Table of Contents:-
- Credit Rating Agencies in India
- Meaning of Credit Rating
- Definition of Credit Rating
- Benefits of Credit Rating
- What is Credit Rating Agency?
- Characteristics of Credit Rating
- Importance of Credit Rating
- Limitations of Credit Rating
Credit Rating Agencies in India
The establishment of Credit Rating Agencies in India forms an important step in the process of financial reforms. Following are the credit rating agencies in India explained in brief:
1) Credit Rating Information Services of India Limited (CRISIL)
The Credit Rating Information Services of India Limited (CRISIL) was promoted in 1987 by the ICICI and UTI. Other shareholders include:
- Asian Development Bank,
- State Bank of India,
- Life Insurance Corporation of India,
- Housing Development Finance Corporation Limited,
- General Insurance Corporation of India and its subsidiaries,
- Standard Chartered Bank,
- Banque Indosuez,
- Bank of Tokyo,
- Sakura Bank,
- Hong Kong and Shanghai Banking Corporation,
- Citibank, Grindlays Bank,
- Bank of India,
- UCO Bank, Bank of Baroda,
- Allahabad Bank,
- Canara Bank,
- Central Bank of India,
- Indian Overseas Bank and
- Bank of Madura Ltd.
Its primary objective is to rate the debt obligations of Indian companies. Its rating provides a guide to the investors as to the degree of certainty of timely payment of interest and principal on a particular debt instrument. CRISIL rates debentures, fixed deposit programmes, and short-term instruments like commercial paper, structural obligations, and preference shares. CRISIL is the market leader in India and works as a ‘full service’ rating agency. It has the most wide range of rating services. By combining its expertise in risk analysis and the art of constructing risk frameworks with a profound contextual understanding of business, CRISIL ratings offer the most reliable opinions on risk.
CRISIL’s Impact on Debt Markets: Ratings, Services, and Contributions
Since its inception on March 31, 1994, CRISIL has rated a total of 926 debt instruments issued by 668 companies. It has introduced the CRISIL card, CRISIL view, CRISIL ban card, and CRISIL rating digest service. CRISIL has published CRISIL bond yield tables to provide a handy reference to investors for determining yield-to-maturity on a c, given the price of the debenture, its coupon rate, and its maturity period. It has also published a CRISIL RATING Scan containing rating reports on companies whose instruments have been rated by CRISIL. during the quarter. CRISIL ratings continue to play an important role in the development of the debt markets in India. Till March 31, 2003, it has rated more than 4438 debt instruments worth over 4,46,329 crore, for more than 2000 companies.
2) Investment Information and Credit Rating Agencies of India (ICRA)
ICRA or the Investment Information and Credit Rating Agencies of India is sponsored by IFCI jointly with the other lead financial institutions and banks and became operational in September 1991 to guide the investors or creditors in determining the credit risk associated with an de instrument or credit obligation. The ICRA rated debentures, bonds, preference shares, fixed deposits, and short-term instruments like commercial paper, etc, of several companies. Since its time of inception in March 1995, ICRA rated 485 dels instruments evolving 17,638 crore. In addition, ICRA provides a “general assessment report on different aspects of the company’s operations management”.
ICRA is an independent and professional company providing investment information and credit rating services. With the growth and globalization of the Indian capital market leading to an exponential surge in demand for professional credit risk analysis, ICRA has actively responded to this need. The response includes executing assignments such as credit ratings, equity gradings, and mandated studies spanning diverse industrial sectors. ICRA presently provides its services under three banners, namely:
i) Advisory services
ii) Rating services,
iii) Information services,
3) Credit Analysis and Research Limited (CARE)
Credit Analysis and Research Limited (CARE) is sponsored by the Industrial Development Bank of India jointly with Canara Bank, UTI, private sector banks, and financial services companies to offer credit rating information and equity research services to Indian industries and institutions. CARE was incorporated on April 21, 1993, and started its operations in October 1993. It undertakes the rating of all types of debt instruments like commercial paper, fixed deposits, bonds, debentures, and structural obligations, involving an independent and professional assessment of the debt servicing capabilities of companies. Since its inception till the end of March 1995, CARE has rated 249 debt instruments covering a total debt volume of 9,729 crore.
4) Onida Individual Credit Rating Agency (ONICRA)
Onida Finance has set up a private company, Onida Individual Credit Rating Agency (ONICRA). It undertakes ratings for credit cards, leasing, hire purchase transactions, housing finance, and bank finance. The main objective of these credit rating agencies in India is primarily to restore confidence in the capital market and to provide an unbiased assessment of the creditworthiness of the companies issuing debt instruments. It also provides information about the creditworthiness of corporation to investors at a low cost. In addition to this, it provides a sound basis for a proper risk-return structure. It also assists the institutional investment regarding the framing of public policy guidelines. However, ONICRA was abolished in the latter part.
