CHAPTER 2 CREDIT RATING

INTRODUCTION

The main role of financial markets is mobilization of savings into investments. However, the
investors may not be aware of all the available investment options as well as associated risks thereof.
Further, investors may not be in a position to gather the relevant and reliable information or have
the ability to analyze each investment avenue. Thus, there was a need for some expert authority to
facilitate such analysis and recommendations. This led to the birth of Credit Ratings.

MEANING

Credit Rating is the evaluation of the credit worthiness of an individual or a business concern or an
instrument of a company. Credit rating establishes a link between risk and return. It is an opinion
on the future repayment ability of the issuer of securities. Such ratings are based on the perceived
overall risk of a company’s business and financial profile. Credit rating represents the evaluation of
qualitative and quantitative information for a company or government. Thus, a credit rating is not
a general evaluation of an issuing organization. It essentially reflects the probability of timely
payment of principal and interest by a borrower company. It is not a one-time evaluation of credit
risk of a security, but the rating agency may change the rating considering the changes periodically.

An investor or any other interested person uses the rating to assess the risk level and compares the
offered rate of return with its expected rate of return. Generally, ratings are expressed alphabetically
or alpha-numerically, hence they are simple and easily understood tool for the investors. It
facilitates the investors in taking a decision, whether to invest or not. The agency, which performs
the credit rating, is called the Credit Rating Agency (CRA).

Thus, Credit Rating is:

(1) An expression of opinion of a rating agency.
(2) The opinion is in regard to a debt instrument.
(3) The opinion is as on a specific date.
(4) The opinion is dependent on risk evaluation.
(5) The opinion depends on the probability of interest and principal obligations being met timely.

Compiled by – Prof. Onkar Pathak (CS, M. Com, NET) Page 1

FEATURES:

a) Credit rating is an assessment of a borrower’s ability to repay the obligation in accordance with
its terms and conditions.
b) Credit rating is only an opinion, but not a recommendation or suggestion to purchase, sell, or
hold a borrower’s security. Such rating does not create any fiduciary relationship between the
rating agency and the investor.
c) A Credit Rating Agency relies on information provided by the issuer entity and other
information collected from various other reliable sources. Thus, no audit or investigation of the
issuer is conducted by the CRA and the agency does not give any guarantee of the completeness
and accuracy of the information on which the ratings are based.
d) A Rating is just a symbolic indicator of the current opinion on the relative capability of timely
repayment of the debts and obligations by the issuer entity.
e) The credit rating agencies can change their ratings based on any significant and permanent
changes in a company’s financial and operating performances.
f) Credit rating agencies rate securities and not issuers. Generally, the rating of highest rated debt
is taken as the rating of the company.

BENEFITS:

Credit rating is beneficial to many participants in the financial markets. Given below are uses of
credit rating category-wise:

A) Use To Investors:
 It enables the investors to get superior information at low cost.
 Communication of the relative ranking of various securities.
 It enables the investors to take calculated risk in their investments.
 It provides vital information to safeguard against possible insolvency of issuers of securities.
 It encourages the common man to invest his savings in corporate securities and get high returns.
 It provides the investors with an independent, professional and genuine judgement in the credit
quality of the instrument which the investor would not otherwise to able to evaluate.
 Easy to understand rating through symbols and codes.

Compiled by – Prof. Onkar Pathak (CS, M. Com, NET) Page 2

B) Use To Issuers / Corporate Borrowers:
 It facilitates companies with good rating enter the capital market confidently (even in adverse
market conditions).
 It facilitates to raise funds at comparatively cheaper cost.
 It can be used as a marketing tool to promote their issue.
 It facilitates foreign collaborations.
 It encourages (financial) discipline among the corporate borrowers.
 It serves as a motivation for growth.

C) To Intermediaries:
 Credit rating also helps intermediaries like merchant bankers, brokers, etc.
 Credit rating helps merchant bankers in planning, pricing, placement, underwriting and
marketing of issues,
 It helps the brokers in monitoring their risk exposure.
 Saves time, money, energy, and manpower in convincing their clients about investments.
 Less effort in studying company’s credit position to convince their clients.

