MES - Pillai Institute of Management Studies and

Research (PIMSR),
New Panvel

Master of Management Studies (MMS)

(Batch: 2022-2024)

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 MMS – Semester – III
Elective Subject – Finance

Subject : Banking, Financial Services and

Insurance (BFSI)

Chapter-9: CREDIT RATING

Lecture date : 4.12.2023

by
Dr. K.G.S. MANI

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Lecture date : 4.12.2023
Chapter- 9 : CREDIT RATING
(1) Definition :
(i) According to Moody’s Investors’ Services, (USA, established in
1900, oldest Credit Rating Agency in the world), They define as:
“A credit rating is an opinion on the future ability and legal
obligation of the issuer to make timely payment of principal and
interest on a specific fixed income security. The rating measures
the probability that the issuer (issuing company) will default on the
security over its life, which depending on the instrument may be a
matter of few days to many years. In addition, long term rating
incorporate an assessment of the expected monetary loss, if the
default occur.”
(ii) According to Standard & Poor (S & P, USA), established in 1941),
“Credit ratings help investors by providing an easily recognisable,
simple tool that couples a possibility unknown issuer (issuing
company) with an informative and meaningful symbol of credit
quality.”
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(2) Meaning of Credit Rating :
(i) Besides share capital, other forms of fund like long term
debentures, bonds, company Public Deposits and Commercial
Papers are important sources for a Company.
(ii) The issuer of these instruments approaches capital market,
financial institutions and investment banks to raise necessary
finance at terms and conditions.
(iii) As investors are concerned with the timely payment of interest
and principal, credit rating indicates the creditworthiness of a
borrower.
(iv) Credit Rating refers to the rating (assessment and gradation) of
creditor-ship securities of debt instruments, particularly with
regard to the probability of timely discharge of payment of
interest and repayment of principal obligations.
(v) It indicates the risk involved in a debt instrument as well as its
qualities.
(vi) Credit rating essentially reflects the probability of timely repayment
of principal and interest by a borrower company.
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(vii) Higher the credit rating, greater is the probability that the
borrower will make timely payment of principal and interest and
lower the rating, the lower is probability of payment.
(viii)Credit rating is not a general evaluation of the issuing company. It
is not a one time evaluation of credit risk of a security.
(ix) The credit rating agencies may change the rating considering the
changes relating to the company periodically.

(3) Objectives of Credit Rating:

The objectives of Credit Rating are to analyse and give an opinion
(not recommendation) on the type of instrument. The following
are some of its objectives:
(x) To provide credence to financial commitments made by the
company.
(xi) To provide information to the investor in selecting debt securities
(xii) To help the company by providing it with the service of
marketability through grading of debt securities with technical
expertise of rating the securities.
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(4) Rating of instruments :
Credit Rating Agencies rate and assign credit rating to the
following instruments:
(i) Debt securities (debentures, bonds),
(ii) Short term debt instruments (Commercial papers, Certificate of
Deposits),
(iii) Loans taken by companies (now mandatory under BASEL Risk
Management frameworks of BCBS and RBI guidelines),
(iv) Public Deposits issued by companies,
(v) Mutual Fund schemes,
(vi) Asset-backed securities and Structured debt obligations (securities
debts viz. Pay through certificates, Pass through certificates and
others)
(vii) Important: Now Individuals can also get rated by the Rating
Agencies and get a ‘Credit Score’ which indicates their
‘Creditworthiness’. (in USA, if a person does not a credit score, he
cannot borrow any loans from banks and other lending
institutions.
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(5) Factors essential for Crediting Rating :
Credit Rating depends on many factors which are dependant on
the judgment of the Rating Agency. For example, the important
factors influencing the safety of the bond are given below:
(i) Earning capacity of the company and the volatility of its business.
(ii) Liquidity position of the Company.
(iii) Overall macro position of the business and industrial environment
has to be ascertained.
(iv) Financial capability of the Company to raise funds from outside
sources when in need of temporary requirements.
(v) Leverage existing with the company and its financial risk position
are important factors for analysis of credit worthiness.
(vi) Funds position of the company to meet its irrevocable
commitments must be analysed.
(vii) Credit Rating agencies evaluate in detail, Fundamental and
Technical data of the company before coming to any conclusions.

