to get constant encouragement, support and guidance from
all Teaching staff and Director Sanoj Kumar of Pramod Ram Ujagar Tiwari Saket Institute of
Management who helped me in successfully completing my project work.

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 Table of Contents

Chapter Headings Page No.

Number
1 Introduction 1
2 Review of Literature 14
3 Methodology 16
4 Results 27
5 Discussion 32
6 Conclusion 44
7 Bibliography/References 45
8 Appendices 46-47

Chapter 1

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 INTRODUCTION TO CREDIT RATING

The Ratings industry in India has been built up to its present position over a period of fifteen
years. Over the years, credit ratings have evolved into a 90-crore market, with four agencies
providing rating services, and significant pull from investors for the product. The ratings
business in India has seen three phases. During the first of these phases, as described above,
there was no experience of credit ratings, and virtually no awareness, on the part of investors
and issuers.

The second phase saw the advent of regulatory support for credit ratings, with the
introduction and Increasing rigor of regulations covering primarily the markets for public issue
of debt and for fixed deposits. Aimed at protecting smaller investors, these measures also
amounted to regulatory recognition of the role of credit ratings and the quality of the effort put
in till then, in estimating credit quality. With these measures, credit ratings rapidly passed out
of the arcane realm of high finance, and into the lexicon of the individual market participant.
This phase also saw the arrival of competition, in the form of other domestic agencies entering
the market.

Recent years have seen a third phase of the market’s development with public issues
of debt reducing in volume; the focus has shifted to the market for private placements. Almost
all the privately placed debt issued in the Indian market is rated, even though this is not a
regulatory requirement. This shift is entirely driven by investors in these securities, who
typically tend to be highly sophisticated financial sector entities. We are looking therefore at a
qualitative maturing of the market, where a rating is required not as a compliance issue or a
mandatory requirement, but as an opinion on credit quality demanded by discerning buyers.

Going forward, following trends are expenditure types of mouse.

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- More intensive use of ratings by investors.
- Increasing sophistication in use of ratings.

These two trends will result in credit ratings not being used only as a go/no-go input,
as is currently often the case. We expect the major use of credit ratings to be in the pricing of
debt instruments. The correlation of yields and ratings, already strong, will deepen as the bond
market evolves further. Measures increasing the sophistication of the market, such as the
introduction of credit derivatives, will add a further dimension to the use of ratings.

Credit rating is also known as SECURITY RATING in India. It is mandatory for the
issuance of debt instruments, debentures, commercial paper issued by corporate and public
deposits of all NBFCs (Non-Banking Financial Companies). A credit rating is an evaluation of
the credit risk of a prospective debtor (an individual, a business, company or a government),
predicting their ability to pay back the debt, and an implicit forecast of the likelihood of the
debtor defaulting. The credit rating represents an evaluation of a credit rating agency of the
qualitative and quantitative information for the prospective debtor, including information
provided by the prospective debtor and other non-public information obtained by the credit
rating agency's analysts.

DEFINITION OF CREDIT RATING

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 Credit ratings are judgments about firms financial and business prospects.
Credit rating is defined ‘as a process by which a statistical service prepares various ratings
identified by symbols which are indicators of the investment quality of the credit rated’. The
credit may be a debt instrument or equity. In case of debt, ratings are given while in the case of
shares grading is done.

It is an independent assessment of the creditworthiness of a bond (note or

any security of any indebt ness) by a credit rating agency. It measures the probability of the
timely repayment of principal and interest of a bond. Generally, a higher credit rating would
lead to a more favorable effect on the marketability of a bond. The credit rating symbols (long
term) are generally assigned with “triple A” as the highest and “triple B” as the lowest in
investment grade. Anything below “triple B” is commonly known as a ‘junk bond’.

Credit rating is the process of assigning standard scores which summarize

the probability of the issuer being able to meet its repayment obligations for a particular debt
instrument in a timely manner. Credit rating is integral to debt markets as it helps market
participants to arrive at quick estimates and opinions about various instruments. In this manner
it facilitates trading in debt and money market instruments especially in instruments other than
Government of India Securities. Credit rating is not a recommendation to buy, hold or sell.

Rating is usually assigned to a specific instrument rather than the company

as a whole. In the Indian context, the rating is done at the instance of the issuer, which pays
rating fees for this service. If it is unsatisfied with the rating assigned to its proposed
instrument, it is at liberty not to disclose the rating given to it. There are 4 rating agencies in
India. These are as follows:

Credit rating is a dynamic concept and all the rating companies are
constantly reviewing the companies rated by them with a view to changing (either upgrading or
downgrading) the rating. They also have a system whereby they keep ratings for particular
companies on "rating watch" in case of major events, which may lead to change in rating in the
near future. Ratings are made public through periodic newsletters issued by rating companies,

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which also elucidate briefly the rationale for particular ratings. In addition, they issue press
releases to all major newspapers and wire services about rating events on a regular basis.

According to CARE: “Credit ratings 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
obligation as and when they arise”.

According to CRISL: “Credit rating is an unbiased, objective and independent opinion to an

issuer’s capacity to meet financial obligation, it is the current opinion as to the relative safety
of timely payment of interest and principal on a particular debt instruments. Thus, rating
applies to a particular debt obligation of the company and is not a rating for the company as a
whole”

According to ICRA:” credit rating is a simple and easy to understand symbolic indicator of the
opinion of the credit rating agency about the risk involved in a borrowing program of an issuer
with reverence to the capability of the issuer to repay the debt as per terms of issues. This is
neither a general purpose evaluation of the company nor the recommendation to buy, hold or
sell a debt instrument.”

Thus, precisely, rating is a measure of credit risks and is only element in the investment
decision making.

Credit rating does not indicate market risks or predict prices or yield of credits instrument. It
evaluates only a specific instrument and indicates risk associated with such instrument only. It
is general purpose evaluation of the issuer business or operations.

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 ORIGIN OF CREDIT RATINGS

T he concept of Credit Rating originated in the United States. The first

Credit Ratings were published by John Moody during 1909 in his analysis or rail road
investments. This evolved into the rating company, Moody’s Investors Services Inc, a division
of Dun and Bradstreet Inc.

Moody was followed by Poor’s publishing Company in 1916 and the

Standard Statistics Company in 1922, which merged, into Poor to become the largest bond
rating concern, Standard and Poor’s corporation, a subsidiary of Mc Graw Hill, Inc. The third
is Fitch publishing company of New York, which was established in 1924. The fourth agency
is Duff & Phelps of Chicago, which was recognized by Securities and Exchange Commission
in 1982. It acquired Crisanti and Maffei Inc. of New York in 1991. These four security raring
agencies are the only ones with Securities and Exchange Commission recognition as national
bond rating agencies. There are other services that rate securities especially stock, like Value
Line Investment Survey.

The recognition of rating agency by Securities and Exchange Commission in U.S.A

does not constitute approval. Actually, such recognition is not necessary to enter the security
rating business. SEC uses the ratings of recognized agencies for evaluation of bong assets of
brokers and dealers registered with it.

In India there are 5 credit rating agencies. First, Credit Rating Information
Services Of India Limited (CRISIL) set up by ICICI AND UTI in 1988. Secondly Investment
Information and Credit Rating Agency of India limited (ICRA) set up by IFCI in 1991.
Thirdly, Credit Analysis and Research Limited (CARE) promoted by IDBI in 1993 in
association with financial institutions. Fourthly, Duff and Phelps Credit Rating India Private
Limited (DCR India) for rating non-banking financial companies for fixed deposits.

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 Meaning of a credit rating agency

A credit rating agency is a private company that looks at the credit worthiness of a large-
scale borrower, such as a company or country. It effectively ranks the borrower on their ability
to pay off their loan.
A credit rating agency (CRA, also called a ratings service) is a company that assigns
credit ratings, which rate a debtor's ability to pay back debt by making timely principal and
interest payments and the likelihood of default. An agency may rate the creditworthiness of
issuers of debt obligations, of debt instruments, and in some cases, of the servicers of the
underlying debt, but not of individual consumers.
The debt instruments rated by CRAs include government bonds, corporate bonds, CDs,
municipal bonds, preferred stock, and collateralized securities, such as mortgagebacked
securities and collateralized debt obligations.
The issuers of the obligations or securities may be companies, special purpose entities,
state or local governments, non-profit organizations, or sovereign nations. A credit rating
facilitates the trading of securities on a secondary market. It affects the interest rate that a
security pays out, with higher ratings leading to lower interest rates. Individual consumers are
rated for creditworthiness not by credit rating agencies but by credit bureaus (also called
consumer reporting agencies or credit reference agencies), which issue credit scores.
The value of credit ratings for securities has been widely questioned. Hundreds of
billions of securities that were given the agencies' highest ratings were downgraded to junk
during the financial crisis of 2007–08. Rating downgrades during the European sovereign debt
crisis of 2010–12 were blamed by EU officials for accelerating the crisis.
Credit rating is a highly concentrated industry, with the "Big Three" credit rating
agencies controlling approximately 95% of the ratings business. Moody's Investors Service and
Standard & Poor's (S&P) together control 80% of the global market, and Fitch Ratings controls
a further 15%.

