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A
Project Work On ANALYSIS OF CREDIT RATING AGENCIES AND THEIR POTENTIAL IMPACT ON DEVELOPING COUNTRIES WITH REFERENCE TO INDIA AND WITH SPECIAL REFERENCE TO MUMBAI

By MOGRADIA JAVED 15 Submitted to the FACULTY OF MUMBAI UNIVERSITY In partial fulfillment for the award of the degree Of BACHELOR OF MANAGEMENT STUDIES HABIB COLLEGE OF COMMERCE AND ECONOMICS January, 2012

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Certificate
Certified that the Project report titled analysis of credit rating agencies and their poteial impact on developing countries with reference to india and with special reference to mumbai. is the bonafide work of Mr. MOGRADIA JAVED - 15 who carried out the work under my supervision. Certified further that to the best of my knowledge the work reported herein does not form part of any other project report or dissertation on the basis of which a degree or award was conferred on an earlier occasion on this or any other candidate.

Signature of Supervisor

Signature of HOD

Submitted to Project Viva Voce held on .

Internal Examiner

External Examiner

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Declaration
I hereby declare that the project work entitled analysis of credit rating agencies and their poteial impact on developing countries with reference to india and with special reference to mumbai submitted in partial fulfillment of the requirement of the BMS program of Mumbai University is my original work and the project is not submitted as a project previously to any institution for the award of any degree, associate ship, fellowship or any other similar titles.

Place:

Signature of the Student

Padmajakanta Mishra Date:

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Acknowledgement
Firstly, I would like to thank almighty for helping me throughout my life specially in making this project Secondly, I would like to express my deep and sincere gratitude to my Principal Ms. Nasim Shaikh and my Co-ordinator prof. Ms. Khan Gulfam jaha for his constant encouragement and motivation which was very positive and fruitful for shaping up my idea of research. His support and guidance have been of great value in my study. Thirdly, I am indebted to my guide prof. Ms. Khan Gulfam jaha for his valuable guidance and co operation extended to me directly and indirectly during preparation of my project report . His patience and continuous encouragement and support have acted as a source of strength and motivation to peruse my dissertation work successfully. His vast knowledge and clarity, exceptionally inspired and enriched my growth as a student and researcher. I am grateful for his detailed review, constructive criticism and excellent advice during the preparation of this dissertation. Fourthly, I am thankful to my family for constantly encouraging and supporting me during my endeavor. I am grateful and extremely fortunate to receive valuable advice and guidance from my father mohd. hanif. His abundance knowledge in diverse areas has benefited me always. Word fail me to express my appreciation and absolute indebtedness to my mother sufya m. hanif for her continuous patience, tolerance, tremendous help and unconditional love.

Fifthly, I owe collective and individual acknowledgement to all my colleagues. A special thanks to my friend who have constantly assisted me in numerous ways.

Page |6 Finally, It gives me extreme pleasure to all those who have helped me a lot in completing this Research project report. I would like to thanks all those who have spent their valuable time to contribute the required information to me and gave me support while preparing this dissertation. I would like to express my sincere thanks to everyone who helped me in successful realization of this dissertation.

Place: Mumbai

Date:

MOGRADIA JAVED

Table of Contents
Page No.

List of Tables List of Abbreviations

8 9

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Chapter 1: Introduction Chapter 2: Theoretical Perspective Chapter 3: Organization Profile Chapter 4: Rules and Regulations of SEBI Followed by Gandhi Securities Chapter 5: Regulatory Functions of SEBI for the Financial Year 2007-08 With Reference to Gandhi Securities and Investment Pvt. Ltd. Chapter 6: Major Findings Based on the Study Chapter 7: Questions and Answers used for Data Collection during the Interview Chapter 8: Conclusion of the Study

10-13 14-32 33-36

37-51 52-58

59-60

61-68 69-70

Bibliography

71

List of Tables
Page No.

Table1: Departments of SEBI Table 2: Mutual funds registered with SEBI Table 3: Inspection of stock Brokers

21 53 54

Page |8 Table 4: Investigations by SEBI Table 5: Nature of investigations completed by SEBI Table 6: Type of regulatory actions taken by SEBI Table 7; Redressel of Governance 56 56 57 58

List of Abbreviations
CRAs : Credit Rating Agencies GSI; Gandhi Securities and Investment Pvt. Ltd. MIRD: Market Intermediaries Registration and Supervision Department MRD: Market Regulation Department

Page |9 DNPD: Derivatives and New Products Department FCD: Fully convertible Debenture PCD: Partly convertible Debenture NCD: Non-convertible Debenture DRR: Debenture Redemption Reserve IPO: Initial Public Offerings PMS: Portfolio Management Software CDSL: Central Depository Services Limited NAV: Net Asset Value AMC: Asset Management Company SRO: Self Regulatory Organizations

Chapter 1
Introduction
 introduction  Objective of the Study

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 Scope and need of the Study  Research Methodology  Limitations of the Study

Executive Summary
Credit Rating Agencies first emerged in 1940s following the financial crisis of 1937 in New York. Louis Tappan established the first mercantile credit agency in New York in 1841. The agency rated the ability of merchants to pay their financial obligations. It was subsequently acquired by Robert Kun and its first rating guide was published in 1859.Another similar agency was set up by John Bradstreet in 1849, which published a rating book in 1857. These two agencies were merged together to form Dun and Bradstreet in 1933, which became the owner of Moodys Investors Service in 1962. The history of Moodys itself goes back about 100 years. In 1900 Joyn Moody founded Moodys Investors Service, and in 1909 published his Manual of Railroad Securities. This was followed by the rating of utility and industrial bonds in 1914, and the rating of bonds issued by U.S. cities and other municipalities in the early 1920s.

P a g e | 11 Further expansion of the credit rating industry took place in 1919, when the Poors Publishing Company published its first rating followed by the Standard Statistics Company in 1922, and Fitch Publishing Company in 1924. The Standard Statistics Company merged in 1941 to form standard and poors which was subsequently taken over by McGraw Hill in 1966. For almost 50 years, since the setting up of Fitch Publishing in 1924, there were no major new entrants in the field of credit rating and then in the 1970s, a number of credit rating agencies commenced operations all over the world. These included the Canadian Bond Rating Service (1972), Thomson Bank watch (1974), Japanese Bond Rating Institute (1975), Dominican Bond Rating Service (1997), IBCA Limited (1978), and Duff and Phelps Credit Rating Company (1980).There are credit rating agencies in operation in many other countries such as Malaysia, Philippins, Mexico, Indonesia, Pakistan, Cyprus, Korea, Thailand and Australia.

In India, the concept of Credit rating came up when Credit rating and information Services of India Ltd. (CRISIL) was set up as the first rating agency in 1987, As the scope of credit rating widened ICRA (formerly known as Investment Information and Credit Rating Agency of India Limited) was set up in 1991, and Credit Analysis and Research Ltd. (CARE) was set up in 1994. The ownership pattern of all the three agencies is institutional. The first private sector credit rating institution was Duff and Phelps credit rating India Pvt. Ltd. Formed in 1995(After merger with DCR its known as Fitch India Ltd. John Knowles Fitch founded the Fitch Publishing Company in 1913. Fitch published financial statistics for use in the investment industry via "The Fitch Stock and Bond Manual" and "The Fitch Bond Book." In 1924, Fitch introduced the AAA through D rating system that has become the basis for ratings throughout the industry In this project we have discussed some of the Impact of Credit Rating Agencies on the Developing Countries with Relation to India and with Special reference Mumbai. WE have also analyzed the acceptability of these rating agencies as a measuring tool for investment risk as per the answers of the clients of this concern.

Objective the Study

Since this is a project on a topic of Finance with less mathematical applications after much discussion with my mentor I have formulated the following objectives for the Study. 1. To give an investors necessary ideas about the impact of rating agencies on India or developing countries.

P a g e | 12 2. Today much of the common men are not well informed about the scopes in the investment market for earning purposes and even if they know, they cannot invest because of fear of losing money due to uncertainties in the capital market. So my project aims to make them feel secure while involving in the trading and investing activities with the necessary tool which is credit rating agencies. 3. To make them understand what is the ability of a firm to pay its debt. 4. To help the investors who may be a common man or a business concern in making a right decision while investing in one of the globally proven trading and investing firm by credit rating agency with this point of view this project is mainly designed for the people who want to invest and trade in the stock market. 5. To encourage people to invest with limited risk by providing them an option of selecting firm through rating.

Need of the Study

There is not any scope of argument if it is said that todays world is the world of commerce. Even a layman who has no access to the capital market should be aware of the trends of the securities market now-a-days. It is very certain that those trends and the movement of capital market are full of uncertainties. But since it represents the overall economical state of the country we should know the rises and falls in the trends of the market. Besides that it provides an ample scope of money making through investment and trading. But with todays new scam are making it tough for people to invest. Anyone who is rich or poor cannot want his money got loss. To fulfill all those purposes we need to be well acquainted with the rating scale, and work of credit rating agency. In order to feel secure an investor or a trader must know what the companies position is. We should get the knowledge of all the companies and their rating. Rating shows their ability to pay the debt. In simple to give the investors money back. My main aim was to fulfill this common goal for the general investors and this is also the need of the project.

Scope of the Study

The study here has been limited to the analysis of credit rating agencies and their impact on Indian markets, their working, need for CRAs.the function of CRAs in developing countries, through the data collected from financial consultants, investors, etc. In the process of analysis only theoretical interpretations of the tables and pie charts have been used.

Research Methodology
The research methodology involves of data from the financial consultants, as well as investors and analyzing them theoretically with the help of pie charts and tables. The data collected for the project is basically from two sources, they are: -

P a g e | 13 1. Primary sources: Primary data was collected through Actual interview of the finance consultant. I also surveyed the investors through questions and answers. 2. Secondary sources: collection of data from internet, books, various research papers and annual reports

Limitations of the Study

In spite of much of hard work some limitations of the study can be found out in this research activity. The limitations are listed below. 1) The study is based mainly on the basis of secondary data available from various books, research papers, websites etc. because primary data was not possible to be collected in many cases. 2) The study only provides the advantages of CRAs but does not focuses on scam relating to CRA. 3) The study only relates to the Mumbai but does not tell much about the whole capital market of India.

Chapter 2 Theoretical Perspective

       Understanding Financial Market of India Necessities for Setting up of SEBI Objectives of SEBI Functions of SEBI Powers for SEBI Organizations SEBI and the Central Govt.

SEBI Guidelines For  Secondary Market

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Foreign Institutional Investors Bonus Issues Rights Issue Debentures Protection of the Debenture Holders Underwriters Investor Protection New Issues Prohibition Of unfair Trade Practices Book Building  Buyback of Shares

Introduction on Credit Rating Agencies (CRAs)

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

Credit rating is an opinion expressed by an independent professional organization, after making a detailed study of all relevant factors. Such an opinion will be of great assistance to investors in making investment decisions. It also helps the issuers of debt instrument to price their issue correctly and to reach out to new investors. Regulators like Reserve Bank of India (RBI) and Securities & Exchange Board of India (SEBI) often use credit rating to determine eligibility criteria for some instruments. In general, credit rating is expected to improve quality consciousness in the market and establish over a period of time,

P a g e | 15 a more meaningful relationship between the quality of debt and the yield from it. Credit rating is also a valuable input in establishing business relationships of various types.1

Credit rating, however is neither a general purpose evaluation of a corporate entity nor an overall assessment of the credit risk likely to be involved in all the debts/financial instruments contracted/to be contracted by such issuers. A rating is specific to a debt/financial instrument and is intended to grade different and specific instruments in terms of the credit risk associated with the particular instruments. Although it is an opinion expressed by an independent professional organization, on the basis of a detailed study of all the relevant factors, the rating does not amount to any recommendation to buy, hold or sell an instrument as it does not take into consideration factors such as market prices, personal risk preferences of an investor and such other considerations, which may influence an investment decision.