D) Regulators / Government:
 In India, the main regulator related to securities market is SEBI and one of the important
functions of SEBI is to protect the interest of investors in securities market. SEBI ensures this by
specifying requirements of a certain credit rating for a particular instrument.
 Fair and good ratings motivate the public to invest their savings in company shares, deposits
and debentures. Thus, the idle savings of the public are channelized for productive uses.
 It facilitates formulation of public guidelines on institutional investments.
 Credit rating system plays a vital role in investor protection without putting burden on the Govt.

Compiled by – Prof. Onkar Pathak (CS, M. Com, NET) Page 3

RATING SERVICES

Following rating services are generally provided by the credit rating agencies. For this purpose, the
example of Credit Analysis & Research Limited (CARE) has been taken:

(i) Credit Rating

CARE undertakes credit rating of all types of debt instruments, both short-term and long-term.

Credit rating is basically a view expressed by the credit rater on the ability of an issuer of a debt (i.e.
bonds and debentures) to make timely payments. So, credit rating is basically a relative ranking of
the credit quality of debt based instruments. After the liberalization of the Indian economy in 1991,
credit rating agencies have started playing a significant role in assessing the credit quality of
debentures and bonds issued. The process of credit rating also reinforces the faith of investors in
debt-based instruments issued by corporates.

(ii) Information Services

The broad objective of the Information Service will be to make available information on any
company, local body, industry or sector required by a business enterprise. Credit Rating Agencies
through detailed analysis will enable the users of the service, like individual, mutual funds,
investment companies, residents or non-residents, to make informed decisions regarding
investments. CARE, also prepares ‘credit reports’ on companies, for the benefit of banks and
business enterprises. It will generally benefit the banks, insurance companies and other business
enterprises by being cautious in granting loans or investing in the debt securities of a company.

(iii) Equity Research

Equity Research is another activity which credit rating companies pursue. CARE also does this. It
generally covers detailed analysis of the major stock exchanges and identification of potential
winners and losers. This includes among other things, judging them on the basis of industry,
economy, market share, management capabilities, international competitiveness and other relevant
factors.

Compiled by – Prof. Onkar Pathak (CS, M. Com, NET) Page 4

CREDIT RATING PROCESS:

1. The rating process begins at the request of the company or the regulators.
2. First, a team visits the company’s plants and inspects its various operations. This team consists
of professionally qualified analysts, well-versed with the workings of the industry in which the
company operates.
3. Meeting with different levels of management to obtain data and discussions on relevant matters.
4. Generally, top-level and middle-level management meetings cover background of company,
organizational structure, operating performance, finance, marketing, projects, etc.
5. In credit rating, the basic analytical framework deals with the evaluation of the risk. Risk could
be classified as –
 Business risk includes an evaluation of the industry characteristics, performance outlook
and the operating efficiencies of the issuer.
 Financial risk is the evaluation of the financial management, cash flow adequacy, earning
forecasting, accounting quality, cost structure, customer advances, credit advances, credit
worthiness of clients, bank guarantee rates, contingent liabilities, insurance cover,
liquidated damages exposure, leverage, etc.
6. Certain qualitative factors like management capability, group strength, support, business
philosophy are considered.
7. Final meeting and discussions with the Chief Executive Officer (CEO) of the company.
8. In completion of the assignment, the team interacts with a back-up team that separately collects
additional industry information and prepares a report.
9. The report is placed before an internal committee of senior executives of CRA, experienced in
rating assignments.
10. Then, the internal committee discusses the same with team members and amongst themselves
to arrive at a rating.
11. To avoid any sort of bias, the ratings proposed are placed before an external committee of some
of the directors who are respected, eminent people unconnected with credit rating agency.
12. The external committee takes the final decision which is communicated to the company.
13. The company may volunteer any further information at this point which could affect the rating;
it is passed on to the external committee again for affirmation / change.
14. The company has the option to request the agency to review the rating.
15. Communicate final rating to the company along with assessment report outlining the rationale
for the rating assigned.