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 CHARACTERISTICS OF CREDIT RATING

1. Assessment of issuer's capacity to repay. It assesses issuer's capacity to meet its financial
obligations i.e., its capacity to pay interest and repay the principal amount borrowed.
2. Based on data. A credit rating agency assesses financial strength of the borrower on the
financial data.
3. Expressed in symbols. Ratings are expressed in symbols e.g. AAA, BBB which can be
understood by a layman too.
4. Done by expert. Credit rating is done by expert of reputed, accredited institutions.
5. Guidance about investment-not recommendation. Credit rating is only a guidance to
investors and not recommendation to invest in any particular instrument
.

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 FUNCTIONS/IMPORTANCE OF CREDIT RATING

1. It provides unbiased opinion to investors. Opinion of good credit rating agency is unbiased
because it has no vested interest in the rated company.
2. Provide quality and dependable information. Credit rating agencies employ highly qualified,
trained and experienced staff to assess risks and they have access to vital and important
information and therefore can provide accurate information about creditworthiness of the
borrowing company.
3. Provide information in easy to understand language. Credit rating agencies gather
information, analyse and interpret it and present their findings in easy to understand language
that is in symbols like AAA, BB, C and not in technical language or in the form of lengthy
reports.
4. Provide information free of cost or at nominal cost. Credit ratings of instruments are
published in financial newspapers and advertisements of the rated companies. The public has
not to pay for them. Even otherwise, anybody can get them from credit rating agency on
payment of nominal fee. It is beyond the capacity of individual investors to gather such
information at their own cost.
5. Helps investors in taking investment decisions. Credit ratings help investors in assessing
risks and taking investment decision.
6. Disciplines corporate borrowers. When a borrower gets higher credit rating, it increases its
goodwill and other companies also do not want to lag behind in ratings and inculcate financial
discipline in their working and follow ethical practice to become eligible for good ratings, this
tendency promotes healthy discipline among companies.
7. Formation of public policy on investment. When the debt instruments have been rated by
credit rating agencies, policies can be laid down by regulatory authorities (SEBI, RBI) about
eligibility of securities in which funds can be invested by various institutions like mutual funds,
provident funds trust etc. For example, it can be prescribed that a mutual fund cannot invest in
debentures of a company unless it has got the rating of AAA.

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 BENEFITS OF CREDIT RATING

Credit rating offers many advantages which can be classified into:

A. Benefits to investors.
B. Benefits to the rated company.
C. Benefits to intermediaries.
D. Benefits to the business world.

BENEFITS TO INVESTORS

1. Assessment of risk.
The investor through credit rating can assess risk involved in an investment. A small
individual investor does not have the skills, time and resources to undertake detailed risk
evaluation himself. Credit rating agencies who have expert knowledge, skills and manpower to
study these matters can do this job for him. Moreover, the ratings which are expressed in
symbols like AAA, BB etc. can be understood easily by investors.
2. Information at low cost.
Credit ratings are published in financial newspapers and are available from rating agencies at
nominal fees. This way the investors get credit information about borrowers at no or little cost.
3. Advantage of continuous monitoring.
Credit rating agencies do not normally undertake rating of securities only once. They
continuously monitor them and upgrade and downgrade the ratings depending upon changed
circumstances.
4. Provides the investors a choice of Investment.
Credit ratings agencies helps the investors to gather information about creditworthiness of
different companies. So, investors have a choice to invest in one company or the other.
5. Ratings by credit rating agencies is dependable.
A rating agency has no vested interest in a security to be rated and has no business links with
the management of the issuer company. Hence ratings by them are unbiased and credible.

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BENEFITS TO THE RATED COMPANY

1. Ease in borrowings.
If a company gets high credit rating for its securities, it can raise funds with more ease in the
capital market.
2. Borrowing at cheaper rates.
A favorably rated company enjoys the confidence of investors and therefore, could borrow at
lower rate of interest.
3. Facilitates growth.
Encouraged by favorable rating, promoters are motivated to go in for plans of expansion,
diversification and growth. Moreover, highly rated companies find it easy to raise funds from
public through issue of ownership or credit securities in future. They find it easy to borrow
from banks.
4. Recognition of lesserknown companies.
Favorable credit rating of instruments of lesser known or unknown companies provides them
credibility and recognition in the eyes of the investing public.
5. Adds to the goodwill of the rated company.
If a company is rated high by rating agencies it will automatically increase its goodwill in the
market.
6. Imposes financial discipline on borrowers.
Borrowing companies know that they will get high credit rating only when they manage their
finances in a disciplined manner i.e., they maintain good operating efficiency, appropriate
liquidity, good quality assets etc. This develops a sense of financial discipline among
companies who want to borrow.
7. Greater information disclosure.
To get credit rating from an accredited agency, companies have to disclose a lot of information
about their operations to them. It encourages greater information disclosures, better accounting
standards and improved financial information which in turn help in the protection of the
investors.

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BENEFITS TO INTERMEDIARIES

1. Merchant bankers' and brokers' job made easy.

In the absence of credit rating, merchant bankers or brokers have to convince the investors
about financial position of the borrowing company. If a borrowing company's credit rating is
done by a reputed credit agency, the task of merchant bankers and brokers becomes much
easy.

BENEFITS TO THE BUSINESS WORLD

1. Increase in investor population.

If investors get good guidance about investing the money in debt instruments through credit
ratings, more and more people are encouraged to invest their savings in corporate debts.
2. Guidance to foreign investors.
Foreign collaborators or foreign financial institutions will invest in those companies only
whose credit rating is high. Credit rating will enable them to instantly identify the position of
the company.

WHAT CREDIT RATING IS NOT?

1. Not for company as a whole.
Credit rating is done for a particular instrument i.e., for a particular class of debentures and not
for the company as a whole, it is quite possible that two instruments issued by the same
company may carry different rating.
2. Does not create a fiduciary relationship.
Credit rating does not create a fiduciary relationship (relationship of trust) between the credit
rating agency and the investor.
3. Not attestation of truthfulness of information provided by rated company.
Rating does not imply that the credit rating agency attests the truthfulness of information
provided by the rated company.
4. Rating not forever.

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Credit rating is not a one-time evaluation of risk. Which remains valid for the entire life of a
security. It can change from time to time.
COMPULSORY CREDIT RATING
Obtaining credit rating is compulsory in the following cases:
1. For debt securities.
The Reserve Bank of India and SEBI have made credit rating compulsory in respect of all non-
government debt securities where the maturities exceed 18 months
2. Public deposits.
Rating of deposits in companies has also been made compulsory.
3. For commercial papers (CPs).
Credit rating has also been made compulsory for commercial papers. As per Reserve Bank of
India guidelines rating of P2 by CRISIL or A2 by ICRA or PP2 by CARE is necessary for
commercial papers.
3. For fixed deposits with non-banking financial institutions (NBFCs).
Under the Companies Act, credit rating has been made compulsory for fixed deposits with
NBFs.

FACTORS CONSIDERED IN CREDIT RATING

1. Issuer’s ability to service its debt. For this credit rating agencies calculate
a) Issuer Company’s past and future cash flows.
b) Assess how much money the company will have to pay as interest on borrowed funds and
how much will be its earnings.
c) How much are the outstanding debts?
d) Company's short-term solvency through calculation of current ratio.
e) Value of assets pledged as collateral security by the company.
f) Availability and quality of raw material used, favorable location, cost advantage.
g) Track record of promoters, directors and expertise of the staff.

2. Market position of the company.

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What is the market share of various products of the company, whether it will be stable, does
the company possess competitive advantage due to distribution net- work, customer base
research and development facilities etc.