As a fee based financial advisory service, credit rating is, obviously, extremely useful to investors, corporate (borrowers), banks, and financial institutions. For the investors, it is an indicator expressing the underlying credit quality of an (debt) issue program. The investor is fully informed about the company as any effect of changes in business/economic conditions on the company is evaluated and published regularly by the rating agencies. The corporate borrower can raise funds at a cheaper rate, with a good rating. It minimizes the role of name recognition and lesser-known companies can also approach the market on the basis of their rating. Fund ratings are useful to the banks and other financial institutions when they decide on lending and investment strategies. A prospective investor who is going to invest his earned money in securities (more specific debt securities) would naturally like an assessment of risk associated with the securities enabling him for the proper evaluation of risk-return trade-off. But, factors such as lack of time, lack of knowledge of security evaluation, lack of reliability etc. could leave any investor looking for an agency, which would provide an unbiased judgment of risk associated with the security.

P a g e | 16 Thus, the assessment of risk associated with particular security/financial instrument regarding timely repayments of interest and principal is termed as credit rating.

A rating is specific to a debt/instrument. Thus, a rating is a general-purpose evaluation neither of the company or issuer, nor an overall assessment of the credit risk likely to be involved in all the debts contracted or to be contracted by such issues.

Although it is an opinion expressed by an independent credit rating agency, on the basis of a detailed study of all the relevant factors, the rating does not make any recommendations to buy, hold or sell an instrument as it does not take into consideration another factors such as market prices, personal risk preferences of an investor and such other considerations, which may influence an investment decision. 2

Definitions: -

 According to the Moodys, A rating on the future ability and legal obligation of the issuer to make timely payments of Principal and interest on a specific fixed income security. The rating measures the probability that the issuer will default on the security over its life, which depending on the instrument of the expected monetary loss, should a default occur.  According to the Standard & poors, it helps investors by providing an easily recognizable, simple tool that couples a possibly unknown issuer with an informative and meaningful symbol of credit quality.

 According to the CRISIL, Credit Rating is an unbiased, objective and independent opinion as to an issuers capacity to meet financial obligations.

P a g e | 17  According to the 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 programme of an issuer with reference to the capability of the issuer to repay the debt as per terms of issue. This is neither a general purpose evaluation of a company nor a recommendation to hold, buy or sell a debt instrument.

List of credit rating agencies

     Agencies that assign credit ratings for corporations include: M. Best (U.S.) Baycorp Advantage (Australia) Bulgarian Credit Rating Agency (Bulgaria, European Union) Capital Intelligence (Cyprus)

 Capital Standards Rating (Kuwait)  Credo line (Ukraine)  Dagong Global (People's Republic of China)  Dominion Bond Rating Service (Canada)  Egan-Jones Rating Company (U.S.)  Fitch Ratings (Dual-headquartered U.S./UK), 80% of which is owned by FIMALAC, a French firm.  CRISIL (India)  Japan Credit Rating Agency, Ltd. (Japan)  Moody's Investors Service (U.S.)  Muros Ratings (Russia alternative rating agency)  Rapid Ratings International (U.S.)  Standard & Poor's (U.S.)  Weiss Ratings (U.S.)

Big Three (credit rating agencies)

The Big Three credit rating agencies are Standard & Poor's, Moody's Investor Service, and Fitch Ratings. Moody's and S&P each control about 40 percent of the market. Thirdranked Fitch Ratings, which has about a 14 percent market share, sometimes is used as an alternative to one of the other majors.

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Credit rating agencies in India

 ONICRA CREDIT RATING AGENCY OF INDIA  CREDIT RATING INFORMATION SERVICES OF INDIA LTD. (CRISL)  INVESTMENT INFORMATION AND CREDIT RATING AGENCY OF INDIA (ICRA)  CREDIT ANALYSIS AND RESEARCH LTD. (CARE)

 DUFF & PHELPS CREDIT RATING INDIA PVT. LTD. (DCR INDIA)

The Determinants of Rating

The default-risk assessment and quality rating assigned to an issue are primarily determined by three factors: i) ii) iii) The issuers ability to pay. The strength of the security owners claim on the issue, and The economic significance of the industry and market place of the issuer. Ratio analysis is used to analyze the present and future earning power of the issuing corporation and to get the insight into the strengths and weaknesses of the firm. Bond rating agencies have suggested guidelines about what value each ratio should have within a particular quality rating. Different ratios are favored by rating agencies. For any given set of ratios, different values are appropriate for each industry. Moreover, the values of every firms ratios vary in a cyclical fashion through the ups and downs of the business cycle. To assess the strength of security owners claim, the protective in the indenture (legal instruments specifying bond owners rights), designed to ensure the safety of bond holders investment, are considered in detail.

P a g e | 19 The factors considered in regard to the economic significance and size of issuer includes: nature of industry in which issuer is operating (specifically issues like position in the economy, life cycle of the industry, labour situation, supply factors, volatility, major vulnerabilities, etc.), and the competition faced by the issuer (market share, technological leadership, production efficiency, financial structure etc.).

Regulatory Framework for CRAs

SEBI guidelines for Credit Rating Agencies General Obligations of Credit Rating Agencies Code of Conduct Every credit rating agency shall abide by the Code of Conduct contained in the Third Schedule. Agreement with the client Every credit rating agency shall enter into a written agreement with each client whose securities it proposes to rate, and every such agreement shall include the following provisions, namely:(a) The rights and liabilities of each party in respect of the rating of securities shall be defined; (b) The fee to be charged by the credit rating agency shall be specified; (c) The client shall agree to a periodic review of the rating by the credit rating agency during the tenure of the rated instrument; (d) The client shall agree to co-operate with the credit rating agency in order to enable the latter to arrive at, and maintain, a true and accurate rating of the clients securities and shall in particular provide to the latter, true, adequate and timely information for the purpose.

P a g e | 20 (e) The credit rating agency shall disclose to the client the rating assigned to the securities of the latter through regular methods of dissemination, irrespective of whether the rating is or is not accepted by the client; (f) The client shall agree to disclose, in the offer document;(i) The rating assigned to the clients listed securities by any credit rating agency during the last three years and (ii) Any rating given in respect of the clients securities by any other credit rating agency, which has not been accepted by the client. (g) The client shall agree to obtain a rating from at least two different rating agencies for any issue of debt securities whose size is equal to or exceeds, rupees one hundred crores. Monitoring of ratings 3. (1) Every credit rating agency shall, during the lifetime of securities rated by it continuously monitor the rating of such securities. (2) Every credit rating agency shall disseminate information regarding newly assigned ratings, and changes in earlier rating promptly through press releases and websites, and, in the case of securities issued by listed companies, such information shall also be provided simultaneously to the concerned regional stock exchange and to all the stock exchanges where the said securities are listed.

Procedure for review of rating 4. (1) Every credit rating agency shall carry out periodic reviews of all published ratings during the lifetime of the securities. (2) If the client does not co-operate with the credit rating agency so as to enable the credit rating agency to comply with its obligations under regulation 15 of this regulation, the credit rating agency shall carry out the review on the basis of the best available information. Provided that if owing to such lack of co-operation, a rating has been based on the best

P a g e | 21 available information, the credit rating agency shall disclose to the investors the fact that the rating is so based. (3) A credit rating agency shall not withdraw a rating so long as the obligations under the security rated by it are outstanding, except where the company whose security is rated is wound up or merged or amalgamated with another company. Internal procedures to be framed 5. Every credit rating agency shall frame appropriate procedures and systems for monitoring the trading of securities by its employees in the securities of its clients, in order to prevent contravention of (a) The Securities and Exchange Board of India (Insider Trading) Regulations, 1992; (b) The Securities and Exchange Board of India (Prohibition of Fraudulent and Unfair Trade Practices relating to the Securities Market) Regulations, 1995; and (c) Other laws relevant to trading of securities. Disclosure of Rating Definitions and Rationale 6. (1) every credit rating agency (a) Shall make public the definitions of the concerned rating, along with the symbol and, (b) Shall also state that the ratings do not constitute recommendations to buy, hold or sell any Securities. (2) Every credit rating agency shall make available to the general public information relating to the rationale of the ratings, which shall cover an analysis of the various factors justifying a favourable assessment, as well as factors constituting a risk. Submission of information to the Board 7. (1) where any information is called for by the Board from a credit rating agency for the purposes of these regulations, including any report relating to its activities, the credit rating agency shall furnish such information to the Board

P a g e | 22 (a) Within a period specified by the Board or (b) If no such period is specified, then within a reasonable time. (2) Every credit rating agency shall, at the close of each accounting period, furnish to the Board copies of its balance sheet and profit and loss account. Compliance with circulars etc., issued by the Board 8. Every credit rating agency shall comply with such guidelines, directives, circulars and instructions as may be issued by the Board from time to time, on the subject of credit rating. 8A. Appointment of Compliance Officer (1) Every credit rating agency shall appoint a compliance officer who shall be responsible for monitoring the compliance of the Act, rules and regulations, notifications, guidelines, instructions etc issued by the Board or the Central Government. (2) The compliance officer shall immediately and independently report to the Board any noncompliance observed by him. Maintenance of Books of Accounts records, etc. 9. Every credit rating agency shall keep and maintain, for a minimum period of five years, the following books of accounts, records and documents, namely: (a) Copy of its balance sheet, as on the end of each accounting period; (b) A copy of its profit and loss account for each accounting period; (c) A copy of the auditors report on its accounts for each accounting period. (d) A copy of the agreement entered into, with each client; (e) Information supplied by each of the clients; (f) Correspondence with each client;

P a g e | 23 (g) Ratings assigned to various securities including up-gradation and down gradation (if any) of the ratings so assigned. (h) Rating notes considered by the rating committee; (i) Record of decisions of the rating committee; (i) Letter assigning rating; (k) Particulars of fees charged for rating and such other records as the Board may specify from time to time. (2) Every credit rating agency shall intimate to the Board the place where the books of account, records and documents required to be maintained under these regulations are being maintained. Steps on auditors report 10. Every credit rating agency shall, within two months from the date of the auditors report, take steps to rectify the deficiencies if any, made out in the auditors report, insofar as they relate to the activity of rating of securities. Confidentiality 11. Every credit rating agency shall treat, as confidential, information supplied to it by the client and no credit rating agency shall disclose the same to any other person, except where such disclosure is required or permitted by under or any law for the time being in force.

Rating process 12. (1) Every credit rating agency shall (a) Specify the rating process; (b) File a copy of the same with the Board for record; and file with the Board any modifications or additions made therein from time to time.

P a g e | 24 (2) Every credit rating agency shall, in all cases, follow a proper rating process. (3) Every credit rating agency shall have professional rating committees, comprising members who are adequately qualified and knowledgeable to assign a rating. (4) All rating decisions, including the decisions regarding changes in rating, shall be taken by the rating committee. (5) Every credit rating agency shall be staffed by analysts qualified to carry out a rating assignment. (6) Every credit rating agency shall inform the Board about new rating instruments or symbols introduced by it. (7) Every credit rating agency, shall, while rating a security, exercise due diligence in order to ensure that the rating given by the credit rating agency is fair and appropriate. (8) A credit rating agency shall not rate securities issued by it. (9) Rating definition, as well as the structure for a particular rating product, shall not be changed by a credit rating agency, without prior information to the Board. (10) A credit rating agency shall disclose to the concerned stock exchange through press release and websites for general investors, the rating assigned to the securities of a client, after periodic review, including changes in rating, if any.

Code of conduct for Credit Rating Agencies (1) A credit rating agency in the conduct of its business shall observe high standards of integrity and fairness in all its dealings with its clients. (2) A credit rating agency shall fulfill its obligations in an ethical manner. (3) A credit rating agency shall render at all times high standards of service, exercise due diligence, ensure proper care and exercise independent professional judgement. It shall wherever necessary, disclose to the clients, possible sources of conflict of duties and interests, while providing unbiased services.

P a g e | 25 (4) The credit rating agency shall avoid any conflict of interest of any member of its rating committee participating in the rating analysis. Any potential conflict of interest shall be disclosed to the client. (5) A credit rating agency shall not indulge in unfair competition nor shall they wean away client of any other rating agency on assurance of higher rating. (6) A credit rating agency shall not make any exaggerated statement, whether oral or written, to the client either about its qualification or its capability to render certain services or its achievements in regard to services rendered to other clients. (7) A credit rating agency shall always endeavor to ensure that all professional dealings are affected in a prompt and efficient manner. (8) A credit rating agency shall not divulge to other clients, press or any other party any confidential information about its client, which has come to its knowledge, without making disclosure to the concerned person of the rated company / client. (9) A credit rating agency shall not make untrue statement or suppress any material fact in any documents, reports, papers or information furnished to the Board or to public or to stock exchange. (10) A credit rating agency shall not generally and particularly in respect of issue of securities rated by it be party to (a) Creation of false market; (b) passing of price sensitive information to brokers, members of the stock exchanges, other players in the capital market or to any other person or take any other action which is unethical or unfair to the investors. (11) A credit rating agency shall maintain an arms length relationship between its credit rating activity and any other activity. (12) A credit rating agency shall abide by the provisions of the Act, regulations and circulars which may be applicable and relevant to the activities carried on by the credit rating agency.