5) Duff Phelps Credit Rating (DPCR)
Duff Phelps Credit Rating (DPCR) India Pvt. Ltd is another private sector credit rating agency that was set up in 1996. It has already rated several companies. However, SEBI has started giving guidelines to them to regulate them as one of the capital market institutions.
6) Fitch Ratings
Fitch Ratings India Ltd is the latest agency to conduct credit ratings from the foreign sector. It is a 100 per cent subsidiary of its parent company abroad, operating in India.
Meaning of Credit Rating
A credit rating is a numerical assessment of a borrower’s creditworthiness, either in general or about a specific debt or financial obligation. This rating can be assigned to any entity seeking to borrow money, whether it’s an individual, corporation, state or provincial authority, or sovereign government.
Credit bureaus like Experian and TransUnion determine individual credit scores using a 3-digit numerical scale and Fair Isaac (FICO) credit scoring. For companies and governments, credit assessment is typically conducted by credit rating agencies such as Standard & Poor’s (S&P), Moody’s, or Fitch. These credit rating agencies in India are compensated by the entity seeking a credit rating, whether it’s for itself or one of its debt issues.
Definition of Credit Rating
Credit rating can be defined as an expression, conveyed through the use of symbols, offering an opinion on the credit quality of the issuer of debt securities regarding a specific instrument. According to SEBI regulations, credit rating is essentially an opinion on securities expressed in the form of a standard symbol or any other standardized form assigned by a credit rating agency. The symbol assigned by the rating agency indicates the credit character of that particular security, facilitating an assessment of its credit risk. However, it does not directly advise whether to buy, sell, or hold that security. Therefore, a rating serves as a measure of credit risk exclusively and does not provide information about the level of market risk.
Credit rating is predominantly considered about debt instrument. In addition to this, lenders such as banks and non-banking finance companies use internally developed credit rating score models to assess the creditworthiness of their borrowers or rely on rating agencies to obtain a rating for the same. Companies that issue debt instruments cannot independently rate their instruments.
Benefits of Credit Rating
The rating of debt instruments offers benefits to interested parties, such as investors, issuers, and intermediary agencies like brokers, etc. These benefits are described below:
Benefits to Investors
1. Recognition of Risk
Credit rating offers investors easily recognizable rating symbols that convey information about the risk involved in an investment. Investors can quickly understand the worth of the issuer company by examining the symbol, as the instrument is rated through scientific and professional analysis of the company’s financial position. Consequently, investors are spared the need to incur costs for collecting credit information and conducting analysis. Even investors without any knowledge of financial analysis can use rating symbols for investment decisions.
2. Safeguards against Bankruptcy
The credit rating of an instrument provided by the credit rating agency offers investors insight into the financial strength of the issuer company. This useful information enables investors to make decisions related to their investments. A highly rated instrument from a company assures investors regarding the safety of their investment and the interest (or return) on their investments with minimal risk of bankruptcy.
3. Rating Facilitates Quick Investment Decisions
Investors can make swift decisions about investments in various instruments with the assistance of credit ratings assigned to those instruments. Consequently, there is no need for investors to conduct a fundamental analysis of a company, considering factors such as the financial strength of the company, the quality of management, and other parameters.
4. Credibility of Issuer
The rating symbol assigned to a debt instrument provides an insight into the credibility of the issuer company. The rating agency is entirely independent of the issuer company and has no business connections or any relationship with its Board of Directors, etc. The absence of business links between the rating agency and the issuer company enhances the confidence of investors in such a rating symbol.
5. Choice of Investment
Several alternative credit-rated instruments are available at a particular point in time for deploying investible funds. Investors can choose from various instruments based on their own risk profile and diversification plan.
6. Benefits of Rating Surveillance
Investors benefit from the credit rating agency’s ongoing surveillance of rated instruments from different companies. The credit rating agency downgrades the rating of any instrument if, subsequently, the company’s financial performance is not satisfactory or its financial position has suffered due to internal or external events. This downgrade necessitates the subsequent dissemination of information about its position to the investors.
7. No Need to Depend on Investment Advisors or Professionals
Investors lacking knowledge about investments may have to seek advice from financial intermediaries, such as stockbrokers, portfolio managers, or financial consultants when investing funds in debt instruments. However, investors do not need to rely on the advice of these financial intermediaries, as the rating symbol assigned to a particular instrument suggests the creditworthiness of the instrument and indicates the degree of risk involved. Therefore, investors can make direct investment decisions.