3. Quality of management.
Credit rating agency will also take into consideration track record, strategies, competency and
philosophy of senior management.
4. Legal position of the instrument.
It means whether the issued instrument is legally valid, what are the terms and conditions of
issue and redemption; how much the instrument is protected from frauds, what are the terms of
debenture trust deed etc.
5. Industry risks.
Industry risks are studied in relation to position of demand and supply for the products of that
industry (e.g. cars or electronics) how much is the international competition, what are the
future prospects of that industry, is it going to die or expand?
6. Regulatory environment.
Whether that industry is being regulated by government (like liquor industry), whether there is
a price control on it, whether there is government support for it, can it take advantage of tax
concessions etc.
7. Other factors.
In addition to the above, the other factors to be noted for credit rating of a company are its cost
structure, insurance cover undertaken, accounting quality, market reputation, working capital
management, human resource quality, funding policy, leverage, flexibility, exchange rate risks
etc.

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 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.

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.

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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:

a) Financial analysis, including accounting quality: accuracy of statement of profit, auditors

comments, valuation and depreciation policies.
b) Earnings protection: Sources of future earning growth, profitability ratios and earnings in
relation to fixed income charges.
c) Adequacy of cash flow: Sustainability of cash flows and working capital management.
d) 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 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.
The rating agencies employ nearly identical symbols. They examine the
above factors before assigning a grade. The symbols are A, B, C and D and each symbol is

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graded with associated risk by adding two or one of the same symbols, like AAA, AA and A;
BBB, BB and b; and so, on.

UTILITY OF RATINGS

Investors have always received credit ratings with enthusiasm. But issuers do not share
the enthusiasm since they have to share their securities at higher yields if their issue gets
inferior rating.

Credit rating gives an investor a simple and easy indicator to the credit quality of the debt
instrument, the risks and likely returns, thus providing a yardstick against which the risk
inherent in an instrument can be measured. An investor uses the rating to assess the risk level
and compares the offered rate of return, which is expected rate of return (for the given level of
risk) to optimize his risk return trade- off. Ratings also provide a comparative framework,
which allows the investor to compare investment opportunities.

Credit rating also benefits the issuer. If a public offer is contemplated, the financial
manager must bear in mind the rating while determining the appropriate leverage. Additional
debt may lower the rating from an investment to a speculative grade category, thus rendering
the security ineligible for investment by many institutional investors. It may well be that the
advantages of debt outweigh the disadvantages of the lower credit rating.

Junk bonds, for instance, are a high risk and a high yield (16 to 25% in USA)
instruments. Investment may be limited in such instrument to what an investor can afford to
loose.

Ratings will also effect the pricing of the issue. Actually pricing should reflect the
rating. The marketability of a relatively unknown issuer who is competent is enhanced and the
role of name recognition in an investment decision is minimized.

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 In actual practice ratings are reflected in prices. There is no difference between
the interest rates that are paid on the fixed deposits of two companies even if they are rated
differently. Same is true of long dated debentures. But in commercial paper market where
banks are major players differentials in ratings are reflected in pricing. A reliance CP would be
cheaper than of a company, which is not rated well.

Ratings are used by brokers for opinions and as a service for their customers.
Insurance companies and mutual funds use them in the purchase of securities even though their
own staff prepares investment analysis. Portfolio managers also use them in security
management. Banks depend on them for their investment in commercial paper. Individual
investors depend on them for their decisions to place fixed deposits. Ratings are bound to
assume greater importance with the institutionalization of investors in the form of unit trusts,
mutual funds, pension and provident funds. The debt has shown considerable buoyancy in
1996 not only at the wholesale level (institutional investors) but also at retail level in view of
poor offerings of equity in the primary market. This has come about largely on account of the
availability of ratings on debt instruments, which boosted investor confidence.

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 THE GROWTH OF CREDIT RATING INDUSTRY IN INDIA

The prominent rating agencies in India are: -

i) CRISIL: - Credit Rating Information Services of India Limited.

ii) ICRA: - Investment Information and Credit Rating Agency of India Limited.
iii) CARE: - Credit analysis and Research Limited.
iv) Fitch Ratings India Private Limited.

Fitch Rating India Limited was formally known as DCR India- Duff and Phelps Credit
Rating Co. USA and DCR India merged to form a new entity called Fitch India. Fitch India is a
100% subsidiary of Fitch IBCA, and is the only wholly owned foreign operator in India. Fitch
is the only international rating agency with a presence on the ground in India.
The Indian credit rating industry is next to US in terms of number of ratings issued
and in the number of agencies. Between the four 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. For private placements, rating is
not mandatory but mutual funds and banks ask for a rating. In 1997, the penetration of rating,
that is, the number of rated issues, out of the total number of issues was 35%. In the year 2002,
it was 97%. This means that the credit rating industry has transited from a regulatory driven
market to an investor driven market in the growing debt markets. Between fiscal 1997 and
2001, rated debt volumes increased from Rs. 13,743 crore to Rs. 52,746 crore, which is 84% of
the total issuance.

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 TYPES OF CREDIT RATINGS

Two type of credit rating has been noticed:

1) Traditional debt rating (TDR)

2) Private placement rating (PPR)

Traditional debt ratings (TDR): Traditional debt ratings are a symbolic prediction about the
debt security probability resulting in a default in timely payment of interest and principal. In
other words, traditional debt rating reflects the current opinion of a credit rating agency of the
relative capability and willingness of an issuer of a debt instrument to service the debt
obligation as per the term of contract .Traditional debt rating is specific to specific to to a debt
instrument in term of credit risk associated with such instrument .Traditional debt rating
enable an investor to establish a link between risk and return and provide a symbolic yardstick
to identify the risk level associated with the instrument and the return it offers to match with
his preferences with expectations

Private placement rating (PPR): Privately rating is newly introduced credit rating system
finding in the literature generated by standard & poor on credit rating, private placement rating
is not much different to traditional debt rating but it goes one step ahead to traditional debt
rating ,i.e. Apart from evaluating a risk of default in timely payment it also evaluates the
likelihood of loss to an investor in the vent of default according on the investment .

Never the less, either or both of the two types of rating can be used for new issues of debt
securities or structured obligations.

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 1. Rating of bonds and debentures.
Rating is popular in certain cases for bonds and debentures. Practically, all credit rating
agencies are doing rating for debentures and bonds.
2. Rating of equity shares.
Rating of equity shares is not mandatory in India but credit rating agency ICRA has formulated
a system for equity rating. Even SEBI has no immediate plans for compulsory credit rating of
initial public offerings (IPOs).
3. Rating of preference shares.
In India preference shares are not being rated, however Moody's Investor Service has been
rating preference shares since 1973 and ICRA has provision for it.
4. Rating of medium term loans (Public deposits, CDs etc.).
Fixed deposits taken by companies are rated on regular scale in India.
5. Rating of short-term instruments [Commercial Papers (CPs).
Credit rating of short term instruments like commercial papers has been started from 1990.
Credit rating for CPs is mandatory which is being done by CRISIL, ICRA and CARE. 6.
Rating of borrowers. Rating of borrowers, may be an individual or a company is known as
borrower’s rating.
6. Rating of real estate builders and developers.
A lot of private colonizers and flat builders are operating in big cities. Rating about them is
done to ensure that they will properly develop a colony or build flats. CRISIL has started rating
of builders and developers.
7. Rating of chit funds.
Chit funds collect monthly contributions from savers and give loans to those participants who
offer highest rate of interest. Chit funds are rated on the basis of their ability to make timely
payment of prize money to subscribers. CRISIL does credit rating of chit funds.
8. Ratings of insurance companies.
With the entry of private sector insurance companies, credit rating of insurance companies is
also gaining ground. Insurance companies are rated on the basis of their claim paying ability
(whether it has high, adequate, moderate or weak claim-paying capacity). ICRA is doing the
work of rating insurance companies.

25
 9. Rating of collective investment schemes.
When funds of a large number of investors are collectively invested in schemes, these are
called collective investment schemes. Credit rating about them means (assessing) whether the
scheme will be successful or not. ICRA is doing credit rating of such schemes. 11. Rating of
banks. Private and cooperative banks have been failing quite regularly in India. People like to
deposit money in banks which are financially sound and capable of repaying back the deposits.
CRISIL and ICRA are now doing rating of banks.
12. Rating of states.
States in India are now being also rated whether they are fit for investment or not. States with
good credit ratings are able to attract investors from within the country and from abroad.
13. Rating of countries.
Foreign investors and lenders are interested in knowing the repaying capacity and willingness
of the country to repay loans taken by it. They want to make sure that investment in that
country is profitable or not. While rating a country the factors considered are its industrial and
agricultural production, gross domestic product, government policies, rate of inflation, extent
of deficit financing etc. Moody’s, and Morgan Stanley are doing rating of countries.