P a g e | 26 [Inserted on 25-9-2001 (11 A) (a) A credit rating agency or any of his employees shall not render, directly or indirectly any investment advice about any security in the publicly accessible media, whether real time or non- real time, unless a disclosure of his interest including long or short position in the said security has been made, while rendering such advice. 3

1.1.5 Types of Credit Rating

There are various types of credit rating. The most common forms of credit ratings are: y y y y y y y Long Term Instrument Rating. Equity Rating. Short Term Instrument Rating. Customers/Borrowers Rating. Sovereign Rating. Individual Rating. Compulsory Rating.

Credit Ratings

Financial Instruments Rating

Customer Rating Sovereign Rating

Borrowers Rating

Individuals Rating

Compulsory Rating

Long Term Instrument

Short Term Instrument Rating

Equity Rating

Figure 1.1: These common forms of credit ratings are shown in the following diagram:4
3

www.icraindia.com/services/inves/sebi.htm, SEBI Guidelines for Rating Agency

P a g e | 27 1. Long Terms Instruments Rating : Long-term instrument rating refers to the rating of bonds, debentures and another long-term debt securities issued by a government or quasi-governmental body. 2. Equity Rating: Equity rating refers to the rating of equity issued in the capital market. The concept of equity rating is still not adopted by the rating agencies in India.

3. Short term Instrument Rating : In this kind of rating we include the rating of commercial papers, short-term public deposits etc.

4.

Customer or Borrower Ratings:

Customer/Borrowers rating require the assessment credit worthiness of the customers to whom the credit sale is being made or grant of loan is under consideration. . Sovereign Rating:

Sovereign rating refers to evaluation of credit worthiness of a country in which investment by a foreign body (foreign Govt. or corporate body) is envisaged or to which a loan is to be given. This kind of rating is generally done by the international rating agencies. The international rating agency standard and poor has improved its outlook on India foreign currency rating to positive from stable but retained the sovereign rating at junk grade due to high public debt and serious fiscal inflexibility.

S&P said the revision reflects Indias improving external liquidity and better prospects for the governments debt burden to stabilize.

S&P had last revised Indias foreign currency outlook from negative to stable in December 2003 on account of improved external finance.5

P a g e | 28 6. Individuals Rating:

Rating of individuals is called as individuals credit rating.

7.

Compulsory Rating:

The rating at which the government bound the obligation is called the compulsory rating like commercial papers etc.

Following on the rating change, criticism of ratings per se has been in some evidence. One, that sovereign ratings have not been a good predictor of currency crisis, basically a reference to Asian difficulties in 1997-98. The principal problem of the Asian miracle was regulatory weakness, with large gaps in what the central banks knew about the external liabilities of their domestic banks, and rating agencies were affected by the same information lapses. Second, till this crisis, mainstream economic theory, had oversimplified the process by which capital flows occur. The received wisdom in the mid-nineties had little space for the singularity of large currency crises and contagion.

Importance of Credit Rating

In todays changing scenario where corporates are increasingly dependent on the public credit rating, which provides an unbiased judgment to the general public has emerged as a critical element in the functioning of Indian financial market.

A rating published by a rating agency provides superior information to various groups, which is not publicity available. Credit rating provides several benefits to different sections of people that are summarized as follow:

1. Benefits to the Investors: - Provides cost-effective and reliable information. - Investor can evaluate risk-return trade off on the basis of rating. - Provides investor with an insight of risk involved in an investment. 2. Benefits to the company: - A company with high credit rating can mobilize large amount of funds.

P a g e | 29 - High credit rating indicates less associated with security. So, the company with high credit rating can lower its cost of borrowing. - High credit rating helps companies to build its image among customers, lenders and creditors. 3. Benefits to brokers and financial intermediaries: - Brokers can convince clients to put money in investments with high credit rating. -Financial intermediaries such as banks can be assured of their investing in a company.

Approaches of Credit Rating Agencies

Rating related products and activities CRAs in India rate a large number of financial products: 1. Bonds/ debentures- [the main product]. 2. Commercial paper. 3. Structured finance products. 4. Bank loans. 5. Fixed deposits and bank certificate of deposits. 6. Mutual fund debt schemes. 7. Initial Public Offers (IPOs). CRAs also undertake customized credit research of a number of borrowers in a credit portfolio, for the use of the lender. CRAs use their understanding of companies business and operations and their expertise in building frameworks for relative evaluation, which are then applied to arrive at performance grading. For example, developer gradings are carried out to assess the ability of the developers to execute projects on a timely basis and promised quality while maritime institute gradings are carried out to assess quality of education imparted to the students vis a vis DGS (Directorate General of Shipping) objectives.

P a g e | 30 Non-rating related activities CRAs often undertake a variety of non rating related activities. These include the following:

1. Economy and Company Research: Some Indian CRAs have set up research arms to complement their rating activities. These arms carry out research on the economy, industries and specific companies, and make the same available to external subscribers for a fee. In addition, they disseminate opinions on the performance of the economy or specific industries, available through releases to the media. The research would also be used internally by the rating agencies for arriving at their rating opinions. SEBI permits CRAs to carry out this activity subject to relevant firewalls.

2. Risk consulting: There is considerable demand for tools and products that will allow banks to compute their capital adequacy ratios under the revised guidelines. The risk consulting groups of credit rating agencies would leverage the agencies understanding of credit risk to develop and provide the tools and data that banks would require. The products in this area include tools for internal ratings, operational risk evaluation, and overall capital calculation.

3. Funds research: Some CRAs have diversified from mutual fund ratings into mutual fund research. The services that are available under this head include fund rankings, performance attribution tools (to help users understand the reasons for funds performance), desktop tools, and fixed income research.

4. Advisory services: CRAs offer various kinds of advisory services, usually through dedicated advisory arms. Most of this is in the nature of developing policy frameworks, bid process management, public private partnership consulting, and creating an enabling environment for business in India and globally.

5. Knowledge Process Outsourcing:

P a g e | 31 Some Indian CRAs (CRISIL and ICRA) have KPO arms that leverage their analytical skills and other process and manpower capabilities. These arms provide services to the CRAs affiliates in developed markets, and also to other clients outside India. 6

Rating symbols and their definations

AAA - 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.

AA - 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.

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

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

Ministry of Finance Capital market division, p17-18

P a g e | 32 BB - Instruments with this rating are considered to have moderate risk of default regarding timely servicing of financial obligations. B - Instruments with this rating are considered to have high risk of default regarding timely servicing of financial obligations.

C - Instruments with this rating are considered to have very high risk of default regarding timely servicing of financial obligations.

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

Modifiers {"+" (plus) / "-"(minus)} can be used with the rating symbols for the categories AA to C. The modifiers reflect the comparative standing within the category.

Credit Rating Agencies in India

In India, the credit rating agencies are governed by the SEBI Regulations, 1999 and the SEBI (Amendment) Regulations, 2003. Accordingly, anybody corporate that is engaged in or proposes to be engaged in the business of rating of securities has to obtain a certificate of registration from the SEBI and comply with the provisions of the Act.

Further, according to the SEBI (Disclosure and Investor Protection) Guidelines, 2000, a company offering convertible/non-convertible debt instruments through an offer document must comply with the requirements of credit rating. The provisions are as follows:  No public or rights issue of debt instruments including convertible instruments in respect of their maturity or conversion period shall be made unless credit rating agency has been obtained and disclosed in the offer document.  For a public/rights issue of debt security greater than or to Rs 1 billion, two ratings from two different credit rating agencies shall be obtained.  In cases where credit rating is obtained from more than one credit rating agency, all the credit rating/s, including the unaccepted credit ratings, shall be disclosed.

P a g e | 33  All the credit ratings obtained during the three years preceding the public or rights issue of debt instrument (including convertible instruments) for any listed security of the issuer company shall be disclosed in the offer document.  The progressive liberalization of economic policies, which led to the establishment of new projects and corporate sectors increasing dependence on primary market for raising funds, highlighted the need for setting up a credit rating agency in India.  During this period primary as well as secondary market witnessed a phenomenal growth. So in order to provide unbiased assessment of the credit worthiness of companies issuing debt instrument. The first credit rating agency (CRISIL) was established in1987 and it started its operations in 1888. In response to the ever-increasing role of credit rating, two more agencies were not up in 1990 (ICRA) and 1993 (CARE) respectively.

Today, following are the credit rating agencies functioning in India:

1. Credit Rating Information Service of India Ltd. (CRISIL) 2. Investment Information and Credit Rating Agency. (ICRA) 3. Credit Analysis and Research Ltd. (CARE) 4. Duff and Phelps Credit rating Pvt. Ltd. 5. Brickwork Ratings.

Credit Rating and Information services of India Limited (CRISIL)

The Credit Rating Information Service of India Ltd. (CRISIL) was established in 1987 jointly by the ICICI Ltd and the UTI. Other shareholders include the Asian Development Bank Life Insurance Corporation of India, HDFC Ltd., General Insurance Corporation of India and several foreign and India banks. CRISIL is Indias premier credit rating agency and ranks amongst the top five in the world.

It commenced its operation in January 1998. In 1996 CRISIL forged a strategic business alliance with Standard and Poor with purpose to drive benefits such as international

P a g e | 34 experience revamping of operating systems, introduction of value added methodologies in new areas and assist the client-companies in raising funds across the country. CRISILs core competencies are in the areas of risk identification, classification and assessment.

Credit Rating and Information Services of India Ltd (CRISIL) is one of the country's top research, rating, risk and Policy Advisory Company Known for its analytical rigor and credibility, CRISIL aims to enable the market function in a better way. It also helps its customers and clients with managing their financial risks and business properly. Major shares of the company are held by Standard & Poor, a division of the McGraw-Hill Companies. Standard & Poor is, indeed, the world's first company to provide financial market intelligence. On 14th August 2008 in Mumbai, CRISIL ascribed ratings to several bank services such as cash credit, term loan, bill discounting and bank guarantee of Global Coal and Mining Private Limited (GCMPL) as 'A/Stable/P2+'. It expects that company would maintain healthy credits on the basis of sound cash accruals. Besides, on the same day, CRISIL also allotted a rating of 'AAA(so)' to the receiver's payout in business dealing with Cholamandalam DBS Finance Ltd. CRISIL was set up with a basic purpose to rate debt obligations, which would guide investors as to the risk of timely payment of interest and principle. At present, functions performed by CRISIL fall under three board categories:1. Credit Rating Services. 2. Advisory Services. 3. Research and Information Services. 4. CRISIL.com Ltd. 5. Credibility First (CF). 6. Global Data Services. 7. CRISIL Training Services. 8. CRIS.

1. Credit Rating Services: -

P a g e | 35 The principle function of CRISIL is to rate mandated debt obligations of Indian Companies, chit funds, real estate developers, non-banking finance companies, and Indian States and so on. It is the core business of CRISIL while new business has begun to make a moderate contribution, which is about 80% to the revenue. Being a pioneer in credit rating business in India, the rating agency ranks amongst the top five in the world.

A CRISIL rating reflects CRISIL's 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.

So far, CRISIL has rated 30,000 debt instruments, covering the entire debt market. The debt obligations rated by CRISIL include:

 Non-convertible debentures/bonds/preference shares.  Commercial papers/certificates of deposits/short-term debt.  Fixed deposits.  Loans.  Structured debt.

CRISIL Ratings' clientele includes all the industry majors - 23 of the BSE Sensex constituent companies and 39 of the NSE Nifty constituent companies, accounting for 80 per cent of the equity market capitalization, are CRISIL's clients.