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(6) Importance of Credit Rating:
The importance of credit rating is three-fold. It is useful for
investors, companies issuing securities and intermediaries which
are providing funds to corporate.
(i) Investors : It is useful for the investors as data is presented to
them to take decisions on investments. The Rating indicates the
‘credit quality’ of the instruments (Debenture, Bonds, other
securities).

(ii) Companies : It helps the companies as they are ranked according

to the security and safety of their instruments. It provides them
with credibility. They are the issuers of securities (instruments)
and they offer the instruments to the public. Getting a good rating
from the Rating Agency will enhance their credibility.

(iii) Intermediaries : Merchant Bankers, Marke Traders, Brokers, and

Financial Institutions and other market players use the information
for pricing, placement and marketing of intruments.
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(7) SEBI guidelines on Credit Rating :
Credit Rating Agency (CRA) means a body corporate engaged in
the business of rating of securities. They are regulated by SEBI
under Credit Rating Agencies Regulations, 1999. The main
elements of SEBI regulations are as under :
(i) Promotion and Registration of Credit Rating Agencies (CRA),
(ii) General obligations of CRA,
(iii) Restrictions on rating of securities,
(iv) Procedure for inspection and investigation
(v) Action in case of default.

(i) Promotion of CRA in India :

Under SEBI guidelines, the CRA can be promoted and established
by (i) public financial institutions, (ii) Scheduled Banks, (iii)
Foreign bank operating in India, (iv) foreign rating agency having
minimum five years of experience, with paid-up equity capital and
reserves of Rs 100 crores for last 5 years as per audited annual
accounts.
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(i) Registration of CRA:
The registration with SEBI is mandatory for carrying on the rating
business. The application for grant of Certificate of registration
should be made to SEBI on the prescribed application form.

(ii) General obligations of CRA :

(1) Code of conduct :
In the conduct of business, CRA should observe high standard
integrity, fairness and transparency in the conduct of business.

(2) Agreement with the client (company) :

CRA should enter into a written agreement with each client
containing the following provisions : (i) rights and liabilities of both
CRA and Company, (2) periodic of review of credit rating, (iii)
client’s agreement to provide necessary information for rating
purpose (co-operating in the rating process with CRA), (iv)
disclosure by CRA to the client regarding rating to be assigned to
them. (v) fee to be charged by CRA for their rating services.
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(3) Confidentiality :
CRA should treat the information provided by the client (company)
as confidential and not disclose it any other person except under
the requirements of law or court order.

(4) Compliance Officer :

CRA should appoint a qualified person as ‘Compliance Officer’ to
comply with the SEBI regulatory guidelines issued from time to
time. Compliance Officer should all Returns and Reports to SEBI
as per stipulations. CRA should furnish any specific
information/statement as may be required by SEBI.

(4) Maintenance of Books of Accounts and Records :

Every CRA has to keep and maintain for a minimum period of 5
years, the books of accounts, records and documents, as
mentioned in the SEBI guidelines and intimate to SEBI the place
where they are kept for inspection by SEBI.

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(iii) Restrictions on Rating of Securities :
The restrictions imposed by SEBI, relates to securities issued by
(1) promoters of the Credit Rating Agency, (2) securities issued
by certain other entities.
(1) Credit Rating Agency is prohibited from rating securities issued by
the companies established by promoters of CRA. For example,
Mr Prakash is the promoter of ABC Rating Agency. He has
substantial investments in XYZ Company. ABC Rating agency is
not allowed to Rate XYZ Company or the securities issued by
them.
(2) Certain other entities :
The securities of the following entities cannot be rated by the
Credit Rating Agency.
(i) the borrower (borrowing company) of the promoter of Credit
Rating Agency, (ii) a subsidiary of its promoter, (iii) the
chairman/director/employee of the company is on the rating
committee of the CRA.
(example : see next slide)
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Example : Mr Prakash Nambiar is the promoter of ABC Credit Rating
Agency. XYZ Company Ltd, Mr Suresh Nambiar is the brother of
Mr Prakash Nambiar and he has also borrowed from Prakash.
XYZ company proposes to issue debt securities which are to be
rated. The position is explained below:
(i) As both are brothers (relatives) and that Suresh has borrowed
from Prakash, XYZ company cannot be rated by ABC Rating
agency.
(ii) If Prakash has made investments in XYZ company, even without
giving any loan to Suresh, XYZ co. cannot be rated by ABC Rating
Company.
(iii) If Suresh, the promoter and Chairman of XYZ company, is on the
Rating Committee of ABC Rating Agency, the securities of XYZ co.
cannot be rated by ABC rating agency.
(iv) Another independent Director Mr Mahesh Deshmukh or General
Manager (employee) Prashant Dhankar of XYZ Company, is on the
Rating Committee of ABC Rating Co. Even in this case, the
securities of XYZ Co. cannot be rated by ABC Rating agency.