26
 How Credit Rating Works

A loan is a debt—essentially a promise, often contractual, and a credit rating determines

the likelihood that the borrower will be able and willing to pay back a loan within the confines
of the loan agreement, without defaulting. A high credit rating indicates a high possibility of
paying back the loan in its entirety without any issues; a poor credit rating suggests that the
borrower has had trouble paying back loans in the past and might follow the same pattern in
the future.
The credit rating affects the entity's chances of being approved for a given loan or
receiving favorable terms for said loan. Credit ratings apply to businesses and government,
while credit scores apply only to individuals. Credit scores are derived from the credit history
maintained by credit reporting agencies such as Equifax, Experian, and TransUnion. An
individual's credit score is reported as a number, generally ranging from 300 to 850. Similarly,
sovereign credit ratings apply to national governments, while corporate credit ratings apply
solely to corporations. (For related reading, see "Credit Rating vs. Credit Score: What's the
Difference?")
A short-term credit rating reflects the likelihood of the borrower defaulting within the year.
This type of credit rating has become the norm in recent years, whereas in the past, long-term
credit ratings were more heavily considered. Long-term credit ratings predict the borrower's
likelihood of defaulting at any given time in the extended future.
Credit rating agencies typically assign letter grades to indicate ratings. Standard & Poor’s,
for instance, has a credit rating scale ranging from AAA (excellent) to C and D. A debt
instrument with a rating below BB is considered to be a speculative grade or a junk bond,
which means it is more likely to default on loans.

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 KEY TAKEAWAYS

▪ A credit rating is a quantified assessment of the creditworthiness of a borrower in general

terms or with respect to a particular debt or financial obligation.
▪ A credit rating not only determines whether or not a borrower will be approved for a loan or
debt issue but also determines the interest rate at which the loan will need to be repaid.
▪ A credit rating or score can be assigned to any entity that seeks to borrow money—an
individual, corporation, state or provincial authority, or sovereign government.
▪ Individual credit is rated on a numeric scale based on the FICO calculation, bonds issued by
businesses and governments are rated by credit agencies on a letter based system.

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 KINDS OF INSTRUMENT RATED

Followings are the bodies or organization which can be rated:

1) Manufacturing Companies
2) Banks
3) Non- Banking Financial Institution
4) Financial Institutions
5) Housing Finance Companies
6) Municipal Bodies
7) Companies In Infrastructure Sector

To keep the pace with the changing credit requirements of new instruments the rating agencies
have been upgrading the technology and bringing in analytical innovation. The instrument
being rated by such agencies include:

1) Mortgage & Asset –Backed Securities

2) Letter Of Credit Backed Bonds, Commercial Paper and Structure Finance for Global
Market;
3) Project Finance
4) Municipal and Corporate Bond Insurance;
5) Bonds and Money Market Funds;
6) Syndicated Banks Loans:

29
In Indian context

With reference to India the rating agencies have been rating the following types of debts &
debt obligations:

1) Debenture Bonds
2) Fixed Deposits
3) Commercial Paper
4) Structured Obligations
5) other ratings :

a) Utilities Rating
b) State Government Ratings
c) Asset Backed Securities
d) Mutual Funds Rating
e) Equity Grading/Assessment
f) Bank Lines Of Credit
g) Others

DUAL RATINGS s

Dual Rating would mean rating opinion on one or more instrument s from two different rating
agencies. Such dual rating leaves several question unanswered in the minds of the investor, viz.
firstly, which of the two CRA’S rating opinion relied upon; secondly, why the difference in

30
two rating should occur when both follow alike methodology, and thirdly, if such difference is
unavoidable why should not the rating s be rendered unreliable etc.

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 and 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.

BB: - Triple B denotes moderate safety in terms of timely payment of interest and principal
speculative grades.

Speculative Grades

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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.
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.

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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 SEBI REGULATIONS FOR CREDIT RATING AGENCIES

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.

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.

1) Rating agencies are required to have a minimum net worth of Rs 5 crore.

2) Rating agencies cannot assess financial instruments of their promoters who have 10 %
stake in them.

3) Rating agencies cannot rate a security issued by an entity, which is (a) a borrower of its
promoter. (b) a subsidiary of its promoter. (c) 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.

4) 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.

33
5) 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.

REGISTRATION OF CREDIT RATING AGENCIES

1) Grant of Certificate

i) Any person proposing to commence any activity as a credit rating agency on

or after the date of commencement of these regulations shall make an application to the Board
for the grant of a certificate of registration for the purpose.
ii) A non- refundable application fee shall accompany an application for the grant of a
certificate.

2) Promoter of Credit Rating Agency

The Board shall not consider an application under unless a person belonging to any
of the following categories promotes the applicant:

a) A Public Financial Institution.

b) A Scheduled Commercial Bank.
c) A Foreign Bank operating in India.
d) A foreign credit rating agency having at least five years’ experience in rating securities.
e) Any company or a body corporate, having continuous net worth of minimum rupees of one
hundred crores for the previous five years prior to filling of the application with the board
for the grant of certificate under these regulations.

3) Eligibility Criteria

34
 The Board shall not consider an application for the grant of a certificate unless the
applicant satisfies the following condition: -

a) The applicant is set up and registered as a company under the Companies Act, 1956;
b) The applicant has, in its memorandum of Association, specified rating activity as one of its
main objects;
c) The applicant has a minimum net worth of rupees five crores.
d) The applicant has adequate infrastructure, to enable it to provide rating service.
e) The applicant and the promoters of the applicant have professional competence, financial
soundness and general reputation of fairness and integrity in business transactions, to the
satisfaction of the Board.
f) Neither the applicant, nor its promoter, nor any director of the applicant or its promoter, s
involved in any legal proceeding connected with the securities market, which may have an
adverse effect on the interest of the investors;
g) Neither the applicant, nor its promoters, nor any director, or its promoter has at any time in
the past been convicted of any offence involving moral turpitude or any economic offence.
h) The applicant has, in its employment, persons having adequate professional and other
relevant experience to the satisfaction of the Board.
i) The applicant in all other respects is a fit and a proper person for the grant of a certificate.
j) The grant of certificate to the applicant is in the interest of the investors and the securities
market.

4) Application to Conform to the Requirements

The Board shall reject any application for a certificate, which is not complete in all
aspects or does not confirm to the requirements of regulation or instructions. Providing that,
before rejecting any such application, the applicant shall be given an opportunity to remove.
Within thirty days of the date of receipt of relevant communication, from the Board such
objections as may be indicated by the Board.

35
 Provided further, that the Board may, on sufficient reason being shown, extend the
time for removal of objections by such further time, not exceeding thirty days, as the Board
may consider fit to enable the applicant to remove such objections.

5) Furnishing of Information, Clarification and Personal Representation

i) The Board may require the applicant to furnish such further information or clarification, as
the Board may consider necessary, for the purpose of processing of the application.

ii) The Board, if it so desires, may ask the applicant or its authorized representative to appear
before the Board, for personal representation in connection with the grant of a certificate.

6) Grant of certificate

i) The Board. On being satisfied that the applicant is eligible for the grant of a
certificate of registration, shall grant a certificate.
ii) The grant of certificate of registration shall be subjected to the payment of the
registration fee specified.

7) Conditions of Certificate and Validity Period

The certificate shall be granted subject to the following conditions, namely;

a) The credit rating agency shall comply with the provisions of the Act, the regulations made
there under and the guidelines, directives, circulars and instructions issued by the Board
from time to time on the subject of credit rating.
b) Where any information furnished to the Board by a credit rating agency:
i) is found to be false or misleading in any material particular; or
ii) has undergone change subsequently to its furnishing at the time of the
application for the certificate; the credit rating agency shall forthwith inform
the Board in writing;
c) The period of validity of the certificate of registration shall be three years.

36
 8) Renewal of certificate

A credit rating agency, if it desires renewal of the certificate granted to it, shall make
to the Board an application for the renewal of the certificate or registration within 3 months
before expiry of the period of the validity of the certificate.
The application for the renewal shall be accompanied by a renewal fee.