Following functions has been included in the rating services by CRISIL: -Rating the debt obligations -Rating of structural obligations ` -Rating of real estate developers projects

P a g e | 36 -bond fund rating -Rating of collective investment schemes. 2. CRISIL Advisory Service: CRISIL Advisory Services for consultancy services to various state Government, Disinvestments Commission on disinvestments plan for public sector enterprise, major port authorities, and state Electricity Boards and so on. Other clients availing of advisory services from CRISIL are the Public sector enterprises, banks and financial institutions and instigating risk. It also formulates and executes strategies for that.

CRISIL Infrastructure Advisory: It provides policy, regulatory and transaction level advice to governments and leading organizations across sectors.

Investment and Risk Management Services: CRISIL Risk Solutions offers integrated risk management solutions and advice to Banks and Corporate by leveraging the experience and skills of CRISIL in the areas of credit and market risk.

3. CRISIL Research and Information Services: CRISIL Research and Information Services include value-added research activities and customized studies in following areas: -Indian Capital Market. -Indian Industries, and -Indian Corporate Sector.

Following are the services, which are included in CRISIL: A. CRISIL Sector Wise. B. CRISIL View. C. International Information Vending.CRISIL Index Services.

P a g e | 37

4. CRISIL.com Ltd.:The internets ability to inform, educate, interact and customize is unlimited. CRISIL has recognized this medium as opportunity to widen and deepen its customer reach in its existing and new segments, create value added content and deliver it to new market segments. CRISIL has transferred its internet business to CRISIL.com a wholly owned subsidiary in order to give it the required focus. CRISIL.com leverages CRISILs existing competencies, resources and credibility and positions itself as an important resource center for authentic information and a valuable decision support system. It works for increased penetration, exclusive and superior content and increased market exposure.

The CPR rankings and popularity index are covered each quarter. CRISIL.com is also pursuing strategic Alliances/ tie-ups for creating rich contents and value added products aimed at meeting the research and information needs of business and investment decision makers.

5.

Credibility-First (CF):Credibility First provides rating and evaluation services across the cross-section of

the Indian economy. While, CRISILs rating division focuses on top-ended corporate, especially in the small sized sector, where information is not easily available. CF provides its services to banks, financial institutions, B2B exchanges, yellow page directories and business counterparts.

CF provides the following services: 1. Verification Services. 2. Certification Services. 3. Rating Services.

P a g e | 38 CF verification services are a pre-requisite for corporate to list on some major B2B exchanges. CF is positioning this service as a national standard for listing on any domestic exchange. CF Certification Services help merchants to communicate their business strength to the potential buyers. These certifications would help buyers short-list suppliers from a number of similar suppliers.

CF Rating Services are aimed at corporate to help them establish credibility in trade and financial transactions. These ratings facilitate the corporate business transactions and financial transactions.

6. Global Data Services:The Global Data Services of India Ltd. is a 100% subsidiary of CRISIL. It has been formed with a view to using the existing strengths and resources of CRISIL to provide high quality, reliable and timely financial analysis of Indian corporate, covering more than 1500 of the largest companies listed on the Indian stock exchanges. This list is gradually expanded. The data is provided both, online and offline

It also provides data entry services and offers to maintain financial updates of credit and investment portfolios of clients. This service is especially useful to institutional investors, capital market intermediateries, banks and financial institutions, mutual funds, provident funds and high net worth individual investors including NRIs.

7.

CRISIL Training Services:CRISIL provides a wide spectrum of training programmes, including the tailor- made

ones, to meet the specific needs of various agencies and individuals connected with credit as well as investments. Programmes are specially designed for professionals whose business necessitates assessment of credit and investment risk. The programmes are especially useful for credit analysts, lending and investment officers of banks and financial institutions, portfolio managers and debt market traders, corporate treasurers and finance managers. Other

P a g e | 39 training programme have been designed for business strategists including entrepreneurs and company executives, faculty of educational institutions individual investors and students. At present, all training programme are available only offline, in various cities of India.7

CRISIL RATING SYMBOLS CRISIL assigns ratings only to rupee denominated debt instruments. These symbols are symbolic expression of opinion/assessment of the credit rating agency. Here is a brief summary of CRISILs rating symbols used for the rating of: 1. Debenture. 2. Fixed Deposits. 3. Short Term Instruments. 4. Structured Obligations. 5. Foreign Structured Obligations. 6. Instrument Carrying Non-credit Risk. 7. Financial Strength ratings of insurance companies. 8. Debt Fund Portfolio 9. Real Estate Projects. 10. Government and Creation Ratings
instrument High invest Grade Highest Safety High Safety Investment Grade Adequate Safety Moderate Safety Speculative Grade Inadequate Safety High Risk Substantial Risk Default

P a g e | 40

Debentures Fixed Deposits

AAA FAAA

AA FAA

A FA

BBB

BB FB

B FC

D FD

Short Term Instrument

P1

P2

P3

P4

P5

Structured Obligations

AAA(so)

AA(so)

A(so)

BBB(so)

BB(so)

B(so)

C(so)

D(so)

Foreign Structured Obligations Debt Funds Portfolio

AAA(FSo)

AA(FSo)

A(FSo)

BBB(FSo)

BB(FSo)

B(FSo)

C(FSo)

D(Fso)

AAAf

AAf

Af

BBBf

BBf

Cf

Instrument Carrying Non Credit Risk

AAAr

AAr

Ar

BBBr

BBr

Br

Cr

Dr

Rating of Insurance Companies

AAA

AA

BBB

BB

Debt Fund Portfolio

AAAf

AAf

Af

BBBf

BBf

Cf

Real Estate Projects

PA1

PA2

PA3

Source: Credit Rating Information Service of India

Note:-CRISIL may apply +or -signs for ratings with rating symbols to reflect comparative standing within the category.8

P a g e | 41 CRISIL places ratings of MFIs on Rating watch with negative Implications

CRISIL has placed its outstanding ratings on the debt instruments of 12 micro-finance institutions (MFIs) on Rating watch with negative implications. Six of these MFIs have ratings that are in the BB category or below. The implementation of the Andhra Pradesh (Andhra) ordinance has triggered a chain of events that can permanently damage the business models of MFIs, by impairing their growth, asset quality, profitability and capital raising ability. The Rs. 250 billion (as on 31st March 2010) microfinance plays an important role in extending formal financial services to 28 million of Indias under-served rural poor; with the decline of the sector, the flow of credit to this segment of the population will be curtailed.

The Andhra ordinance has been highly unfavorable for the industry resulting in a precipitous drop in the collection efficiency and profitability of MFIs, especially those operating in Andhra. Further, the flow of funding to the entire sector from the banking system has been severely constrained. Consequently, the liquidity position and growth prospects of many MFIs, including those operating outside Andhra Pradesh have been affected. Structurally, the regulatory jurisdiction and framework for MFIs remain unclear, with actions by multiple authorities increasing the challenges for the industry. Unless urgent steps, including regulatory intervention, are taken to address these issues, these developments have a potential to materially weaken the business and financial risk profiles of MFIs and result in rating downgrades. The impact on the credit worthiness of the individual entities will differ depending to their exposure to Andhra, their liquidity and their ability to raise the capital from alternate sources. CRISIL will actively monitor the developments in the sector and take appropriate rating actions.

Another risk is that other states may initiate state- level legislation similar to the Andhra ordinance. Moreover, the regulatory environment for the sector could evolve further after the decision of Andhra Pradesh High Court, recommendations of the Malegam committee instituted by the Reserve Bank of India (RBI), any potential changes in RBI norms related to priority sector funding to the sector, and provisions of the microfinance bill proposed by the Ministry of Finance. CRISIL has consistently highlighted that as an emerging sector, the MFI industry is exposed to the risk of changes in the political, legislative, and regulatory environment. Some of these risks are now becoming evident.

P a g e | 42 Collections in Andhra have plummeted below 20 per cent, from nearly 99 per cent prior to the ordinance, with MFIs finding it difficult to make contact with borrower groups, and having to move to a monthly repayment cycle in line with the ordinance. Fresh disbursements in Andhra have been negligible over the past few weeks. CRISIL believes that this would lead to a sharp increase in delinquencies for MFIs that have significant Andhra exposure. So far, MFIs with limited or no Andhra presence have maintained good collection levels, though their disbursement growth has reduced sharply.

MFIs ability to raise external funding is correctly significantly constrained. Access to fresh loans from banks and institutions, which form a significantly proportion of the sectors total funding, has dropped materially. Reduced access to funding not only affects MFIs liquidity- and, consequently, their ability to service debt- but also limits their fresh disbursements, which can have a cascading effect on their growth and asset quality in the near term. It is possible that bank funding to the sector will resume later, but the timing and extent of such funding are uncertain. In addition, the quality of the banks exposure to this sector could weaken from the current strong levels.

CRISIL also rates nine securitization transactions originated by MFIs. Only two of these transactions have some exposure to loans originated in Andhra Pradesh. The collection performance of all rated pools remained strong until recently. The credit enhancements and the structural features currently protect investor payouts from any potential increase in delinquencies, and are consistent with the outstanding ratings. CRISIL will continue to monitor the performance of these pools regularly, and will take appropriate rating actions in case collections drop significantly. 9

Name
Asmitha Microfin Limited

Rating Action
BBB(Placed on Rating Watch with Negative implications)

Bhartiya Samruddhi Finance Limited

BBB (Placed on Rating Watch with Negative implications)

Digamber Capfin Limited

B+(Placed on Rating Watch with Negative implications)

Equitas Micro Finance India Private Limited

BBB(Placed on Rating Watch with Negative

P a g e | 43
implications) Grameen Financial Services Private Limited P4+(Placed on Rating Watch with Negative implications) Sanghamithra Rural Financial Services BB(Placed on Rating Watch with Negative implications) Shri Kshetra Dharmasthala Rural Development Project (R.) SKS Microfinance Limited BB+(Placed on Rating Watch with Negative implications) P1+(Placed on Rating Watch with Negative implications) South Sundarban Janakalyan Sangha B+(Placed on Rating Watch with Negative implications) Spandana Sphoorty Financial Limited A-/P1(Placed on Rating Watch with Negative implications) Ujjiven Financial Services Private Limited BBB-(Placed on Rating Watch with Negative implications) Vedika Credit Capital Limited B+(Placed on Rating Watch with Negative implications)

Table No. 1.2: CRISIL s Ratings of MFI s on Rating watch with negative Implications
Name
Asmitha Microfin Limited

Rating Action
BBB(Placed on Rating Watch with Negative implications)

Bhartiya Samruddhi Finance Limited

BBB (Placed on Rating Watch with Negative implications)

Digamber Capfin Limited

B+(Placed on Rating Watch with Negative implications)

Equitas Micro Finance India Private Limited

BBB(Placed on Rating Watch with Negative implications)

Grameen Financial Services Private Limited

P4+(Placed on Rating Watch with Negative implications)

Sanghamithra Rural Financial Services

BB(Placed on Rating Watch with Negative implications)

Shri Kshetra Dharmasthala Rural Development Project (R.) SKS Microfinance Limited

BB+(Placed on Rating Watch with Negative implications) P1+(Placed on Rating Watch with Negative implications)

P a g e | 44
South Sundarban Janakalyan Sangha B+(Placed on Rating Watch with Negative implications) Spandana Sphoorty Financial Limited A-/P1(Placed on Rating Watch with Negative implications) Ujjiven Financial Services Private Limited BBB-(Placed on Rating Watch with Negative implications) Vedika Credit Capital Limited B+(Placed on Rating Watch with Negative implications) Source: Credit rating and information services of India ltd.

Investment Information and Credit Rating Agency of India Limited (ICRA) Established in 1991, ICRA limited is a leading provider of investment information and credit rating services in India. Promoted by the countrys leading financial institutions, banks and financial services companies, ICRA has, so far, completed nearly 1,800 assignments including credit ratings, equity ratings, customized research and need-based advisory assignments. It has a team of over 100 analysts across nine locations in India, and is a prominent player in the financial services sector.

Committed to the development of the financial market in India, ICRA is focusing on developing innovative concepts and products in a dynamic market environment, generating wider investor education, and enhancing the efficiency and transparency of the financial markets. Completing its rating and advisory functions, ICRAs Research and information services are directed towards the efficient dissemination of information, thus ensuring the highest standards of quality and credibility.