Compiled by – Prof. Onkar Pathak (CS, M. Com, NET) Page 5

For ensuring transparency and disclosure norms, following data shall be maintained for five
years by every CRA –
 Important factors underlying the credit rating and sensitivity of such rating to changes in these
factors,
 Summary of discussions with the issuer, its management, auditors and bankers,
 Decisions of rating committee(s), including dissenting members etc.
 If any quantitative model is used in arriving at the rating, the results given by such model vis-
à-vis actual ratings.

CREDIT RATING METHODOLOGIES

The general methodology adopted by credit rating companies is to analyze various aspects of a
business. They are briefly discussed as below:

(i) BUSINESS RISK

Business risk occurs when there is a possibility of a company earning lower profits than anticipated
or incurring a loss. Business risk can be segregated into four categories - Strategic risk, compliance
risk, operational risk and reputational risk. We have briefly discussed each one as follows

(a) Strategic Risk: A successful business always needs a comprehensive and detailed business
plan. Everyone knows that a successful business needs a comprehensive, well-thought-out
business plan. But it’s also a fact of life that, if things changes, even the best-laid plans can
become outdated if it cannot keep pace with the latest trends. This is what is called as strategic
risk. So, strategic risk is a risk in which a company’s strategy becomes less effective and it
struggles to achieve its goal. It could be due to technological changes, a new competitor entering
the market, shifts in customer demand, increase in the costs of raw materials, or any number of
other large-scale changes.
We can take the example of Kodak which was able to develop a digital camera by 1975. But it
considers this innovation as a threat to its core business model, and failed to develop it.
However, it paid the price because when digital camera was ultimately discovered by other
companies, it failed to develop it and left behind. Similar example can be given in case of Nokia
when it failed to upgrade its technology to develop touch screen mobile phones. That delay
enables Samsung to become a market leader in touch screen mobile phones.

Compiled by – Prof. Onkar Pathak (CS, M. Com, NET) Page 6

 However, a positive example can be given in the case of Xerox which invented photocopy
machine. When laser printing was developed, Xerox was quick to lap up this opportunity and
changes its business model to develop laser printing. So, it survived the strategic risk and
escalated its profits further.

(b) Compliance Risk: Every business needs to comply with rules and regulations. For example
with the advent of Companies Act, 2013, and continuous updating of SEBI guidelines, each
business organization has to comply with plethora of rules, regulations and guidelines. Non
compliance leads to penalties in the form of fine and imprisonment.
However, when a company ventures into a new business line or a new geographical area, the
real problem then occurs. For example, a company pursuing cement business likely to venture
into sugar business in a different state. But laws applicable to the sugar mills in that state are
different. So, that poses a compliance risk. If the company fails to comply with laws related to a
new area or industry or sector, it will pose a serious threat to its survival.

(c) Operational Risk: This type of risk relates to internal risk. It also relates to failure on the part of
the company to cope with day-to-day operational problems. Operational risk relates to ‘people’
as well as ‘process’. We will take an example to illustrate this. For example, an employee paying
out Rs. 1,00,000from the account of the company instead of Rs. 10,000.
This is a people as well as a process risk. An organization can employ another person to check
the work of that person who has mistakenly paid Rs. 1,00,000or it can install an electronic system
that can flag off an unusual amount.

(d) Reputational Risk: Reputational impact mostly follows a decision under business risk. For
example, closing of project in a country on the ground of viability, (which General Motors has
done in India) creates a bad reputation for the company. In the above case, it was observed that
employees have reacted negatively to the decision and started feeling insecure.

On the other hand, adding related products down the line adds customer confidence and boost
investor’s confidence. For example, several Indian banks have embarked on opening e-trading
account. This has added to the reputation and market confidence.