STEPS IN CREDIT RATING PROCESS

Rating may differ with respect to different instrument of same organization. Also different
rating assigned to different instrument of two different organizations does not indicate the
superiority or inferiority of the organizations. the steps involved in credit rating activity are
given below:

PROCESS FLOW CHART OF CREDIT RATING

MANDATE
INITIAL STAGE
ASSIGN RATING TEAM

RECEVE INITIAL INFORMATION,

CONDUCT BAIC RESEARCH

MEETING & VISIT

FACTS FINDING &
ANALYSIS
ANALYSIS & PREPARTION OF REPORT STAGE

PREVIEW MEETING

37
RATING
FINALISA RATING MEETNG FRESH INPUT CLARIFI
TION
STAGE
ASIGN RATING
REQUEST FOR
REVIEW
COMMUNICATE THE RATING & RATIONALE

ACCEPTNCE

SURVEILLANCE

The entire rating process is normally completed in three stage in practical scenario-

1) Primary Or Initial Stages.

2) Facts Finding & Analysis Stage.
3) Rating Finalization Stage.

1) The rating process begins at the request of the company.

2) The tem consisting of professionally qualified analyst well versed with the workings of the
industry in which the company operates, first visits the company plants and inspect the
operations first hand .

3) Meeting with different levels of management follow culminating with the meeting with chief
executive officer.

4) Generally, middle & top level management meeting cover the field of operations , finance ,
marketing , project, etc.

38
5) In completion of the assignment , the team interacts with the backup team that has separately
collected the additional industry information and prepares a report

6) The report is then placed before n internal committee consisting of senior executives of credit
rating agency who themselves have hands on experience in rating assignments.

7) The internal committee then has an open discussion with the term member and amongst
themselves arrives at rating.

8) To avoid any type ort of bias, the ratings proposed are placed before an external committee
consisting of eminent people unconnected with credit rating agency.

9) The external committee then takes the final decision which is communicated to the company.

10) The company may volunteer any further information at this point which could affect the
ratings, it is passed ion to the external committee again for affirmation/change.

11) The company has the option to request the agency for review of the rating.

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 TIME FRAME FOR RATING PROCESS

From Time to Time frame

Initial request Meeting with management 4-6 weeks

Meeting with management Initial rating indication 4-6weeks
Initial rating indication Publication of rating Time depends
Upon completion of formalities

FUNDAMNETAL PRINCIPLE OF RATING & GRADING

The basic requirement in risk grading is that it should reflect a clear and fine distinction
between credit grades covering default risks and safe risks in the short run. While there is no
ideal number of grades covering default risks in the short run. while there is no ideal number of
grades that would facilitate achieving this objective, it is expected that more granularity may
serve the following purpose:

1) Objective analysis of portfolio risks.

2) Appropriate pricing of various risks grade borrowers, with a focus on low risk borrower
in term of lower pricing

40
 3) Allocation of risk capital for high risk graded exposures
4) Achieving accuracy and consistency.

According to the RBI, there should be an ideal balance (in numbers) between ‘acceptable credit
risk and unacceptable credit risk” in a grading system. It is suggested that:

1) A rating scale may consist of 8 – 9 levels.

2) Of the above, the first levels may represent acceptable credit risks
3) The remaining four levels may represent unacceptable credit risks.

MECHANISIM OF CREDIT RATING

The quantitative & qualitative factors in the case of whole sale exposure and four type factors
in the case of retail sector needed to be accorded “weight” or scores. The aggregate outcome
will reflect the rating /grade of an exposure against a benchmark. Hence the mechanism must
lay down the following:

1) For wholesale exposure:

The marks for each parameter, with a range of marks for various ranges of a parameter have
to be fixed .

If the growth in the last completed year compared with the previous year is :

20% & above 4 marks

15% to less than 20% 3 marks

5% to less than 15% 2 marks

0% to less than 5% 1 marks

Negative growth: 0 marks

41
For qualitative factors, also, there can be suitable scoring based on ‘excellent’ (maximum
marks) and the lowest one ‘non satisfactory’ (zero marks) may be fixed.

2) Aggregate marks for all the applicable parameters for each category may then be
mapped into various grades taking the maximum marks as 100, as shown below.
3) Wherever a particular parameter is not applicable for an exposure , it may be ignored
and the aggregate marks be readjusted / graded accordingly

Sl. Total score for an exposure Grade Implication of grade

No. accorded accorded

1 86-100 AA+ Excellent safety

2 71-85 AA Very good safety

3 61-70 A Good safety

4 51-60 BB+ Ordinary safety

5 41-50 BB Less ordinary safety

6 36-35 B Low safety

7 31-35 C Unsafe safety

8 0-30 D Loss category

For retail exposure (consumer lending):

in the wholesale exposure, maximum marks for each parameter can be fixed. for example,
age, months, income etc.

42
 1) Similarly, aggregate marks for each parameter can be determined the overall grading of
the account. While there may be eight grades in wholesale exposure because of the risk
related issue in pricing involved, in the case of retail exposure, four/five grades are
considered sufficient.

2) The scoring /grading system in various banks / financial institution may vary
substantially depending on inter alia, risk perceptions, thrust area and other allied
factors.

ACCOUNTING RATIOS FOR RISK EVALUTION

A ratio conveys a quantitative interrelationship between two attribute/variable for eventual

comparison against the bench mark and for trend analysis. In business, accounting ratios
facilitate meaningful and purpose –oriented decision making. Its utility I determined according
to the purpose for which the ratio is computed.

From the age of credit risk valuation, accounting ratios plays significant role for a
lending/investment banks, since the overall computation of type credit rating of their
account /exposure I aided/ supported by ratio analysis also. Hence, not , not only is it
necessary to identify the relevant ratios depending upon the purpose, quantum, tenure of
exposure etc but also in marketable securities ( rated by approved external rating agency ) ,
one may focus more on current ratio/net profit/sales ratio than an long-term solvency ratios.

Internationally, there are no prescribed accounting ratios for risk evaluation. In India, too, the
banking regulatory authorities have left such matter to the judgments and discretion of the
banks/financial institution to go by established financial practices and frame an accounting
ratio policy that is relevant to the purpose of its credit risk evaluation .

43
 RATIOS FOR CREDIT EVALUATION

For identification criteria – for example, items of current asset, current liabilities, etc.-one is to
be guided by standard accounting practices

1) short term solvency angle:

a) Current ratio: Current asset/ Current liabilities

Minimum expected level: 1.3:1

For financing working capital requirement based on the turnover method for small &
medium enterprise (SME) and others, the minimum expected level may be 1.10:1.

b) Acid test ratios: Quick assets/ Quick liabilities

Minimum expected level : 1:1

For SME’s the minimum expected level may be 0.8:1

c) Cash ratio: (Cash +Bank Balance + Marketable Securities) / Current liabilities

44
 Minimum expected level: 0.5:1

For SME the minimum may be lower

2) Long term solvency angle:

d) Debt equity ratio: Total external liabilities/ Equity (owned funds)

Maximum allowable level: 2:1

e) Debt servicing coverage ratio:

:- Earning available for debt service / One year debt installment payment + interest thereon

Earning include

Net Profit: ****

(+) depreciation on fixed asset, ****

(- ) loss on the sale of fixed assets ****

Interest on debt for one year ****

****

Minimum expected level: 1.5:1

For the priority sector. SME etc. the minimum may be allowed at 1:30:1

3) Profitability angle:

a) Operating profit ratio:

= (Profit before deduction of depreciation, tax & finance charges)/(Sales/income)
45
the expected level will depend upon the nature of the industry/business, operational area, size
of the unit, the duration of the business being carried on, trend analysis and other relevant
factors. However, a good unit is likely to show at least a margin of 25-30 %

b) Return on capital employed ratio (ROCE):

= Operating profit / (Owned funds + long term loan funds)

The expected level will depend upon the nature of the industry /business, operational area, size
of the unit, the duration of the business being carried on, trend analysis and other relevant
factors, however, a good unit is likely to show at least a margin of 15-20%

c) Interest coverage ratio: Operating profit / Interest liability

Subjected to the factor as stated above:

d) Profit asset ratio: Operating profit/ Total tangible asset

Subjected to the factor as stated

e) Indirect overhead ratios:

= (finance charges+ depreciation + selling and administrative cost)/ Sales/income

The maximum allowable unit as stated above, however, it might be 10-15%.

From the asset movement angle

a) Trade debtors*300 days*= (Preferably average outstanding in a year )/ Sales/income

c) Trade creditors*300 days* = (preferably average outstanding in a year )

Credit purchase of assets current

46
 ( preferably average level in a year)

computation based on 300 days in a year is advisable in Indian context keeping in the view the
usual 52 weekly offs, national holidays, etc.

The expected level varies from case to case as stated above, however, generally, the maximum
level in terms of days may be between 90 and 120.