The growth and globalization of Indian capital markets has led to an exponential surge in demand for a professional credit risk analysis. ICRA has actively responded to this need by executing assignments including credit ratings, equity grading and mandated studies spanning diverse industrial sectors. In addition to being a leading credit rating agency with expertise in virtually every sector of the Indian economy, ICRA has broadened its services to the corporate and financial sectors, both in India and overseas.

ICRA presently offers its services under these banners namely Information services, grading services, rating services and advisory services.

P a g e | 45 1. Information Services: The ICRA, in a way, is a culmination of the efforts of ICRA Information services; a division that has evolved out of the core strengths of ICRA Limited in business and financial analysis to service the unique information needs of investors and the capital markets community.

ICRAs Information Services endeavors to constantly upgrade its products and introduce new ones in cognizance of the dynamic and evolving nature of the Indian business environment. This is done for the purpose of helping sustain its pre - eminence as a quality provider of credible, value-added information services, to market participants, both Indian and Foreign. ICRA Information Services has built up a diverse portfolio of publications in response to the increasing market requirements for value-added information and analysis. These include:

1. ICRA corporate review (ICR): This is designed to serve as a first level information resource for the market community.

2. Corporate reports: This is designed to present extensive information along with an analysis on selected India corporate entities. The critic in the corporate reports incorporates business, industry, market and financial and operational analysis.

3. Industry and sector research reports: These focuses on specific industries like steel, cement, tea and cotton yarn. These reports are targeted at institutional investors, practitioners in the area of financial services and decision makers in corporate world.

4. Money and finance bulletin: Complementing the research on industrial sectors is another ICRA research team engaged in the analysis of contemporary developments that characterizes the Indian money and finance sector. The product of this exercise is the quarterly publication titled money and

P a g e | 46 finance bulletin. This bulletin is directed towards individuals interested in delving into the reasons underlying economic and fiscal policy initiative and outcome.

5. Rating profile: The standard reference material for all players in the Indian credit market is the rating profile, currently a quarterly brought out by ICRA Information Services, is a compilation of the rationale of that ratings awarded by ICRA. The rating profile contains the ratings that are in use, the rationales for the ratings assigned, as well as the rating symbols and their implications. 6. Customized studies: The customized studies, which also belong to the portfolio of ICRA Information Services, cover due diligence studies, equity assessments, group assessments, industry analysis and market studies. Such studies, the rising demand for which are being driven by increasing cross-border activities, complexity and volatility, are conducted on an assignment basis, and provide need-based information in the areas mentioned. Needless to say, they go a long way in enhancing investment decision.

2. Grading Services: ICRAs grading services are structured to provide authentic information on relating quality of equity in diverse corporates. The relating quality of equity of company, its growth, stability and composition of earnings are assessed, by analyzing the underlying fundamentals that will affect the companys future performance over the medium term. A complex combination of variables is examined including, industrial outlook, quality of management, financial strength, corporate operations, competitive strength and outlook. The range of grading services include: equity grading, equity assessment and Earning Prospects and Risk Analysis (EPRA)

3. Rating Services: As an early entrant in the credit rating business, ICRA is one of the most experienced credit rating agencies in India today. ICRA rates rupee dominated debt instruments such as: 1. Bonds and debentures (long-term). 2. Fixed deposit programme (medium-term). 3. Commercial papers and certificates of deposit (short-term).

P a g e | 47 4. Structured obligations and sector specific debt obligations (issued by infrastructure companies).

The ICRA rating is a symbolic indicator of the current opinion of the relative capability of timely servicing of debts and obligation by the corporate entity with reference to the instrument being rated. The rating is based on an objective analysis of the information and clarifications obtained from the enterprises and also other sources, which are considered by ICRA to be reliable. The independence and professional approach of ICRA ensures reliable, consistent and unbiased ratings. Ratings facilitate investors to factor credit risk in their investment decision. ICRA rates long-term, medium-term and short-term debt instruments. ICRA offers its rating services to wide range of issuers including: 1. Manufacturing Companies. 2. Banks and financial institutions. 3. Power companies. 4. Service companies. 5. Construction companies. 6. Insurance companies. 7. Municipal and other local bodies. 8. Non-banking financial service companies. 9. Telecom companies. 10. Companies involved in infrastructure such as ports, dams, roads and highways.

4. Advisory Services: ICRAs foray into advisory services represents an organic growth of the cumulative expertise built by ICRA in different industries and sector. The main drive for ICRAs advisory services has been the growing needs in India for an unbiased and professional view on adopting the best business practices, against the backdrop of economic deregulation and increasing competition.

With its extensive knowledge, bank of business and management practices spanning the major sectors of the Indian economy and as a repository of high quality analytical talent, ICRA is well positioned to extend advisory services to different Indian organizations, regulatory authorities and other organizations having business interest in India.

P a g e | 48 ICRA advisory services offers independent, objective and high quality consulting services to organizations with an interest in India, with the fundamental aim of improving the quality of decision making. It is active in the following areas: 1. Strategic Consultancy. 2. Risk Management. 3. Inputs for Policy Formulation.10 Strategy Consulting: This comprises the following: y y y y y y Assisting in the goal setting process. Improving competitiveness. Mergers, Acquisitions and growth strategies. Improving organizational capabilities. Organizational Restructuring. Financial Strategy and systems.

Risk management: This comprising the following: y y y y y Assisting project risks for investors/developers/lenders. Project structuring and financial modeling. Structuring payment mechanisms. Building organizational skills in credit risk management for banks and lenders. Risk audit studies.

Policy Formulation: This includes the following: y y y y y y y Deregulation and privatization studies. Pricing of public goods. Subsidies Concessions. Guarantees management. Fiscal studies. Preparation of license agreements and documents for large projects.

P a g e | 49

ICRA Rating Symbols The ICRA rating is a symbolic indicator of the current opinion of the relative capability of timely servicing of the debt obligations. ICRA rates long term, medium term and short-term debt instruments.

Following is a brief summary of the rating symbols used by ICRA for the following: y y y y Long Term Instruments (Debentures Bonds, Preference Shares) Collative Investment Schemes. Rating of Insurance Companies. Corp. Governance Rating.

Table 1.3: ICRAs Rating Symbols Chart

Instruments Highest Safety High Safety Adequate Safety

SYMBOLS Moderate Safety Inadequate Safety High Risk Risk Substantia l Default

P a g e | 50

Long Term LAAA Instruments Medium Term Debt MAAA

LAA

LA

LBBB

LBB

LB

LC

LD

MAA

MA

MB

MC

MD

Short Term A1 Instruments

A2

A3

A4

A5

Collective Instrument Schemes

CS1

CS2

CS3

CS4

CS5

CARE5

Insurance Companies

iAAA

iAA

iA

iBBB

iBB

iB

iC

Corporate Governance

CGR1

CGR2

CGR3

CGR4

CGR5

CGR6

Source: Investment Information and Credit Rating Agency of India Limited.

Note: - The Suffix of + or -may be used with rating symbols to indicate the comparative position within the group covered by the symbols. Knowledge Process Outsourcing and Online Software ICRA Online Limited (ICRON) is a wholly-owned subsidiary of ICRA Limited. ICRON was incorporated in January 1999 and has over the period since then established itself as an independent and credible source of authentic information, software and outsourcing solutions provider.

P a g e | 51 ICRON caters for some of the biggest names in the financial services sector in India and abroad, which is a testimony to its product quality, commitment and credibility. ICRON has two Strategic Business Units (SBUs) with a list of reputed global and domestic clients:  The Knowledge Process Outsourcing Division (KPO Division); and  The Information Services and Technology Solutions Division (MFI Division). Encouraged by the emerging dynamics of the outsourcing business, ICRON diversified into the Knowledge Process Outsourcing (KPO) business in April 2004, with focus on the Banking, Financial Services and Insurance (BFSI) vertical as well as other verticals like Retail, Healthcare and Pharmaceuticals.

The KPO Division of ICRON offers Knowledge Process Outsourcing services that combine advanced analytical abilities and deep domain expertise to deliver value by translating data and information into structured business inputs. It provides back-end analytical services support to its clients in the areas of Data Extraction, Aggregation, Validation and Analysis, Accounting and Finance, Research, Report Preparation and Modeling. The Division has attained ISO 27001 certification through rigorous adherence to data security policies and practices.

The MFI Division serves the Mutual Fund Industry through Research, Analytics and Mutual Fund Ranking. Besides, it leverages its domain expertise to deliver high quality technology solutions, in the form of products, to a large number of Banks, Mutual Funds, Financial Institutions, Third Party Products Distributors, Insurance Companies, Investment Advisors, Portfolio Managers, Stock Brokers, Treasury Managers, and Academic Institutions, among others. The Company has developed several innovative products to meet the varied needs of its clients. The products are customized to meet specific client requirements, enabling them in research, analysis and decision making while also helping them achieve automation in business operations.

ICRON has a wholly-owned subsidiary M-Serve Business Solutions Private Limited, a KPO Services Company headquartered in Kolkata, India.

P a g e | 52 ICRA assigns equity grading to Havells India Limited

ICRA online has assigned the fundamental 4 and the valuation grade B to Havells India Limited (Havells). The fundamental grade 4 assigned to Havells implies that the company has strong fundamentals to other listed securities in India. The grade factors in Havells diversified product portfolio with core focus on the fast growing consumer goods sector, its effective marketing and distribution reach that supports premium pricing, and the significant growth potential of its subsidiary, Sylvania. The grade also takes note of the intense competition that Havells faces across the segments it operates in. The valuation Grade B assigned to Havells implies that the company is moderately undervalued on a relative basis (as on the date of the grading assigned).

An ICRA Equity Research assessment, while not specifying any target price for the shares evaluated, captures two key factors: fundamental earning quality (fundamental grade) and relative valuation (valuation grade)- that influence the price behaviour of equity shares of companies over the medium and long term. The fundamental grades are on five- point scale, with 5 being the highest grade and 1 the lowest. Similarly, valuation grades are also on five-point scale, wherein A being the significantly undervalued and E the significantly overvalued.11

1.1.8.3 Credit analysis and research Ltd (CARE) Credit analysis and research Ltd. was promoted by IDBI jointly with financial institution, banks and private finance companies. It started its operation in 1993 and now it offers a wide range of products and services in the field of credit information and equity research.

CARE Ratings is well equipped to rate all types of debt instruments like Commercial Paper, Fixed Deposit, Bonds, Debentures, Hybrid instruments, Structured Obligations, Preference Shares, Loans, Asset Backed Securities(ABS), Residential Mortgage Backed

P a g e | 53 securities (RMBS) etc .

CARE Ratings has been recognized by statutory authorities and other agencies in India for rating services. The authorities/agencies include: Securities and Exchange Board of India (SEBI), Reserve Bank of India (RBI), Director General, Shipping and Ministry of Petroleum and Natural Gas (MOPNG), Government of India (GOI), National Housing Bank (NHB), National Bank for Agriculture and Rural development (NABARD), National Small Scale Industries Commission (NSIC). CARE Ratings has also been recognized by RBI as an Eligible Credit Rating Agency (ECRA) for Basel II implementation in India .

CARE Ratings has significant presence in all sectors including Banks / FIs, Corporate, Public finance. Coverage of CARE Ratings has extended to more than 2811 entities over the past decade and is widely accepted by investors, issuers and other market participants. CARE Ratings have evolved into a valuable tool for credit risk assessment for institutional and other investors, and over the years CARE has increasingly become a preferred rating agency .

CAREs Credit Rating is an opinion on the relative ability and willingness of an issuer to make timely payments on specific debt or related obligations over the life of the instrument. CARE rates rupee denominated debt of Indian companies and Indian subsidiaries of multinational companies. CARE ratings are not recommendations to buy/sell or hold any security.

These services are categorized into the following categories:i. ii. iii. Credit Rating Services. Information Services. Equity Research.

i. Credit Rating Services:CARE rates all types of debt instruments including long term. It is the core business of this rating agency.

ii. Information Services:-

P a g e | 54 Like CRISIL and ICRA. It also provides information services to various players in the financial market. It provides information on any company, industry or sector to individuals, mutual funds, and investment companies. So that they can take well informed investment decision.

iii. Equity Research:Equity Research involves extensive study of the shares listed or which are going to be listed on stock exchange and forecasts Potential looser and winner on the basis of this study. For this purpose, it analyzes all the fundamentals affecting the industry, market share, management capabilities etc.