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(9) Instruments Eligible for Credit Rating :
The Credit Rating refers to evaluation of debt instruments. Debt
instruments include both long term instruments like debentures,
bonds, Corporate Public Deposits, Infrastructure bonds, and short
term obligations like commercial paper. Apart from these
Certificate of deposits, mutual funds, asset-backed securities
(securitised assets), are also rated by the Rating Agencies.

(10) Determinants of Rating : (why rating is necessary?)

The default-risk assessment and quality rating assigned to an issue
are primarily determined by three factors.
(i) Company’s ability to pay;
(ii) Strength of the security owner’s (issuer’s) claim on the issue; and
(iii) Economic significance of the industry and marketplace of issuer.

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(11) Process of Credit Rating by Rating Agency :
The following are the steps and processes involved in credit
rating :
(i) Mandate from the issuer (issuing company) :
The issuing company has to issue a mandate to the Credit Rating
Agency for rating the proposed instrument (equity or debt).
(ii) Assigning team of analysts:
After obtaining the mandate from the issuer company, the Rating
agency then proceeds to assign technical team to the issuing
company to hold preliminary discussion and to begin the analysis
process.
(iii) Data collection :
The team of experts collects necessary data pertaining to the
various aspects of the issuer company. For this purpose repeated
visits are made by analysts to the company to pool information.
(iv) Data Analysis :
The data collected by analysts are analysed for inferences. The
results are then benchmarked against general business and
financial parameters. 15
(v) Discussions :
Detailed and personal discussions are held with various
managerial personnel. In addition, interactions are also held with
the bank(s) and statutory auditors of the company.
(vi) Credit Report :
On the basis of the discussions and meetings that are held and
based on data analysed, a report on the company is prepared.
The report is then presented to the Rating Committee, which in
turn assigns the relevant ‘credit rating’ to the company. Based on
the company’s rating Credit Rating is given to the instrument (such
as, AAA, AA, A and so on).
(vii) Rating Communication :
The Rating assigned by the Rating Committee is then officially
communicated to the Company. The option of acceptance, or non-
acceptance rests with the company. The Rating is made public
only if the company accepts it. If not accepted, the company can
appeal to the Rating Agency for review of rating (but the rating
normally remains the same and does not change).
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(viii)Credit Rating symbols and interpretations : (important)
Credit ratings issued by CRISIL for debentures is given below :
High Investment Grades :
AAA (Triple ‘A’) : Highest safety
AA (Double ‘A’) : High safety

Investment Grades :
A : Adequate safety
BBB (Triple ‘B’) : Moderate safety

Speculative Grades :
BB (Double ‘B’) : Inadequate safety
B : High risk
C : Substantial Risk
D : Default

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Other Rating symbols:
(a) Fixed Deposit Rating symbols :
(i) FAAA – Highest Safety
(ii) FAA - High Safety
(iii) FA - Adequate Safety
(iv) FB - Inadequate Safety
(v) FC - High Risk
(vi) FD - Default

(b) Commercial Papers Rating symbols:

(i) P1 - Highest Safety
(ii) P2 - High Safety
(iii) P3 - Adequate Safety
(iv) P4 - Inadequate Safety
(v) P5 - Default

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(8) Credit Rating Symbols and explanations

Symbol Indicator Risk Profile

AAA Highest Safety (i) Indicates fundamentally strong
position.
(ii) Risk factor is negligble.
(iii) Timely payment of principal
and interest as per terms.
AA High Safety (i) Modest and slightly varyng risk
factor.
(ii) Strong protective factors for
risk.
(iii) Prospects of timely payment of
principal and interest as per terms
under adverse conditions, as may
be vuisualised.
A Adequate Safety (i) Risk factors are more variable
and greater in periods of economic
stress.
(ii) Protective factors for risk are
average.
Any adverse change in financial
position of company may alter
fundamental strength and affect
the timely payment of principal
and interest asper terms.