From the stress angle:

(the Basel committee states : stress testing has been adopted as a generic term describing
various technique used by banks to gauge their potential vulnerability to exceptional , but
plausible, events.”)

Stress tested cash flow

Debt payment +preference dividend + interest

For this purpose, cash flow would include only operating cash flow (ignoring investing cash
flow @ financing cash flow). As a point of the stress testing scale, a reduction of a certain
percentage in incomes/sales with the simultaneous increase in the expenses (for example.
Direct costs etc.) may result in charge (reduction) in cash flow. There is no minimum or
maximum. The stress percentage depends upon the industry, operating environment and also
the overall business environment at the time of analysis.

The above cluster is only indicative of the ratios that a commercial bank/financial institution
may find useful from the credit risks evaluation angle. There, may be other important ratios as
well, such as :

1) Finished Good Holding

47
 2) Cash Flow Interest Coverage
3) Capital Gearing Ratio
4) Proprietary Ratio.

PRACTICAL IMPLICATION OF ACCOUNTING RATIO IN CREDIT RISKS

EVALUATION

Accounting ratios are usually computed on the year end position of asset , liabilities, profit/loss
account competent ( over a position of generally 12 months) as reflected in the financial
statements . This is based on a going concern concept approach. However , one limitation here
is that the static” view of the asset liability at the end of the year may not reflect the true and
correct position .the alternative is to collect the figures from the party concerned say , on a
monthly basis( or as frequently as may be possible) and average the same on a 12 months basis
. This may then, for credit risks evaluation process, be a more effective and dynamic tool.
Irrespective of whether a bank financial institution follows the year end or average method of
computation, the implication from the credit risks evaluation angle will depend upon:

Adopting an appropriate credit rating system with generally a large number of grades, where
one of the inputs would be accounting ratios.

The bank/financial institution will have to decide as a matter of corporate finance policy the
nature of the accounting ratio to be used for credit risk evaluation/ (for example, there may be
different focus in assessing working capital for loans for fixed asset or for nonfunded
facilities/investment in securities, etc.

Specific weight has to be allocated for accounting ratios (from the credit rating angle).

Say,20 out of the total of 100 points for the entire credit rating structure.

The benchmarking for each ratio should be consistent with the bank/financial institutions
corporate finance policy.

48
The maximum weight age for each component of the ratio should be fixed- say.4 out of 20
points (20 being the total for all accounting ratios put together)

Ratios conforming to the benchmark should be awarded the highest points. those below the
benchmark should be ranked with the varying points. Down to even zero.

Total marks awarded for all adopted ratios should then be carried forward to the overall credit
rating structure so as to arrive at final grade for each account /exposure.

In sum, accounting ratios is inseparable arm of the credit risks evaluation and its actual
implication will depends upon the purpose, quantum and tenure of the exposure on a case by
case base.

49
 MAJOR PLAYER IN CREDIT RATING & THEIR RESEARCH
METHODOLOGY

CRISIL

INTRODUCTION:

The rating industry in India was ushered in 1988 with the setting up of Credit
Rating and Information Services of India Limited (CRISIL) followed by three more, the latest
entirely devoted to rating NBFC’s. The industry is sustained by mandatory requirement for
rating debt instruments. Crisil was set up by ICICI and UTI in 1988.

Standard and Poor rating service (S&P) has formed a strategic alliance in 1996
with CRISIL for providing analytical and business development co-operation. S&P will share
with CRISIL its advanced rating methodologies and analytical criteria and assist on other
aspects of credit rating agency operations. CRISIL would in turn offer business development
assistance in India and insight into local debt market and issuers.

50
 The purchase by S&P of 6 lakhs shares in 1997 of CRISIL from Asian
development Bank to acquire a stake of 9.6 % in CRISIL is a logical culmination of the
strategic alliance into earlier. Asian Development Bank invested in 1988 in CRISIL as an effort
to play a catalytic role in its establishment.

CRISIL RTAING METHODLOGY:

The rating methodology followed by CRISIL involves an analysis of the following factors: -

i) BUSINESS ANALYSIS

a) Industry risk, including analysis of the structure of the structure, the demand-supply
position, a study of the success factors, the nature and basis of competition, the impact of
government policies, cyclicity and seasonality of the industry.

b) Market position of the company within the industry including market shares, product and
customer diversity, competitive advantages, selling and distribution arrangements.

c) Operating efficiency of the company like locational advantages, labour relationships,

technology, manufacturing efficiency as compared to competitors.

d) Legal position including the terms of the prospectus, trustees and their responsibilities as
systems for timely payments.

ii) FINANCIAL ANALYSIS

a) Accounting quality like any overstatement or understatement of profits, auditors

qualification in their reports, methods of valuation of inventory, depreciation policy.

b) Earnings protection in terms of future earning growth for the company and future
profitability.

51
 c) Adequacy of cash flows to meet debt servicing requirements in addition to fixed and
working capital needs. An opinion would be formed on the sustainability of the cash
flows in the future and working capital management of the company.

d) Financial flexibility including the companies ability to source funds from other sources
like group companies, ability to defer capital expenditure and alternative financing plans
in times of stress.

iii) MANAGEMENT EVALUATION

a) The quality and ability of the management would be judged on the basis of past track
record, their goals, philosophies and strategies their ability to overcome difficult
situations, etc. In addition to ability to repay, an assessment would be made of the
managements willingness to pay debt. This would involve an opinion of the integrity of
the management.

Iv) FUNDAMENTAL ANALYSIS

a) Capital adequacy, that is the true net worth as compared to the volume of business and
risk profile of assets.

b) Asset quality including the companies credit risk management, systems for monitoring
credit, exposure to individual borrowers and management of problem credits.

c) Liquidity management, Capital structure, term matching of assets and liabilities and
policies on liquid assets in relation to financial commitments would be some of the areas
examined.

d) Profitability and financial position in terms of past historical profits, the spread on funds
deployed and accretion to reserves.

e) Exposure to interest rate changes and tax law changes.

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 RATING PROCESS

CRISIL's rating process and rating committee are designed to ensure that all
assigned ratings are based on the highest standards of independence and analytical rigor.

The rating committee comprises members who have the professional competence to
meaningfully assess the credit analysis that underlies the rating, and have no interest in the
entity being rated. A team of analysts carries out the credit analysis . Each team has at least two
members. CRISIL's analysis is based on issuer meetings and an understanding of the business
environment. The analysis is carried out within the framework of clearly spelt-out rating
criteria.

» Rating Process
» Management Meeting
» Rating Committee and assignment of rating
» Confidentiality
» Advice to Issuer
» Publication
» Surveillance and Annual Review

CRISIL ensures confidentiality of the information obtained for the rating exercise by putting in
place appropriate process safeguards. All CRISIL employees are required to sign a

53
confidentiality agreement. CRISIL does not disclose confidential information that it has
obtained for the purpose of credit rating to anyone (other than market regulators or law
enforcement authorities, if required).

A detailed flow chart of CRISIL's rating process is as under:

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CRISIL RATING SYMBOLS

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Rating and description
 
CRISIL AAA
(Highest Safety)
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.

 
CRISIL AA
(High Safety)
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.

 
CRISIL A
(Adequate Safety)
Instruments with this rating are considered to have adequate degree of safety regarding timely
servicing of financial obligations. Such instruments carry low credit risk.

 
CRISIL BBB
(Moderate Safety)    
Instruments with this rating are considered to have moderate degree of safety regarding timely
servicing of financial obligations. Such instruments carry moderate credit risk.

 
CRISIL BB
(Moderate Risk)
Instruments with this rating are considered to have moderate risk of default regarding timely
servicing of financial obligations.

CRISIL B
(High Risk) Instruments with this rating are considered to have high risk of default regarding
timely servicing of financial obligations.

CRISIL C
(Very High Risk) Instruments with this rating are considered to have very high risk of default
regarding timely servicing of financial obligations.

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CRISIL D
Instruments with this rating are in default or are expected to be in default soon.