Apart from basic services, CARE also provides some other services like: y y CARE Loan Rating Credit Analysis Rating etc.

Table 1.4: Rating Experience: (As at March 2010) Total Assignments Completed Total Instruments Rated Total Volume of Debt Rated Total Issuers Rated
Source: Credit Analysis and Research Ltd.

8488

7989 Rs.26609 billion 3071

Table 1.5: CAREs Rating Symbols Chart Instrume nts Highest Safety High Safety Adequate Safety SYMBOLS

Moderat e Safety

Inadequate Safety

High Risk

Substantial Defaul t Risk

P a g e | 55

Long Term& Medium Term Instrume nts Short Term Instrume nts

CAREAA A

CAREA A

CAREA

CAREBBB

CAREBB

CARE B

CAREC

CARED

PR1

PR2

PR3

PR4

PR5

Credit Analysis Rating

CARE1

CARE2

CARE3

CARE4

CARE5

Long Term Loans

CAREAA A (L)

CAREA A (L)

CAREA (L)

CAREBBB (L)

CAREBB (L)

CARE B(L)

CAREC (L)

CAREC (L)

Short Term Loans

PL1

PL2

PL3

PL4

PL5

Collectiv e Investme nt Schemes

CARE1 (CIS)

CARE2 (CIS)

CARE3 (CIS)

CARE4 (CIS)

CARE5 (CIS)

Source: Credit Analysis and Research Limited

P a g e | 56 NOTE: CARE may assign + or -signs after the assigned rating, where necessary, to indicate the relative position within the brand covered by the symbol.12

1.1.8.4 Duff and Phelps Pvt. Ltd. Duff & Phelps was founded in 1932 to provide high quality investment research services focused on the utility industry. Over the decades, it evolved into a diversified financial services firm that provides financial advisory, investment banking, credit rating and investment management services. The investment management and credit rating businesses were acquired by Virtus Investment Partners and Fitch, respectively. The firms current management team acquired Duff & Phelps financial advisory and investment banking business in 2004. The following year, Duff & Phelps strengthened its valuation capabilities with the acquisition of Standard & Poor's Corporate Value Consulting business. Since then, Duff & Phelps has continued to expand and develop its core services. In 2006, it acquired specialty investment bank Chanin Capital Partners, LLC. The following year, it formed a strategic alliance with Tokyo-based Shinsei Bank, Ltd. and added property tax management services through the acquisition of Rash and Associates, LP to complement its tax business. In 2008, it grew its dispute and legal management consulting services with the acquisitions of Dubinsky & Company, P.C. and Lumin Expert Group. It also enhanced its valuation offerings by acquiring Kane Reece Associates, Inc., a valuation consulting firm that specializes in the communications, entertainment and media industries.

In 2010, Duff & Phelps established a presence in Canada and continued to expand its dispute consulting, valuation and corporate advisory services with the acquisition of Cole & Partners, a Toronto-based independent financial advisory practice. Key Facts:
y y y

NYSE-listed company since 2007. Headquartered in New York City. Offices in North America, Europe and Asia.

P a g e | 57
y

Primary services are valuation, investment banking, transaction advisory, dispute, legal management consulting and tax. 13

1.1.8.5 Brickwork Ratings

Brickwork Ratings is a Bangalore-based company incorporated in 2007 with the mission of providing unbiased information to Indian investors for making better investment decisions. Mr. Balasubramanian, Mr. Vivek Kulkarni and Mr. Ravishankar are the founder directors of Brickwork Ratings. Mr. Balasubramanian is the former Chairman of SIDBI and a pioneer in the banking industry. He was instrumental in setting up of SMERA an SME rating agency. He has tremendous credit experience with the Bank of Baroda. Mr. Ravishankar is a financial professional with a rich experience of over 25 years in BFSI segment. He was Managing Director of Asia-Pacific Risk Solutions business of Standard and Poor's .

The initial concept of Brickwork Ratings was conceived by Mr. Vivek Kulkarni after the success of providing high-end financial services to the global market through Brickwork India Pvt. Ltd. a knowledge process outsourcing company.

Brickwork Ratings, a SEBI licensed credit rating agency, founded by bankers, credit rating professionals, former regulators as well as professors, is committed to promoting Financial Literacy, having its corporate office in Bangalore and branches at New Delhi, Mumbai, Chennai, Hyderabad and Pune.

While Indian financial markets have been liberalized in the past two decades, useful information is still scarce. Complex structures, inadequacy of information and below-average disclosures make it difficult for retail investors to make sense of financial markets. No wonder small investors always lose money in every market crash.

P a g e | 58 Brickwork's proprietary models in credit risk customized for large corporates, SMEs, banks, financial institutions, state and local governments, help investors understand the complexity of the investment world. Brickwork Rating Symbols 1) Brickwork Rating Symbols for Long Term debt instruments The long-term debt instruments includes Bonds, Non Convertible Debentures, Certificate of Deposits, Fixed Deposits, Convertible Preference Shares, Redeemable Preference Shares and Structured Obligations, all with original maturity exceeding one year. 1. Investment Grade Ratings: BWR AAA (BWR Triple A) BWR AA (BWR Double A) Instruments with AAA rating are considered to offer the Best credit quality, in terms of timely servicing of debt obligations.

Instruments with AA rating are considered to offer High credit quality.

BWR A

Instruments with A rating are considered to offer Adequate credit quality. Instruments with this rating are considered to offer Moderate credit quality.

BWR BBB (BWR Triple B)

2. Speculative grade: BWR BB (BWR Double B) BWR B

Instruments with this rating are considered to offer Inadequate credit quality.

Instruments with this rating are considered to offer Low credit quality. Instruments with this rating are considered to offer Very Low credit quality. Instruments with this rating are in Default or expected to Default.

BWR C

BWR D

P a g e | 59

2) Brickwork Rating Symbols for Short Term debt instruments Short Term Instruments Rating Scale

The Short Term debt instruments with original maturity up to one year.

BWR P1 BWR P2

Instruments with this rating are considered to offer Excellent credit quality Instruments with this rating are considered to offer High credit quality Instruments with this rating are considered to offer Moderate credit quality Instruments with this rating are considered to offer Low credit quality Instruments with this rating are in Default or expected to Default

BWR P3

BWR P4 BWR P5

3) Brickwork Rating Symbols for issuer rating BWR AAA (BWR Triple A) BWR AA (BWR Double A) BWR A BWR BBB (BWR Triple B) Issuer with AAA rating is considered to offer the BEST credit worthiness. Issuer with AA rating is considered to offer High credit worthiness.

Issuer with A rating is considered to offer Adequate credit worthiness. Issuer with this rating is considered to offer Moderate credit worthiness.

BWR BB Issuer with this rating is considered to offer Inadequate credit worthiness. (BWR Double B)

P a g e | 60 BWR B BWR C BWR D Issuer with this rating is considered to offer Low credit worthiness. Issuer with this rating is considered to offer Very Low credit worthiness. Issuer with this rating is in Default or expected to Default.

4) Brickwork Rating Symbols for IPO Grading BWR IPO Grade 5: BWR IPO Grade 4: BWR IPO Grade 3: BWR IPO Grade 2: BWR IPO Grade 1:

Strong fundamentals

Above-average fundamentals

Average fundamentals

Below-average fundamentals

Poor fundamentals

5) Brickwork Rating Symbols for Fixed Deposit Ratings a) Investment grade: BWR FAAA (BWR F Triple A) Deposits with this rating are considered to offer the BEST safety, in terms of timely servicing of interest & principal

BWR FAA Deposits with this rating are considered to offer a High safety, in terms of (BWR F Double timely servicing of interest & principal A) BWR FA Deposits with this rating are considered to offer Adequate safety in terms of timely servicing of interest & principal

P a g e | 61 b) Speculative grade: BWR FB Deposits with this rating are considered to offer Low safety, in terms of timely servicing of interest & principal Deposits with this rating are considered to offer Very Low safety, in terms of timely servicing of interest & principal Deposits with this rating are in Default or expected to Default

BWR FC

BWR FD

6) Brickwork Rating Symbols for Corporate Governance BWR CG 1 BWR CG 2 BWR CG 3 BWR CG 4 BWR CG 5 BWR CG 6 BWR CG 7 BWR CG 8 Quality of Corporate Governance is The BEST Quality of Corporate Governance is EXCELLENT Quality of Corporate Governance is HIGH Quality of Corporate Governance is ADEQUATE Quality of Corporate Governance is MODERATE Quality of Corporate Governance is INADEQUATE Quality of Corporate Governance is LOW Quality of Corporate Governance is The LOWEST

7) Brickwork Rating Symbols for SME rating BWR aaa (BWR Triple a) BWR aa (BWR Double a) BWR a BWR bbb (BWR Triple b) BWR bb (BWR Double SME with aaa rating is considered to offer the Best credit worthiness in relation to other SMEs. SME with aa rating is considered to offer High credit worthiness in relation to other SMEs. SME with a rating is considered to offer Adequate credit worthiness in relation to other SMEs. SME with bbb rating is considered to offer Moderate credit worthiness in relation to other SMEs. SME with bb rating is considered to offer Inadequate credit worthiness in relation to other SMEs.

P a g e | 62 b) BWR b SME with b rating is considered to offer Low credit worthiness in relation to other SMEs. SME with c rating is considered to offer Very Low credit worthiness in relation to other SMEs. SME with d rating is in Default or expected to Default

BWR c BWR d

8) Brickwork Rating Symbols for Security Receipts Ratings Recovery Value of the Underlying Assets is greater than 150% of SR Face Value. Recovery Value of the underlying assets in the range of over 100% - 150% of SR Face Value. Recovery Value of the underlying assets in the range of over 75% - 100% of SR Face Value. Recovery Value of the underlying assets in the range of over 50% - 75% of SR Face Value. Recovery Value of the underlying assets in the range of 25% - 50% of SR Face Value. Recovery Value of the underlying assets less than 25% of SR Face Value.

BW RR1+

BW RR1

BW RR2

BW RR3

BW RR4 BW RR5

9) Brickwork Rating Symbols for Insurance Companies BWR In AAA BWR In AA BWR In A BWR In BBB BWR In BB BWR In B BEST financial capability to meet policyholders obligations HIGH financial capability to meet policyholders obligations ADEQUATE financial capability to meet policyholders obligations MODERATE financial capability to meet policyholders obligations INADEQUATE financial capability to meet policyholders obligations LOW financial capability to meet policyholders obligations

P a g e | 63 BWR In C BWR In D VERY LOW financial capability to meet policyholders obligations DEFAULT on current policy holder obligations

10) Brickwork Rating Symbols for Mutual Fund BWR MF AAA BWR MF AA BWR MF A BWR MF BBB BWR MF BB BWR MF B BWR MF C BEST credit quality of underlying Debt portfolio HIGH credit quality of underlying Debt portfolio ADEQUATE credit quality of underlying Debt portfolio MODERATE credit quality of underlying Debt portfolio INADEQUATE credit quality of underlying Debt portfolio LOW credit quality of underlying Debt portfolio VERY LOW credit quality of underlying Debt portfolio

11) Brickwork Rating Symbols for Real Estate Project BWR RP 1+ BWR RP 1 BWR RP 2 BWR RP 3 BWR RP 4 BWR RP 5 BEST project implementation EXCELLENT project implementation ADEQUATE project implementation MODERATE project implementation INADEQUATE project implementation LOW project implementation

P a g e | 64 12) Brickwork Rating Symbols for Real Estate Developer BWR RD 1+ BWR RD 1 BWR RD 2 BWR RD 3 BWR RD 4 BWR RD 5
14

BEST project implementation capability EXCELLENT project implementation capability ADEQUATE project implementation capability MODERATE project implementation capability INADEQUATE project implementation capability LOW project implementation capability

1.1.9 Rating Process

In India all the three credit rating agencies adopt almost a similar rating process for rating new debt issues and reviewing the rating of existing instruments. The steps generally taken by the rating agencies in rating process are shown as under: -

1. Rating Request: The purpose of the rating starts with the rating request made by the issuer of the instrument issues a letter to the rating agency and signed an agreement with the agency.

2. Assignment of Analytical Team: On the basis of rating request credit rating agencies assign an analytical team comprising two or more analysts. These analysts would be the experts in the relevant business area. It is a very detailed process. Normally, two-three persons with the required technical skills team up for investigations (due diligence) for about three weeks.

