Dear readers
In continuation of our series, Soul of Banking Awareness, today we are providing information about another important aspect related to banking, Credit Rating Agencies. Hope this helps you in your preparation.
CREDIT RATING AGENCIES
A Credit Rating Agency is simply an institution that allocates Credit Ratings to the borrower’s. The basis of these ratings is the debt repayment capacity of the borrower which involves timely interest payments and the likelihood of default by the customer.
SEBI
- Established: by The Government of India on 12 April 1988
- Headquarter: Mumbai, Maharashtra
- Chairman : U K Sinha
These Credit Rating Agencies are regulated by SEBI (Securities and Exchange Board of India). The SEBI (Credit Rating Agencies) Regulations, 1999 govern the credit rating agencies and provide for eligibility criteria for registration of credit rating agencies, monitoring and review of ratings, requirements for a proper rating process, avoidance of conflict of interest and inspection of rating agencies by SEBI, amongst other things.
The three major Credit Rating Agencies of the world are :
Moody’s Investors Service
- Established in 1909,
- Headquarters in New York, USA.
- CEO of the organization Mr. Raymond W. McDaniel Jr.
Standard & Poor’s
- Founded in 1860
- Headquarters in New York, USA.
- John L. Berisford serves as the acting President.
Fitch Ratings
- Headquarters in New York
- Founded in 1914.
- Paul Taylor is currently the CEO.
- Fitch Ratings is also the parent company of India Ratings & Research Private Limited that operates from Mumbai.CEO of India Ratings & Research Private Limited – Rajesh Patel
A look at the important Credit Rating Agencies in India :
1. CRISIL (Credit Rating Information Services of India Limited)
- Established in 1987
- CRISIL is India’s first and major Credit Rating Agency.
- It has its headquarters in Mumbai, Maharashtra.
- Standard & Poor’s International is the parent company of CRISIL.
- Ashu Suyash is the current CEO.
2. CARE ( Credit Analysis and Research Limited)
- Established in 1993
- This credit rating agency has its headquarters in Mumbai.
- Mr. Rajesh Mokashi is the MD and CEO of the organization.
3. ICRA (Investment Information and Credit Rating Agency)
- Its an associate of Moody’s Investors Service
- Founded in 1991.
- Mr. Naresh Takkar is the CEO of this agency.
- It has its headquarters in Gurgaon.
4. ONICRA (Onida Individual Credit Rating Agency)
- Founded in 1993
- Headquarters in Gurgaon.
- Mr. Varun Mirchandani serves as the Executive Director of the organisation.
5. BRICKWORK RATINGS INDIA PRIVATE LIMITED
- Established in 2007
- This credit rating agency has its headquarters in Bengaluru, Karnataka.
- Mr. Vivek Kulkarni is the chairman of Brickwork India.
6. SMERA (Small and Medium Enterprises Rating Agency of India Limited)
- This credit rating agency was set up in 2005 exclusively for micro, small and medium enterprises.
- It has its headquarters in Mumbai.
- Mr. Sankar Chakraborti is currently the CEO of the organization.
Now a major question that arises is
Why are these Credit Rating Agencies important?
- These agencies determine the risk that is associated by investing in the companies.
- This aids in making Informed Investment Decisions. Credit Ratings give a fair estimate of the ability of the organisations to fulfill their financial commitment.
- A high credit rating indicates a high possibility of paying back the loan.
- The Credit Rating of organizations also helps the lending institutions in deciding the loan eligibility of the their borrower.
- The increasing levels of default resulting from easy availability of finance, is another factor that has led to the growing importance of the Credit Rating.
- Credit Rating also plays a vital role in financial markets. They assess the credit risk of the corporate or government borrowers by analyzing the relevant information available regarding the borrower and its economic circumstances. This analysis is reflected in Credit Rating. This rating represents an opinion about the likelihood of meeting the financial obligations by the borrower.
Role of Credit Rating Agencies in Indian Market
With the increasing market orientation of the Indian economy, investors value a systematic assessment of two types of risks:
1. Business risk arising out of the ―open econom and linkages between money, capital and foreign exchange markets
2. Payments risk
With a view to protect small investors, who are the main target for unlisted corporate debt in the form of fixed deposits with companies, credit rating has been made mandatory. Given the slump faced by economies globally and the rise in the number of defaultees, it is about time that the channel had a credit rating system in place to ensure smooth operation for the entire chain.
What is Credit Rating?
- Credit rating is the opinion of the rating agency on the relative ability and willingness of the issuer of a debt instrument to meet the debt service obligations as and when they arise.