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BBB Moderate safety (i) Considerable variability in risk
factors.
(ii) Risk Protective factors are below
average.
(iii) Adverse changes in
business/economic environment are
likely to affect the timely payment of
principal and interest as per terms.

BB Inadequate safety (i) Timely payment of interest and

principal are more likely to be
affected by the present or
prospective changes in business/
economic environment.
(ii) Risk protective factors fluctuate
in case of changes in
business/economic conditions.
B High Risk (i) Risk factors indicate tht the
obligations may not be met as and
when due and payable.
(ii) Adverse changes in business/
economic conditions could result in
inability to service debts (payment
of principal and interest) on time as
per terms.

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C Substantial Risk (i) Presence of inherent elements
of risk and timely servicing of
debts/ obligations could not be
possible , unless there is of
continued existence of favourable
conditions.
D Default (i) Either already default in
payment of interest and/or
principal as per the terms of issue
or expected to default in payments.

(ii) Recovery of amounts is likely

only on liquidation or restructuring
of the company.

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(12) Benefits of Credit Rating :
(a) Investors:
(i) Credit Rating enables the investors to get superior information at
low cost.
(ii) It enables the investors to take calculated risk in their
investments
(iii) It encourages the common man to invest his savings in corporate
securities and get high ‘returns’.

(b) Corporate Borrowers:

(i) It facilitates companies with good rating to enter the capital
market confidently and raise funds at comparatively at cheaper
rate. Higher the Credit Rating (i.e. lesser the risk), lesser the
interest rate.
(ii) It can be used as a marketing tool.
(iii) It facilitates foreign investments and collaborations.
(iv) It encourages financial discipline among the corporate borrowers.

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(c) Financial Institutions and Banks:
(i) Better credit ratings enables the financial institutions and banks to
extend safe and secured loans.
(ii) As per the Basel risk framework and RBI guidelines, it is
mandatory for companies to get Credit Rating from the Rating
Agency and it is required to be renewed from time to time.
(iii) Fair and good ratings motivate the public to invest their savings in
companies debentures, bonds, public deposits.
(iv) It enable the banks, financial institutions and Regulatory
authorities exercise effective control over the companies. Low
safety (high risk) companies require stricter control, while high
safety (low risk) require less control in the financial markets.
(v) It facilitates formulation of policy guidelines by Regulatory
authorities (SEBI, RBI) on institutional investments in the financial
markets.

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(13) Crediting Rating Agencies:
(a) Domestic Rating Agencies:
(i) CRISIL (Credit Rating and Information Services of India Limited),
(ii) ICRA (Investment Information and Credit Rating Agency of India
Limited),
(iii) CARE (Credit Analysis and Research Limited)
(iv) Brickwork Ratings India Pvt. Ltd
(v) India Ratings and Research Pvt. Ltd.
(vi) Acuite Ratings and Research (P) Ltd.
(vii) Informatics Valuation and Rating Pvt. Ltd.

(b) International Rating Agencies :

(viii)Moody’s Investor Services (USA),
(ix) Standard & Poor
(x) Fitch International Ratings

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Source : www.moneycontrol.com dt. 29.9.2022

• SEBI slaps Rs 1 crore fine on Brickwork Ratings Company

for lapses in assigning credit ratings to Essel Group
companies' NCDs
• Markets regulator Securities and Exchange Board of India (SEBI) on
September 29 imposed a penalty of Rs 1 crore on Brickwork Ratings
India, for lapses while assigning credit ratings to non-convertible
debentures (NCDs) of Essel Group companies.
• Brickwork Ratings also failed to review the rating of NCDs of Great
Eastern Energy Corporation after another credit rating agency
downgraded the NCDs in April 2017 due to "delays in debt servicing
of bank facilities on account of tightening of liquidity", it said. Also,
the regulator has made delay in recognising default of NCDs of
Diamond Power Infrastructure Ltd.

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Assignment-8 :
Identify any one Equity instrument and one Debt instrument issued by
any two companies independently, and write the factors considered
for their rating and rating assigned to each one of the instruments.

Note : Students should practice this exercise on their own for

thorought understanding of credit pocess. Students need not
submit to me.

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THANK YOU

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