P a g e | 65

Issuer request for rating

CRISIL Assigns an analytical

Analytical team collects and analyses information

Meets Companys management and resolves Questions Interaction with back up team for industrial formation

Findings presented to a rating committe

Rating committee decides the rating

Notification of rating to issuer

No
Does issuer wants to appeal

Rating is released

Yes Additional data provided is reviewed and rating revised if necessary

P a g e | 66 Figure 1.2: Rating Process They go to the company, talk to the people, go through the company's books and records, its accounts, talk to its auditors, its bankers, its consumers, look at how the company has handled investor grievances, look at its track record in servicing debt obligations and so on. This pile of data is then screened and, based on that, the team arrives at a structured report.

This report is then presented before the rating committee. A brainstorming session on due diligence ensures that no one gets away by making a sweeping statement. After a lot of interaction, the matter is finally put to vote for a decision on the rating.15

3. Analytical Team Obtains & Analysis Information: After assignment of Analytical Team, the team obtains and analysis information relating to its financial statements, cash flow and other relevant information which have impact on the companys functioning. Generally, following kind of information is obtained and analyzed by this team:

A. Annual reports for past five years including cash flow statements and interim reports. B. Two copies of the prospectus offering statement and application for listing on any major stock exchange. C. Consolidated financial statements for the past three fiscal years. D. Two copies of the projected financial statements along with assumptions on which projection have made. E. A certified copy of resolution passed by the Board of Directors authorizing the insurance of debentures instruments, including the name of authorized signatories.

15

Khan MY(2003), Rating Process Ch. Credit rating, Financial services Tata McGraw Hill Publishing

Company Limited New Delhi sixth edition 2003.p16.25-16.31.

P a g e | 67 F. List of bank showing lines of credit along with the contact officers. Apart from this, analytical team may obtain some addition information, which it considers to be necessary for this purpose. 4. Meeting with Management:After obtaining and analyzing the information explained in previous step, analytical team meets with the management of the company and obtains more information on some important aspects which have impact on the credit quality of the instrument being rated. Though the topics discussed during the management meeting are wide ranging but discussion with management might reveal more information like:

   

Managements Philosophy and Plan for the company in future. Business segment analysis. Competitive position, strategies, financial policies. Historical performance.

5. Interaction with Back Up Team:While Analytical team collects the information from company; its back up team collects the information on industry which this company belongs. It also makes interaction with back up team in order to collect information on industry along with the industry prospects in near future.

6. Rating Committee: After collecting and analyzing information from company and its management, the analytical team presents their report to a rating committee which then decides on the rating. The rating committee meeting is the only aspects of the process in which the issuer does not participate.

7. Deciding on Rating by Rating Committee:Now the rating committee makes assessment or evaluate all the factors concerning the issuer giving greater attention to some key issues. After proper analysis rating committee arrives at the rating, which is suitable to the proposed issue.

P a g e | 68 8. Notification to the issuer: After the committee has assigned the rating, this decision is communicated to the issuer along with the reasons or rational supporting the rating. If the issuer agrees with the ratings and does not wish to appeal fo9r reviewing the rating given to the instrument, then as a last movement rating is released through print media by the rating agency. But if issuer raises objection on the rating given by the rating agency and wants to furnish additional data for that, then this additional information is reviewed and rating agency may revise previous rating. Then this revised rating is released through media and formal notification of final rating assigned to the issuer.16

1.1.10 International Credit Rating Agencies (CRAs)

Currently, the following rating agencies rate general obligation bonds, notes, leasepurchase revenue bonds and commercial papers:

International Credit Rating Agencies

Fitch

Moodys Investor

Standard & Poors

Figure 1.3 International Credit Rating Agencies How are bonds rated?

16

V Bhalla VK(2001), Investment Management S. Chand and Co. Ltd. New Delhi 8 th edition 2001.p 136-137

P a g e | 69 The rating process begins with an application to the rating agencies by the issuer or its agent either via a telephone call or in writing. The State of California has engaged Standard & Poor's, Moody's and Fitch in rating all its debt instruments for decades.

The rating request is usually done several weeks before the issuance of the bonds to allow time for the rating agencies to perform their review and analysis. Generally, the following documentations are provided to the rating agencies as soon as possible: a. The preliminary official statement; b. Latest audited and unaudited financial statements; c. The latest budget information, including economic assumptions and trends; d. Capital outlay plans; The bond counsel opinion addressing the authority and tax-exempt status of the bond issuance; All legal documents relating to the security for the bonds; and Any other documents that may pertain to the bond issuance as requested by the rating agencies.

Following this, a meeting is set up at the rating agency's or issuer's office to present the credit worthiness. The credit analyst prepares a municipal credit report, which discusses key analytical factors. The credit analyst presents credit for "sign-off" with the senior analyst and makes a recommendation for rating. The credit analyst makes a presentation before a rating committee comprised of senior analysts. Finally, the rating is released to the issuer, then to a wire service, followed by a publication of full credit report.

Table 1.6: International CRAs Rating Symbols Chart Moodys S&P Fitch NAIC

P a g e | 70 Aaa Aa1 Aa2 Aa3 A1 A2 A3 Baa1 Baa2 Baa3 Ba1 Ba2 Ba3 B1 B2 B3 AAA AA+ AA AAA+ A ABBB+ BBB BBBBB+ BB BBB+ B BAAA AA+ AA AAA+ A ABBB+ BBB BBBBB+ BB BBB+ B B1 1 1 1 1 1 1 2 2 2 3 3 3 3 3 3

Source: National Association of Insurance Commissioners

Moody's Explanation Aaa indicates Best quality. Aa indicates High quality. A indicates Higher-medium grade. Baa indicates Medium grade.

P a g e | 71 Ba indicates Possess speculative elements. B Generally lack characteristics of desirable investment. Caa indicates Poor standing; may be in default. Ca indicates Speculative in a high degree; often in default. C indicates lowest grade.

Standard & Poor's Explanation AAA Highest grade. AA High grade. A Upper medium grade. BBB Medium grade. BB Lower medium grade. B Speculative. CCC-CC Outright speculation. C' Reserved for income bonds. DDD-DD In default, with rating indicating relative salvage value.

All of these agencies are represented in India through their collaborations: S&P: CRISIL Moodys: ICRA Fitch: CARE (for 1 year only) Fitch: Fitch India (formerly Duff & Phelps India)

P a g e | 72 These collaborations bring in financial capital, and more importantly, know how, experience, depth of expertise, research capabilities and manpower synergies. The global orientation received by CRAs in India is further enhanced by two factors Affiliation to the Association of Credit Rating Agencies in Asia (ACRAA), an ADB sponsored body. Indian CRAs are founder members. Alignment with the IOSCO Code of Conduct, to the extent they coincide with the SEBI Code of Conduct for CRAs. These collaborations, affiliations and alignments enable the Indian CRAs to benefit from an exposure to an international environment. It is also a notable feature that Indian CRAs, in turn, provide technical expertise and knowhow to CRAs in Mexico and other countries in the SAARC and ASEAN regions. This provides an emerging markets perspective. Indian CRAs have a leadership position in Asia, behind only Japan, whos CRAs show a greater affinity in interacting with CRAs from the developed (G7) countries.

1.1.11 Elements involved in determining a credit rating

 Economic Factors.
 Evaluation of historical and current economic factors.  Economic diversity.  Response to business cycles.  Economic restructuring.  Assessing the quality of life in the given area.

 Debt/Issue Structure.
 Economic feasibility and need for project.  Length of bond's maturity, short-term debt financing.  Pledged security and other bondholder protections.

 Futuristic outlook: capital improvement plan.  Financial Factors.

 Sufficient resources accumulated to meet unforeseen contingencies and liquidity requirements.  On-going operations are financed with recurring revenues.  Prudent investing of cash balances.  Ability to meet expenditures within economic base.

 Management/Structural Factors.

P a g e | 73  Organization of government and management.  Taxes and tax limits.  Clear delineation of financial and budgetary responsibilities.  Definitions of Ratings by Standard & Poors and Moodys.

Investors are often confused or uncertain about bond ratings used by the major security rating services.

1.1.12 CREDIT RATING: ITS TRUSTWORTHINESS

Why ratings are so trustworthiness?

Investors and creditors are primarily concerned with relative value based on their lending and for the investment horizon they have. Accordingly, the credit ratings have traditionally provided one element in support of the investment decision-making process. As such, they help lower the aggregate costs of borrowing and lending and increase overall market transparency and efficiency for both issuers and investors. However, certain attributes of ratings have, over time, encouraged proliferation in the types of users and uses of ratings:  Public dissemination Because ratings are publicly available, information about issuers can easily and quickly be disseminated to broad and varying groups of users.  Simplicity Rating symbols distill much information into an easy to use symbol.  Breadth of coverage The worldwide ratings exist on a large and diverse group of entities and debt instruments. Rating service allows investors to assign an individual issuer or debt instrument into a credit risk class vis-a-vis the overall universe of debt issuers and instruments.

P a g e | 74  Objectivity and independence The few reputable players in the Rating industry have strict internal policies and procedures have mitigated the latent conflict of interest that is inherent in the rating agency business model. As such, the rating opinions are the product of analysis that is widely accepted as unbiased and trustworthy.  Predictive content The predictive content of the world-recognized ratings has been consistently mapped and measured. All top rating agencies and many academic researchers have published studies on the relationship between the ratings and credit defaults. Research has shown a strong relationship between assigned ratings and actual default experience.

 Judicious rating process The recognized rating agencies assign ratings through a rigorous and judicious process that tends not to react to transitory conditions in favor of longer-term considerations and ratings stability. For different class of persons different benefits accrue from use of rated instruments. Such benefits directly accruing to investors through rated instruments that become a reason for trustworthiness are as follows:

1.1.12.1 TRUSTWORTHINESS TO INVESTORS Investors are benefited in very many ways if the corporate security in which they intend to invest their saving has been rated by credit rating agency. Some of the benefits, which become a reason for trustworthiness to investors, are as:

 Safeguards against bankruptcy:

Credit rating of an instrument by credit rating agency give an idea to the investors about degree of financial strength of the issuer company, which enables him to decide about the investment. Highly rated instrument of a company gives an assurance to the investors of safety of instrument and minimum risk of bankruptcy.

P a g e | 75

 Recognition of risk:
Credit rating provides investors with rating symbols, which carry information in easily recognizable manner for the benefit of investors to perceive risk involved in investment. Rating symbol gives them the idea about the risk involved or the expected advantages from the investment.

 CREDIBILITY OF ISSUER: Rating gives a clue to the credibility of the issuer company. The rating agency is quite independent of the issuer company and has no business connections or otherwise any relationship with it or its Board of Directors, etc.

 Easy understandability of investment proposal:

Rating symbols can be understood by an investor, which needs no analytical knowledge on his part. Investor can take quick decisions about the investment to be made in any particular rated security of a company.

 Saving of resources: Investors rely upon credit rating. This relieves investors from the botheration of knowing about the fundamentals of a company, its actual strength, financial standing, management details, etc. The quality of credit rating done by professional experts of the credit rating agency repose confidence in him to rely upon the rating for taking investment decisions.

 Independent of investment decisions: For making investment decisions, investors have to seek advice of financial intermediaries, the stock brokers, merchant bankers, the portfolio managers etc. about the good investment proposal, but for rated instruments, investors need not depend upon the advice of these financial intermediaries as the rating symbol assigned to a particular instrument suggests the credit worthiness of the instrument and indicates the degree of risk involved in it.

P a g e | 76

 Benefits of rating surveillance: Investors get the benefit of credit rating agencys on-going surveillance of the rating and rated instruments of different companies. The credit rating agency downgrades the rating of any instrument if subsequently the companys financial strength declines or any event takes place, which necessitates consequent dissemination of information on its position to the investor.

1.1.12.2 Trustworthiness to Company Company which had its credit instrument or security rated by a credit rating agency is benefited in many ways as summarized below:

 Lower cost of borrowing: A company with highly rated instrument has the opportunity to reduce the cost of borrowing from the public by quoting lesser interest on fixed deposits or debentures or bonds as the investors with low risk preference would come forward to invest in safe securities through yielding marginally lower rate of return.  Wider audience for borrowing: A company with a highly rated instrument can approach the investors extensively for the resource mobilization using the press media. Investors in different strata of the society could be attracted by higher rated instrument as the investors understands the degree of certainty about timely payment of interest and principal on a debt instrument with better rating.