Compiled by – Prof. Onkar Pathak (CS, M. Com, NET) Page 7

(ii) FINANCIAL RISK
Financial Risk is referred to as the unexpected changes in financial conditions such as prices,
exchange rate, Credit rating, and interest rate etc. Though political risk is not a financial risk in direct
sense but it actually is as any unexpected political change in any foreign country may lead to country
risk which may ultimately result in financial loss.
Accordingly, the Financial Risk can be broadly divided into following categories:
(a) Counter Party Risk
(b) Political Risk
(c) Interest Rate Risk
(d) Currency Risk

(a) Counter Party Risk: This risk occurs due to non-honoring of obligations by the counter party
which can be failure to deliver the goods for the payment already made or vice-versa or repayment
of borrowings and interest etc. Thus, this risk also covers the credit risk i.e. default by the counter
party.

(b) Political Risk: Generally, this type of risk is faced by overseas investors, as the adverse action
by the government of host country may lead to huge loses. This can be on any of the following
forms:
• Confiscation or destruction of overseas properties.
• Rationing of remittance to home country.
• Restriction on conversion of local currency of host country into foreign currency.
• Restriction on borrowings.
• Invalidation of Patents
• Price control of products

(c) Interest Rate Risk: This risk occurs due to change in interest rate resulting in change in asset and
liabilities. This risk is more important for banking companies as their balance sheet’s items are more
interest sensitive and their base of earning is spread between borrowing and lending rates.
As we know that the interest rates are of two types i.e. fixed and floating. The risk in both of these
types is inherent. If any company has borrowed money at floating rate then with increase in floating
rate, the liability under fixed rate shall remain the same. On the other hand, with falling floating
rate, the liability of the company to pay interest under fixed rate shall comparatively be higher.

Compiled by – Prof. Onkar Pathak (CS, M. Com, NET) Page 8

(d) Currency Risk: This risk mainly affects the organization dealing with foreign exchange as their
cash flows changes with the movement in the currency exchange rates. This risk can affect the cash
flow adversely or favorably. For example, if rupee depreciates vis-à-vis US$, receivables will stand
to gain in comparison to the importer who has the liability to pay bill in US$. The best case we can
quote, Infosys (Exporter) and Indian Oil Corporation Ltd. (Importer).

(iii) MANAGEMENT EVALUATION

In order to evaluate the management of a company, the best way is to see the company’s
Management Discussion and Analysis (MD&A) Report which every listed company is compulsory
required to provide. In case of unlisted companies also, the credit rating companies can influence
the companies to include MD&A in their Annual Report.
Actually, MD&A is the section of a company's annual report in which management provides a
summary of the previous year’s operations and how the company performed financially.
Management also gives an outline for the next year by highlighting futureplans and some brief
about the new projects to be launched by the company.

(iv) BUSINESS ENVIRONMENT ANALYSIS

A business environment analysis includes examining factors which influence from outside of a
business. These business environment factors can range from new laws such as Companies Act,
2013; new trends i.e. the latest trends to shop online; and new technology, for instance battery cars
which in future can be charged on road itself without the even the need to stop the car.
Now, after considering the above mentioned environmental factors, the next step in the business
environment analysis will be to determine as to how much impact they will have on the business.
After that strategies will be developed to ward off any negative impact that has arisen.

Compiled by – Prof. Onkar Pathak (CS, M. Com, NET) Page 9

CAMEL MODEL IN CREDIT RATING

CAMEL Stands for Capital, Assets, Management, Earnings and Liquidity. The CAMEL model
adopted by the Rating Agencies deserves special attention; it focuses on the following aspects:

a. Capital – It includes composition of Retained Earnings and External Funds raised; Fixed
dividend component for preference shares and fluctuating dividend component for equity
shares and adequacy of long term funds adjusted to gearing levels; ability of issuer to raise
further borrowings.

b. Assets – It covers revenue generating capacity of existing/proposed assets, fair values,

technological/ physical obsolescence, linkage of asset values to turnover, consistency,
appropriation of methods of depreciation and adequacy of charge to revenues. It also includes
size, ageing and recoverability of monetary assets viz receivables and its linkage with turnover.

c. Management – It includes extent of involvement of management personnel, team-work,

authority, timeliness, effectiveness and appropriateness of decision making along with
directing management to achieve corporate goals.

d. Earnings – It includes absolute levels, trends, stability, adaptability to cyclical fluctuations and
ability of the entity to service existing and additional debts proposed.

e. Liquidity – It includes effectiveness of working capital management, corporate policies for

stock and creditors, management and the ability of the corporate to meet their commitment in
the short run.