- Rating is usually expressed in alphabetical or alphanumeric symbols. Symbols are simple and easily understood tools which help the investor to differentiate between debt instruments on the basis of their underlying credit quality.
- A credit rating evaluates the credit worthiness of an issuer of specific types of debt, specifically, debt issued by a business enterprise such as a corporation or a government.
- It is an evaluation made by a credit rating agency of the debt issuers’ likelihood of default.
- The credit rating represents the credit rating agency’s evaluation of qualitative and quantitative information for a company or government including non-public information obtained by the credit rating agencies analysts.
- Credit ratings are not based on mathematical formulas. Instead, credit rating agencies use their judgment and experience in determining what public and private information should be considered in giving a rating to a particular company or government.
Sovereign Credit Ratings
A sovereign credit rating is the credit rating of a sovereign entity, i.e., a national government. The sovereign credit rating indicates the risk level of the investing environment of a country and is used by investors looking to invest abroad. It takes political risk into account.
Credit Rating
- Credit rating establishes a link between risk and return. They thus provide a yardstick against which to measure the risk inherent in any instrument.
- An investor uses the ratings to assess the risk level and compares the offered rate of return with this expected rate of return (for the particular level of risk) to optimize his risk-return trade-off.
- The risk perception of a common investor, in the absence of a credit rating system, largely depends on his familiarity with the names of the promoters or the collaborators. It is not feasible for the corporate issuer of a debt instrument to offer every prospective investor the opportunity to undertake a detailed risk evaluation.
- It is very uncommon for different classes of investors to arrive at some uniform conclusion as to the relative quality of the instrument. Moreover they do not possess the requisite skills of credit evaluation. Thus, the need for credit rating in today’s world cannot be overemphasized.
Credit Rating in India
Credit ratings are playing an increasingly important role in financial markets. The most significant change in the recent relates to emphasis on their accountability and more important, the caution in regulators’ use of ratings.
India was perhaps the first amongst developing countries to set up a credit rating agency in 1988. The function of credit rating was institutionalized when RBI made it mandatory for the issue of Commercial Paper (CP) and subsequently by SEBI, when it made credit rating compulsory for certain categories of debentures and debt instruments.
In June 1994, RBI made it mandatory for Non-Banking Financial Companies (NBFCs) to be rated. Credit rating is optional for Public Sector Undertakings (PSUs) bonds and privately placed nonconvertible debentures up to Rs. 50million.
In making their ratings, CRAs analyze public and non-public financial and accounting data as well as information about economic and political factors that may affect the ability and willingness of a government or firms to meet their obligations in a timely manner. However, CRAs lack transparency and do not provide clear information about their methodologies. Ratings tend to be sticky, lagging markets, and then to overreact when they do change.
CRISIL – Credit Rating and Information Services of India Ltd. is India’s leading Ratings, Research, Risk and Policy Advisory Company based in Mumbai. CRISIL’s majority shareholder is Standard & Poor’s, a division of The McGraw-Hill Companies and the world’s foremost provider of financial market intelligence.
A Credit rating reflects current opinion on the relative likelihood of timely payment of interest and principal on the rated obligation. It is an unbiased, objective, and independent opinion as to the issuer’s capacity to meet its financial obligations.
The debt obligations rated by Credit Rating Agencies include:
- Non-convertible debentures/bonds/preference shares
- Commercial papers/certificates of deposits/short-term debt
- Fixed deposits
- Loans
- Structured debt
Credit Rating Agencies rates a wide range of entities, including:
- Industrial companies
- Banks
- Non-banking financial companies (NBFCs)
- Infrastructure entities
- Microfinance institutions xv. Insurance companies
- Mutual funds
- State governments
- Urban local bodies
Types of Credit Ratings:
1. Sovereigns and Local Government
- Long- and short-term local currency ratings
- Long- and short-term foreign currency ratings
2. Banks and other Financial Institutions
- Long- and short-term local currency ratings
- Long- and short-term foreign currency ratings
- Financial strength ratings (an opinion of stand-alone financial health)
- Support ratings (an assessment of the likelihood that a bank would receive external support in case of financial difficulties)
3. Corporates
- Long- and short-term local currency ratings
- Long- and short-term foreign currency ratings
Note – Issue Credit Ratings (for bonds, Sukuk and other financial obligations): these are an opinion of an entity’s ability and willingness to honour its financial obligations with respect to a specific bond or other debt instrument. The ratings assigned to the debt issues of financial institutions and corporates can be either short-term or long-term, depending on the tenor of the financial obligation. A short-term rating is assigned to debt instruments with an original maturity of up to one year.
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