Note
 CRISIL may apply '+' (plus) or '-' (minus) signs for ratings from 'CRISIL AA' to 'CRISIL C' to reflect
comparative standing within the category. 
 CRISIL may assign rating outlooks for ratings from 'CRISIL AAA' to 'CRISIL B'. Ratings on Rating
Watch will not carry outlooks. A rating outlook indicates the direction in which a rating may move over a
medium-term horizon of one to two years. A rating outlook can be 'Positive', 'Stable', or 'Negative'. A
'Positive' or 'Negative' rating outlook is not necessarily a precursor of a rating change. CRISIL may place
an outstanding rating on Rating Watch if the issuer announces a merger or acquisition, or de-merger of
some business that may impact the credit profile of the rated debt instrument. Ratings may also be placed
on watch if the issuer’s credit profile is impacted on account of an action by regulators, or when the
impact of specific events on the credit profile cannot be accurately assessed at the point when they occur,
and additional information may be necessary for CRISIL to fully ascertain the creditworthiness of the
rated instrument. CRISIL may place a rating on watch, with positive, negative or developing
implications. A listing under rating watch does not imply that a rating will necessarily change, nor is it a
prerequisite for rating change.
 A suffix of 'r' indicates investments carrying non-credit risk. The 'r' suffix indicates that payments on the
rated instrument have significant risks other than credit risk. The terms of the instrument specify that the
payments to investors will not be fixed, and could be linked to one or more external variables such as
commodity prices, equity indices, or foreign exchange rates. This could result in variability in payments,
including possible material loss of principal, because of adverse movement in value of the external
variables. The risk of such adverse movement in price/value is not addressed by the rating.
 CRISIL may assign a rating of 'NM' (Not Meaningful) to instruments that have factors present in them,
which render the outstanding rating meaningless. These include reorganization or liquidation of the
issuer, the obligation being under dispute in a court of law or before a statutory authority.
 A prefix of 'PP-MLD' indicates that the instrument is a principal-protected market-linked debenture. The
terms of such instruments indicate that while the issuer promises to pay back the face value/principal of
the instrument, the coupon rates of these instruments will not be fixed, and could be linked to one or more
external variables such as commodity prices, equity share prices, indices, or foreign exchange rates
 A prefix of 'Provisional' indicates that the rating centrally factors in the completion of certain critical
steps/documentation by the issuer for the instrument, without these the rating would either have been
different or not assigned ab initio.
 As mentioned above CRISIL have ratings for the following:
1) Fixed Deposit Rating (Start from FAAA to FD)
2) Short Term Instruments Rating (Start from P-1 To P-5)
3) Structured Obligations Rating (Strat from AAA To D(So))
4) Non-Credit Risk Rating Scale (Start from AAA To Dr)
5) Real Estate Developers/Projects Rating (Start from DA1 To DA5)
6) Rating Scales for Real Estate Projects (Start from PA1 To PA5)
LIMITATIONS OF CRISIL RATINGS

A Credit Rating from CRISIL is NOT

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1) A general-purpose credit or performance evaluation of the rated entity: CRISIL Credit
Ratings are always issue-specific

2) A recommendation to invest in, or not to invest in, any shares, debentures or other
instruments issued by the rated entity, or derivatives thereof.

3) An opinion on associate, affiliate or group companies of the rated entity, or on promoters,

directors or officers of the rated entity

4) A statutory or non-statutory audit of the rated entity

5) An indication of compliance or otherwise with legal or statutory requirements

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MOODY’S

INTRODUCTION:

Moody's Investors Service, often referred to as Moody's, is the bond credit

rating business of Moody's Corporation, representing the company's traditional line of business
and its historical name. Moody's Investors Service provides international financial research
on bonds issued by commercial and government entities. Moody's, along with Standard &
Poor's and Fitch Group, is considered one of the Big Three credit rating agencies. It is also
included in the Fortune 500 list of 2021.
The company ranks the creditworthiness of borrowers using a standardized ratings scale which
measures expected investor loss in the event of default. Moody's Investors Service rates debt
securities in several bond market segments. These include government, municipal and corporate
bonds; managed investments such as money market funds and fixed-income funds; financial
institutions including banks and non-bank finance companies; and asset classes in structured
finance.[3] In Moody's Investors Service's ratings system, securities are assigned a rating from
Aaa to C, with Aaa being the highest quality and C the lowest quality.
Moody's was founded by John Moody in 1909 to produce manuals of statistics related to stocks
and bonds and bond ratings. In 1975, the company was identified as a Nationally Recognized
Statistical Rating Organization (NRSRO) by the U.S. Securities and Exchange Commission.
[4]
 Following several decades of ownership by Dun & Bradstreet, Moody's Investors Service
became a separate company in 2000. Moody's Corporation was established as a holding
company.
Credit ratings are not factual, verifiable statements about a security and its issuer, but rather
subjective, predictive opinions of a private credit rating agency. Although rating agencies will
typically consider numerous objective factors during the rating process, the credit rating itself is
ultimately derived from the subjective weighing of those factors. Therefore, it constitutes a mere
opinion which heavily relies on human judgment, and is as such neither a fact susceptible of
being proved true or false nor a guarantee of credit quality. Furthermore, since credit ratings
express a prediction of the likelihood that the rated security will (or will not) default in the
future, their content is inherently forward-looking. As with any prophesy, this by nature makes
them a subjective statement, because nobody can objectively (i.e., with provable certainty)
predict the future.

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Credit Rating Process

MIS operates under the MIS Code of Professional Conduct (“MIS Code”). The principles in
the MIS Code that seek to secure the quality, integrity, independence, transparency and
timeliness of the rating process, as well as avoidance of conflicts of interest and treatment of
confidential information, are deeply ingrained in our operational practices. The principles
established by the MIS Code are elaborated upon in MIS’s policies and procedures. These
documents establish a consistent approach throughout MIS and govern the conduct of
employees during the credit rating process.

» MIS Code of Professional Conduct, January 2021

Below we describe the various steps in our credit rating process. These descriptions reflect the
general process for all of MIS’s published credit ratings, and some aspects of our detailed
processes may vary in different rating groups or jurisdictions. In these descriptions, we use the
term ‘‘Issuer’’ to mean any entity - regardless of whether it is a structured product, a
corporation, a sovereign country or a municipality - that issues debt, a credit commitment or
debt-like securities, or which has other obligations to make payments.

A. Initiation of a Rating Relationship with MIS

B. Information Used in the Credit Rating Process
C. Interacting with the Management of an Issuer
D. Rating Committee Process
E. Informing the Issuer of the Credit Rating Outcome and Disseminating the Credit Rating
Announcements
F. Credit Rating Appeals
G. Monitoring of Credit Ratings
H. Withdrawal of Credit Ratings / Decision Not to Rate
I. Unsolicited Credit Ratings

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Credit Rating Methodologies and Models

Provision 1.3 of the MIS Code provides that in assessing an Issuer’s or obligation’s
creditworthiness, analysts will use MIS’s published methodologies, where appropriate, and will
apply a given methodology in a consistent manner, as determined by MIS. MIS has established
several groups responsible for credit rating methodologies, credit rating models and credit
rating scorecards: the Methodology Development Group (MDG); the Analytical Tools and
Solutions Group (ATS); and the Methodology Review Group (MRG). MDG is responsible for
methodology development and delivery across MIS. ATS is responsible for the quantitative
models and analytical tools used in the credit rating process. MRG's responsibilities are to
approve new and revised credit rating methodologies including credit rating models, review the
credit rating models and the specifications of MIS credit rating models for consistency with
published methodologies, review the appropriateness of existing methodologies on an annual
basis, and review credit rating actions, on a sampled basis, to evaluate the application of
published methodologies. In addition to MRG, credit rating methodologies or credit rating
models for which a consultation with market participants through a “request for comments”
process occurred must also be approved by the MIS Board of Directors prior to publication.
MIS’s methodological approaches to determining credit ratings encompass an evaluation of
both qualitative and quantitative factors. Many of these credit rating methodologies include
references to quantitative models used to infer the implications of sets of assumptions in a
consistent, rigorous manner. Since every model contains simplifying assumptions and, by
construction, may exclude many credit- relevant factors, individual rating committees rely on
models as tools to varying degrees, depending on the facts and circumstances in the sector and
of the particular Issuer. Some quantitative tools used in the structured finance sector are
relatively quantitative in nature in that they attempt to model collateral loss probability
distributions under various simplifying assumptions, cash flow allocations under each of the
potential collateral loss scenarios, and, together, derive mathematically expected loss rates on
various securities. Other quantitative tools, in particular many of those used within the
fundamental sectors, are relatively qualitative in nature, embedding financial ratio credit scores
and judgment in scorecards that serve as guides for discussion in rating committees and bear a
somewhat imprecise relationship to actual credit rating outcomes. However, credit rating