Benefits of Credit Rating to Issuer Company
A company that has obtained a credit rating from a rating agency for its issuance of debt securities enjoys various advantages. A few of these advantages are given below:
Wider Audience for Borrowing
A company with an excellent rating for its debt instruments can approach various categories of investors for resource mobilization using the press media. Investors from different strata of society could be attracted to higher-rated instruments as they understand the degree of certainty regarding the timely payment of interest and principal on a debt instrument with a better rating.
Lower Cost of Borrowing
A company whose debt instruments or public deposits program receives a high rating will be able to reduce the cost of borrowing by offering lower interest rates on fixed deposits, debentures, or bonds. Investors prefer lower interest rates due to the lower credit risk associated with highly rated instruments.
Self-Discipline by Companies
Rating encourages companies to provide more disclosures about their accounting systems, financial reporting, management patterns, etc. The company gains the opportunity and motivation to improve its existing practices to match the competitive standard and maintain the rating standard it has achieved or make improvements upon the rating.
Rating as a Marketing Tool
Companies with rated instruments enhance their image and can use credit rating as a marketing tool to create a better impression when dealing with customers, lenders, and other creditors. Even consumers feel confident using products manufactured by companies that carry higher ratings for their credit instruments.
Motivation for Growth
Rating motivates the company for growth, as the promoters of the company feel confident in their efforts and are encouraged to undertake the expansion of their existing operations or new projects. With a better image created through a higher credit rating, the company can mobilize funds from the public and institutional lenders like banks and financial institutions.
Reduction of Cost in Public Issues
A company with a higher-rated instrument can attract investors and raise funds with less effort. Thus, a company whose debt instrument is highly rated can minimize the cost of public issues by controlling expenses on media coverage, conferences, and other marketing expenditures.
Benefits to Financial Intermediaries
Highly credit-rated instruments give brokers an advantage, requiring less effort in studying the company’s credit position to convince their clients to select a particular investment proposal. Rated instruments speak for themselves regarding the financial soundness of the company and the strength of the instrument rated by the credit rating agency. This enables brokers and other financial intermediaries to save time, energy, cost, and manpower in convincing their customers about investments in any particular instrument. They use their resources to expand their clientele and boost their business activities.
Other general benefits of credit rating are given below:
1. Positive Impact on the Capital Market
Rated securities contribute to the improvement of the capital market and reflect on its efficient functioning. The trading of rated securities in the secondary market becomes smooth and easy, providing liquidity for such securities. This, in turn, indirectly enhances the primary market for debt instruments with higher credit ratings.
2. Identification of Strengths and Weakness of the Issuer Company
A company that has obtained a rating for its security understands its strengths and weaknesses in all spheres of the corporate environment. It can take corrective steps to improve its position and remain guided by the surveillance efforts of the Credit Rating Agency. Particularly, companies with low credit ratings make efforts to enhance their performance. Thus, credit rating creates a tendency among rated corporate units to remain healthy and maintain a higher standard for corporate governance, which will help them improve their standing both in domestic and international markets.
3. Liquidity and Marketability of Debt Securities
Rated debt securities become easily marketable and therefore, achieve the status of more liquid instruments. Credit rating symbols or grades establish the market price range for the rated securities. The virtues of easy marketability and greater liquidity of the instrument make it popular with investors, and the issuer company can efficiently sell the rated security at the least cost.
What is Credit Rating Agency?
A credit rating agency is a private company that evaluates the creditworthiness of large-scale borrowers, like companies or countries. It effectively ranks borrowers based on their ability to repay loans.
A credit rating agency (CRA), also known as a rating service, assigns credit ratings that reflect a debtor’s ability to make timely principal and interest payments and the likelihood of default. CRAs may rate the creditworthiness of issuers of debt obligations, debt instruments, and, in some cases, the servicers of the underlying debt, but not individual consumers.
Debt instruments rated by CRAs include government bonds, corporate bonds, CDs, municipal bonds, preferred stock, and collateralized securities such as mortgage-backed securities and collateralized debt obligations. The issuers of these obligations or securities may be companies, special purpose entities, state or local governments, non-profit organizations, or sovereign nations. Credit ratings facilitate the trading of financial products (like stocks or bonds) on the secondary market and influence the interest rates that securities pay, 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. During the financial crisis of 2007–08, hundreds of billions of securities that had received the agencies’ highest ratings were downgraded to junk. Rating downgrades during the European sovereign debt crisis of 2010–12 were blamed by EU officials for accelerating the crisis.
The credit rating industry is highly concentrated, with the “Big Three” credit rating agencies controlling approximately 95% of the rating 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%.