 Rating as marketing tool: Companies with rated instrument improve their own image and avail of the rating as a marketing tool to create better image in dealing with its customers feel confident in the utility products manufactured by the companies carrying higher rating for their credit instruments.

P a g e | 77

 Reduction of cost in public issues: A company with higher rated instrument is able to attract the investors and with least efforts can raise funds. Thus, the rated company can economies and minimize cost of public issues by controlling expenses on media coverage, conferences and other publicity stunts and gimmicks. Rating facilitates best pricing and timing of issues.

 Motivation for growth: Rating provides motivation to the company for growth as the promoters feel confident in their own efforts and are encouraged to undertake expansion of their operations or new projects. With better image created through higher credit rating the company can mobilize funds from public and instructions or banks from self-assessment of its own status, which is subject to self-discipline and self-improvement, it can perceive and avoid sickness.

 Unknown issuer: Credit rating provides recognition to a relatively unknown issuer while entering into the market through wider investor base who rely on rating grade rather than on name recognition.

 Benefits to brokers and financial intermediaries: Highly rated instruments put the brokers at an advantage to make less effort in studying the companys credit position to convince their clients to select an investment proposal. This enables brokers and other financial inter-mediaries to save time, energy, costs, and man-power in convincing their clients about investment in any particular instrument.

Credit Rating as a tool for Credit risk management in Banks

A simple way to evaluate credit risk is to think in terms of past credit worthiness. Apart from the big credit rating agencies like Moodys, Standard & Poor or Fitch-IBCA,

P a g e | 78 there are the databases compiled by Equifax and CCN on people whose credit- worthiness is frequently queried by companies and banks.16

CRISIL believes that for radically improving credit risk management, the use of better tools and techniques needs to be complemented by improved information systems, redesigned organizational structures and processes, skill up gradation and most of all, the willingness and ability to adapt attitudes and organizational cultures to suit the changing environment.

The RBI guidelines for risk rating on credit risk management are as:  Set up comprehensive risk scoring system (6 to 8 point scale)  Clearly define rating thresholds.  Periodic (half yearly) review of ratings  Map rating migrations to estimate expected loss.

For purpose of better control, the RBI study group (Tandon Committee) has also suggested a system of borrower classification in each bank within a credit rating scale.

The study group has suggested a five point-point scale in which borrowers could be classified as excellent, good, average, Below-Average or Unsatisfactory: an alphabetical range would do equally well. Such a system of classification according to credit risk, which results for periodic review will facilitate easy identification of the borrower whose affair require to be watched with more than ordinary care. Moreover, such classification will be advantageous for the formulation of a rational base for fixing the rates of interest according to the credit rating of the borrower.

A customer who is given the finest credit rating may be given the lowest lending rate of the bank. On the other hand, a customer who is rated as a poor risk, will have to pay the worst interest rate. In such a case the bank should take appropriate action to improve the quality of loan and lessen the banks exposure.

P a g e | 79 The recommendation of the study group have been, by & large, accepted by the Reserve Bank. Banks have, therefore accepted the suggested procedure as a regular part of their follow-up machinery. A procedural consideration will have to do how management chooses to deal with loans graded anything less than satisfactory, that is, those that are classified below average or unsatisfactory. In effect, the entire administration of a substandard loan should be shared or regularly reviewed with management.

Rating Industry Performance Surprisingly, the largest wealth creating sectors are the industrials-oil & gas, utilities, transportation, financial services, and metals & mining. On the other hand, growth oriented sectors like leisure, telecom, and FMCGs have destroyed shareholders wealth. Moreover wealth-creating sectors have created more wealth than the growth-oriented sectors.

Role of Rating Agencies in Capital Market The capital and financial markets in developing countries are remarkable for their lack of sophistication. Apart from a few stock exchanges and government-appointed regulators, there arent many reliable intermediaries like Credit rating agencies, investment analysts, merchant bankers, or venture capital firms. Credit rating agencies have played an important role in the capital markets for almost a century by providing analytic opinions to investors on the ability and willingness of issuers to make timely payments on debt instruments over the life of those instruments. Issuers pay for the ratings in order to lower the cost of and increase their access to capital. Investors trust the agencies impartiality and quality, and rely on the ratings.

Limitations of Credit Rating System in India

(1) The first problem of Credit Rating System relates to the rating symbols. Sometimes, rating symbols according to the tenure of the instrument and not by the instruments characteristics creates confusion. For example the instruments like Fixed Deposits, Non Convertible Debentures or Commercial papers are rated by ICRA on the basis of their maturity period, them will be given the same rating by ICRA.But on the other hand CRISIL

P a g e | 80 provides rating symbols in accordance with the characteristics of instrument. For example, CRISIL prefix F to the rating for Fixed Deposits. This problem of assigning rating symbols cause confusion among treasury managers and investors who otherwise can determine the product or the instrument on the instrument on seeing the rating.

(2) The rating agencies do not perform an audit and they rely only on the information provided by the issuer of the instrument. If the information provided is inaccurate or incomplete, the ratings process is compromised. Therefore, ultimately, this kind of rating will not reflect the true picture behind the issuance of security or in other words, it will not assess the true creditworthiness of the issuer.

(3) A Credit Rating provides only guidance to the investors and creditors in determining the risk associated with a instrument. It does not recommend buying selling a particular security because it does not take into account factors like: market prices and personal risk preferences, which might influence investors decision. So apart from Credit Rating, investors should analyze all those factors depending on his proposed investment decision.

(4) Sometimes, certain instrument of a specific company is provided lower rating by a rating agency. Now the company has an incentive to go around for the best possible rating by compromising the authenticity of the rating process itself.

(5) Some companies use Credit Rating as a tool to cheat the investors. They get rating done by more then one rating agency and publish only that rating which reflects highest safely. But this published rating may not be true which can mislead investors decision.17

(6) Conflict between the two rating agencies can be happen. E.g. IDBI Bank has been upgraded to AA+ from A on account of the merger with Industrial Development Bank of India (IDBI), said Crisil. Meanwhile, Icra has placed IDBI Bank under rating watch with positive implications. The agency said that the rating action takes into account the announcement of the in-principle approval of the merger of the IDBI Bank with IDBI. The rating agency is in the process of evaluating the impact of the merger and would announce its final view on the outstanding rating after completion of the merger, an Icra official said. The
17

Bhalla VK(2001), Investment Management S. Chand and Co. Ltd. New Delhi 8th edition 2001.p 136-137

P a g e | 81 rating agency is in the process of evaluating the impact of the merger and would announce its final view on the outstanding rating after completion of the merger said an official with the rating agency. Agency has also assigned outstanding ratings of LAA, MAA+ and A1+ to IDBIs long-term, medium-term and short-term debt plans. Now it can create controversy between the two rating agency if the ratings of the bank varies. 18

(7) Ratings volatility The most important issue arising in the present turmoil is do rating agencies need the quasi government authority of inside access at all as rating agencies access to inside access at all as rating agencies access to inside information did not help them anticipate the financial information is essential to understanding company creditworthiness, it is not helpful to detect fraud. It is not economically viable for rating agencies to act as guarantors of fraud. Financial instruments are increasingly designed solely to carry a particular rating, not the other way round. The effect is to discourage agencies from changing ratings on objective grounds until it is too late. Further, though companies tend to give credit rating agencies access to confidential documents in general to justify the highest possible credit rating, there is no requirement that they divulge everything.

ANNEXURE
Questionnaire on analysis of credit rating agencies and their poteial impact on developing countries with reference to india and with special reference to mumbai.

18

Sowdeepti(2004), Rating volatility titled financial services rating agencies inducing competition, Chartered

Financial Analyst, Vol. X, Issue 1, p.49

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Please read the instructions below and answer all questions:

1. This information collected will be kept confidential and only aggregated results will be presented in the research. 2. Please answer the questions by putting a tick mark on the relevant choice that best reflects your opinion. 3. If for any reason you feel uncomfortable with answering some questions, simply leave them blank. However, we would appreciate it if you answer all questions. 4. Try to answer as accurately as possible. 5. You can put a tick mark on more than one option also.

PART - 1 Basic Information

Contact Name : Age Contact No Email Occupation : : : :

Qualification :

PART 2
Please indicate your response to each question by ticking the relevant option. You can mark more than one choice also. 1. How many credit rating agencies listed below are you aware of? a) CRISIL b) CARE c) ICRA d) Duff & Phelps. 2. Are you aware of credit rating agencies with their rating symbols? a) Yes. b) No. 3. Do you trust credit rating agencies? a) Yes b) No 4. In which of these securities you prefer to invest your money? a) Shares. b) Debentures. c) Bonds. d) Government Securities.

P a g e | 83 5. How occasionally do you invest in shares and debentures? a) Very frequently. b) Frequently. c) Rarely. 6. In which of these financial Institutions you prefer to invest your money? a) Commercial Banks. b) Insurance Companies. c) Mutual Funds d) Government Securities. e) Other FIs.

7. Does your investment decision get affected by rating given to the instrument by credit rating agencies? a) Yes. b) No. 8. Are you satisfied with the working and rating of Credit Rating Agencies in India? a) Yes. b) No.

9. Do you know anything about Multiple Credit Rating? a) Yes. b) No.

10. Do you think Multiple Credit rating is boom to the capital market? a) Yes. b) No.

11. Do you think Credit Rating Agencies prove to be an effective tool for risk management? a) Yes. b) No. 12. Do you think that it is safe for small investor to depend upon the ratings provided by the Credit Rating Agencies? a) Yes. b) No. 13. Do you know any of these services provided by Credit Rating Agencies? a) Credit Rating Services. b) Advisory Services. c) Equity Research. d) Research and Information Services. e) Information Assistant to govt.

14. Should the rating agencies monitor the issue already rated? a) Yes. b) No. 15. Do you think a good rating given to an instrument can help it sail easily in the market?

P a g e | 84 a) Yes. b) No.

16. Does the introduction of Credit Rating Agencies prove conductive for capital market? a) Yes. b) No. 17. What are the main shortcomings of credit rating agencies in India? a) Confusion created by various rating symbols. b) Rely only on information provided by issuer of the instrument. c) Companies publishing only the higher rated securities. d) Conflict between ratings given by two agencies. e) Any, Other. If, any other, specify. Ans:

18. What are the sources from where you get credit rating information? a) News Paper. b) Magazines. c) Web-sites d) Personal Contacts. e) Television f) Other Sources.

Chapters
Chapter 1 Introduction     introduction Objective of the Study Scope and need of the Study Research Methodology

P a g e | 85

 Limitations of the Study

Chapter 2 Theoretical Perspective

 Definitions  List of credit rating agencies  Big Three (credit rating agencies)  Credit rating agencies in India  The Determinants of Rating  Regulatory Framework for CRAs
(a) SEBI guidelines for Credit Rating Agencies 1)General Obligations of Credit Rating Agencies (i)Code of Conduct (a) Agreement with the client (b) Monitoring of ratings (c) Procedure for review of rating (d) Internal procedures to be framed (e) Disclosure of Rating Definitions and Rationale (f) Submission of information to the Board (g) Compliance with circulars etc., issued by the Board GA. Appointment of Compliance Officer

P a g e | 86 (h) Maintenance of Books of Accounts records, etc. (i) Steps on auditors report (j) Confidentiality (k) Rating process

(i)

Code of conduct for Credit Rating Agencies

 Types of Credit Rating



Importance of Credit Rating

 Approaches of Credit Rating Agencies

(A) Rating related products and activities (B) Non-rating related activities

 Rating symbols and their definations  Credit Rating Agencies in India

1. Credit Rating Information Service of India Ltd. (CRISIL) 2. Investment Information and Credit Rating Agency. (ICRA) 3. Credit Analysis and Research Ltd. (CARE) 4. Duff and Phelps Credit rating Pvt. Ltd.

5.

Brickwork Ratings.

 Rating Process  International Credit Rating Agencies (CRAs)  Elements involved in determining a credit rati

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Credit Rating as a tool for Credit risk management in Banks

 Limitations of Credit Rating System in India

 ANNEXURE