61
methodologies suggest quantitative and qualitative information for consideration as inputs to
rating committee deliberations. The following paragraphs provide a high-level description of
the qualitative and quantitative factors that are broadly considered relevant in each of the
sectors for which MIS is registered as an NRSRO. These descriptions should not be considered
exhaustive or mandatory for each credit rating published in the individual sectors. Furthermore,
not all of the enumerated factors will be deemed relevant by an individual rating committee,
and within individual sub- sectors additional factors may also be considered. Credit rating
methodologies include additional factors that might be considered relevant by a rating
committee when issuing a credit rating in a given sector.

a. Financial Institutions,

Brokers or Dealers Relevant qualitative factors may include: management quality; key entity
risks; the impact of economic and industry outlook on lending policy and criteria; product
development; risk measurement and management tools; credit risk review and controls; and/or
reach and influence of regulatory authorities. MIS also considers the likelihood and quality of
external forms of support including parental support and, for banks and certain other
systemically important financial institutions, government support. Relevant quantitative factors
may include: profitability; portfolio diversification by geography, region, industry, product,
and portfolio granularity; actual amount of non-performing loans; loan-loss provisioning
requirements; loan-loss coverage levels; actual losses; loss expectancy and recent trends; type
and impact of relevant portfolio stress tests (e.g., potential increases in interest rates or
unemployment rates); loan-to-value (‘‘LTV’’) overview by valuation at inception and LTV
limits in the case of property lending; overview of off-balance sheet risks; projected business
growth; capital ratios (Core Equity Tier 1, tangible common equity) and trends; composition of
risk-weighted assets (e.g., 20% risk weight, 50% risk weight, etc.); and/or quality of capital by
type (e.g., Tier 1, Tier 2, etc.), instrument (e.g., subordinated debt, hybrid, innovative / non-
innovative, etc.) and currency; funding structure; and/or liquidity resources.

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 b. Insurance Companies

Relevant qualitative factors are tailored to the specific type of insurer (e.g., life,
property/casualty, mortgage, financial guaranty, etc.) and may include: strategy, market
position, brand and distribution; product focus; ease of access to capital; management quality,
governance and risk management; accounting policy and disclosure; and/or the sovereign and
regulatory environment. Relevant quantitative factors are also specific to the type of insurer
and may include: portfolio diversification (by geography, product/risk type, and distribution
channel); asset quality (as reflected by, for example, the proportion of high risk investments
and reinsurance assets); capital adequacy (as measured by capital ratios appropriate for the type
of insurer and including estimates of catastrophe risk); profitability (as reflected by, for
example, returns on equity, loss and expense ratios, and earnings volatility); financial
flexibility (as indicated by coverage and leverage ratios); reserve adequacy (as implied by ratio
analysis and actuarial analysis); and/or liquidity risk (assessing asset and liability matching).

c. Corporate Issuers

Relevant qualitative factors may include: industry sector(s); key markets; market position(s);
business mix; geographical diversity; business strategy; size of company; barriers to entry;
competitive advantages; growth opportunities; financial policy; management quality; risk
management; capital structure and structural considerations; liquidity and debt maturity
analysis; analysis of salient features of the security; legal structure; ownership considerations;
corporate governance; and the sovereign and regulatory environment. Relevant quantitative
factors may include: level of sales or assets; growth rates; profitability ratios; leverage ratios;
coverage ratios; capitalization ratios; cash flow ratios; liquidity measures; industry specific key
indicator ratios; off balance sheet adjustments; working capital management indicators; capital
expenditure levels (both maintenance and development); extraordinary/exceptional items;
and/or financing flows, including dividends, foreign currency exposure and accounting effects.

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 d. Issuers of Asset-Backed Securities

Qualitative factors typically include an evaluation of the originator’s policies and practices,
including analysis of the performance of its previously originated loans, and of its business
strategy and underwriting practices, quality control and auditing, financial strength,
management strength, and governance and regulatory oversight. In certain consumer asset
classes and when sufficient historical data is available, these capabilities are already reflected
in the historical data used for rating analysis; however, in other asset classes or when sufficient
data is not available, the strengths and weaknesses identified in the originator evaluation may
be incorporated into the quantitative assumptions regarding future asset performance. Strengths
or weakness in one or more aspects of an originator evaluation may, respectively, lead to a
lower or higher credit enhancement for a given target rating, or to a lower assigned rating for a
given enhancement level, than what the quantitative analysis would otherwise suggest.
Perceived weaknesses or significant concerns about particular aspects of the originator may
also impact the maximum achievable rating on a transaction.

Other relevant qualitative factors may include: geographical location of assets; details of the
relevant insolvency regime; bankruptcy remoteness of the special purpose entity; integrity of
the legal structure; adequacy of servicing asset management employed; presence or absence of
third party guarantors; credit quality characteristics of underlying assets; and/or credit factors
relevant for the industry sector. Relevant quantitative factors may include: level of over-
collateralization; quantity of excess spread on assets; size and structure of tranching of the
bonds; interest rates; value of the reserve fund; availability, amount and details of liquidity;
degree and level of amortization of the debt and payment priority; economic analyses; and/or
historical performance of the relevant asset class for the sponsor and the sector. In providing
credit ratings for long-term and short-term securities backed by an asset-backed pool or as part
of any asset-backed or mortgage-backed securities transaction, MIS forms an opinion on a
specific transaction by analyzing its legal structure and sources of credit protection, as well as
the credit risk characteristics of the collateral pool backing the securitization. To evaluate the
risk characteristics of the underlying collateral pool, MIS considers data from a wide variety of
public sources and information provided by the securitization’s sponsor. Moody’s does not
independently verify the existence and performance of the assets underlying or referenced by a

64
security or money market instrument issued by an asset pool or as part of an asset-backed or
securities transaction. Rating committees consider the key factual elements that are relevant for
the credit rating and the sources of information for such key factual elements. Examples of
information provided by or verified by sources or experts that are separate and independent
from the Issuer may include, but are not limited to, statements audited or reviewed by auditors,
agreed upon procedures, and servicer and trustee reports. Moody’s also generally assumes that
disclosures required in regulatory filings may be relied upon. Information provided solely by
the Issuer or an agent of the Issuer, such as the underwriter, is generally not relied upon for key
factual elements unless Moody’s is able to check or test the information against independent
sources. Examples of independent sources include, but are not limited to, independent data
providers and consultants and data produced by third party or governmental entities. It should
also be noted that for some transactions the assets are not fully known at the time of
assignment of the rating and the initial rating analysis is primarily based on covenants as
described in the governing documents for the transaction. In cases where a rating committee
determines that the reliability and quality of information is not satisfactory, Moody’s will
refrain from issuing a credit rating or will withdraw an existing credit rating. MIS’s credit
opinion is based on its own independent analysis.

e. Issuers of Government Securities,

Municipal Securities or Securities Issued by a Foreign Government Relevant qualitative

factors may include: willingness to pay public debt (track record, political tolerance for public
defaults); revenue structure (or suitability of tax or revenue-raising mechanisms with respect to
the economic base); revenue raising ability and tolerance; political dynamics and institutional
and governance aspects; government structure; quality of financial management (budgetary,
capital and strategic planning, timely implementation of strategies in response to changing
circumstances); public policy frameworks; track record of social and political stability; all
forms of solidarities (inter-generational, central government-local governments, central
government publicly owned enterprises and local governments-local government enterprises);
assessment of political commitments (fiscal adjustment, price stability); and/or environmental
issues.

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Relevant quantitative factors may include: factors reflecting the economic base (structure of
the economy, investment rate, saving rate, size of GDP, GDP per capita, percentage change in
real GDP, inflation record, openness of the economy, trends of personal income and wealth,
tax base growth trends, employment growth, unemployment rate and diversity of economic
activity); demographic trends (such as population growth, age distribution, and geographic
concentration); financial operations (such as revenue structure, growth and diversity, expense
structure, including fixed cost trends, trend of budget surplus or deficit, size and liquidity of
financial and foreign currency reserves); and/or factors that help assess the sustainability of
public debt (such as stock of general government debt, off-balance sheet liabilities, debt of
overlapping governments paid from the same base, future liabilities such as pension and
healthcare costs, banking sector size in the context of contingent liabilities, composition of the
debt in terms of currency, maturity, interest-rate sensitivity, size of assets that can be mobilized
to repay the debt, nature of public spending and degree of leverage relative to tax base or
resource base). For U.S. municipal securities issued by entities that operate in competitive
markets, such as hospitals, universities, and airports, additional factors may include the Issuer's
market share, pricing power within its market, competitive pressures from other service
providers, degree of governmental support, and quality of management and governance.

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MOODY’S RATING SYMBOLS

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68