Characteristics of Credit Rating
1. Based on Data: A credit rating agency assesses the financial strength of the borrower using financial data.
2. Assessment of Issuer’s Capacity to Repay: It evaluates the issuer’s ability to meet its financial obligations, including the capacity to pay interest and repay the principal amount borrowed.
3. Done by Experts: Credit rating is conducted by experts from reputable, accredited institutions.
4. Guidance about Investment – Not Recommendation: Credit rating guides investors but does not recommend investing in any particular instrument.
5. Expressed in Symbols: Ratings are expressed in symbols such as AAA, and BBB, which can be easily understood by laypeople.
Importance of Credit Rating
1. Quality and Dependable Information: Credit rating agencies employ highly qualified, trained, and experienced staff to assess risks. They have access to important information, which allows them to provide accurate information about the creditworthiness of the borrowing company.
2. Unbiased Opinion to Investors: A good credit rating agency provides an unbiased opinion because it has no vested interest in the rated company.
3. Free or Nominal Cost Information: Credit ratings of instruments are published in financial newspapers and advertisements of the rated companies, often at no cost to the public. Additionally, individuals can obtain them from credit rating agencies for a nominal fee, which is more affordable than the cost of independently gathering such information.
4. Information in Easy-to-Understand Language: Credit rating agencies gather, analyze, and interpret information, presenting their findings in easy-to-understand language, often in symbols like AAA, BB, and C, rather than technical language or lengthy reports.
5. Discipline for Corporate Borrowers: Higher credit ratings enhance a borrower’s goodwill, encouraging other companies to also aim for good ratings. This promotes financial discipline and ethical practices among companies striving for favourable ratings.
6. Assistance in Investment Decisions: Credit ratings help investors assess risks and make informed investment decisions.
7. Formation of Public Policy on Investment: Rated debt instruments allow regulatory authorities (SEBI, RBI) to establish policies regarding the eligibility of securities for investment by institutions like mutual funds and provident funds. For instance, a policy may specify that a mutual fund cannot invest in the debentures of a company unless it holds a AAA rating.
Limitations of Credit Rating
While recognizing the benefits of credit rating, it is necessary to keep in mind certain limitations. A few limitations of credit rating are explained below:
1. Concealment of Material Information
The company approached for credit rating may not provide all material information to the credit rating agency. In such cases, the credit rating given by the agency may not reflect the true picture of the credit risk.
2. Biased Rating and Misrepresentations
In the absence of quality ratings based on objective analysis, credit rating becomes a curse for the capital market. To avoid biased ratings or subjectivity in the credit rating process, executives working with Credit Rating Agencies, involved in the credit rating process, should have no links with the company or individuals interested in the issuer company. This ensures their reports are impartial, and credit rating recommendations are judicious for the rating committee. Additionally, rating committee members should also be impartial and judicious in their decision-making.
Companies with lower-grade ratings often do not advertise or use the rating when raising funds from the public. In such cases, Credit rating agencies in India should, in the public interest, advertise the rating symbols assigned to such companies for public information. This helps make the public aware of the poor financial position of such companies.
3. Static study
Credit rating is conducted based on present and past data of the company, making it a static study. The disclosure about the company’s health through credit rating is a one-time exercise, and anything can happen after the assignment of rating symbols to the company. Depending on the rating for future results defeats the very purpose of risk indicativeness of rating. After the credit rating is assigned, many changes may take place in the economic environment, political situation, government policy framework, etc., directly affecting the operations of a company. With such changes, the original purpose for which credit rating was done may become obsolete.
Once a company has been rated and is unable to maintain satisfactory financial performance, the credit rating agency would review the grade and downgrade the rating, resulting in the impairment of the company’s image. Most of the limitations mentioned above can be overcome by taking precautions at every stage of the credit rating process.
5. Rating is no guarantee of the company’s soundness
Credit rating is conducted for a particular instrument to assess credit risk. Therefore, it cannot be construed as a rating for the quality of management or the overall financial position of the company.
Credit rating agencies in India are like giving a grade to how likely someone is to pay back the money they’ve borrowed. It’s a way of assessing the risk of a credit assignment, and it covers things like debentures, fixed deposits, and commercial papers. This process is super helpful for issuers, investors, intermediaries, and regulators.
What makes credit rating successful? A big part of it is the reputation and credibility of the credit rating agency. It’s not a one-time thing but an interactive process with different steps. The rating, expressed in symbols, can go up or down based on various factors. Lately, credit rating has expanded to cover things like the rating of equity, structured obligations, utilities, sovereign entities, and municipalities.
In India, SEBI keeps an eye on the credit rating business, making sure things are fair and square. There are four SEBI-recognized credit rating agencies doing their thing in the country.