Compiled by – Prof. Onkar Pathak (CS, M. Com, NET) Page 10

RATING REVISIONS

Credit Rating is an opinion expressed by a credit rating agency at a given point of time based on the
information provided by the company and collected by credit rating agency. However, the
information collected from the company at the time of giving credit rating to it is amenable to
change. Therefore, revision of credit rating is required.

To protect the interest of investors, SEBI has mandated that every credit rating agency shall, during
the lifetime of the securities rated by it, continuously monitor the rating of such securities and carry
out periodic reviews of all published ratings.

Moreover, India Ratings & Research (A Fitch Group Company) continuously monitors the ratings
assigned to a particular instrument. In case of any changes in the ratings so assigned, India Ratings
discloses the same through press releases and on its websites.

For instance, the CRISIL has updated long term credit rating of Sterlite Technologies Limited to
‘CRISIL AA-/Stable from CRISIL A+/Watch Developing’ and also its short-term credit rating have
been upgraded to CRISIL A1+ from CRISIL A1/Watch Developing. Additionally, CRISIL has
removed its rating on bank loan facilities and debt instruments of the company from ‘Watch with
Developing Implications’ and it has also withdrawn its rating on ‘bonds’ at the Company’s request,
as there is no amount outstanding against the said instrument.

LIMITATIONS OF CREDIT RATING

a. Rating Changes – Ratings given to instruments can change over a period of time. They have
to be kept under rating watch. Downgrading of an instrument may not be timely enough to
keep investors educated over such matters.

b. Industry Specific rather than Company Specific – Downgrades are linked to industry rather
than company performance. Agencies give importance to macro aspects and not to micro ones
and over-react to existing conditions which come from optimistic/pessimistic views arising
out of up/down turns.

Compiled by – Prof. Onkar Pathak (CS, M. Com, NET) Page 11

c. Cost Benefit Analysis – Rating being mandatory, it becomes a must for entities rather than
carrying out Cost Benefit Analysis. Rating should be left optional and the corporate should be
free to decide that in the event of self-rating, nothing has been left out.

d. Conflict of Interest – The rating agency collects fees from the entity it rates leading to a conflict
of interest. Rating market being competitive there is a possibility of such conflict entering into
the rating system.

e. Corporate Governance Issues – Special attention is paid to

a. Rating agencies getting more of its revenues from a single service or group.
b. Rating agencies enjoying a dominant market position engaging in aggressive competitive
practices by refusing to rate a collateralized/securitized instrument or compelling an
issuer to pay for services rendered.
c. Greater transparency in the rating process viz. in the disclosure of assumptions leading to
a specific public rating.

Compiled by – Prof. Onkar Pathak (CS, M. Com, NET) Page 12

 JINDAL POWER LTD. V. ICRA LTD.

Brief Facts of the Case: -

Jindal Power Ltd. (JPL) and ICRA have been in an agreement since 2016 for carrying out the credit
rating of JPL. ICRA being a Credit Rating Agency, was bound to follow the SEBI (CRA) Regulations,
1999 while carrying out the rating. Despite the fact that all the parameters of JPL for the purposes
of rating, were same in the present year, as the preceding year, ICRA decided to downgrade the
credit rating from BBB+ (in 2019) to BBB (in 2020). JPL objected to the same and conveyed its non-
acceptance to ICRA but ICRA continued maintaining it and published the downgraded credit rating
of the company on its website. JPL hence filed a suit against ICRA seeking an injunction against the
downgraded rating and to declare the rating null and void.

Contention of the Parties: -

The main contention of JPL was that credit rating is only for the purpose to indicate whether the
company is in a position to clear its debts and does not address any other risk like the liquidity risk,
market value risk or price volatility. On perusal of JPL’s parameters of last financial year as
compared to the present financial year it is shown that the long-term fund-based term loans, long
term non-fund based, short term fund based and unallocated instrument’s value all remain the
same. The total bank facilities along with the non-convertible debentures also remain the same so
there is no negative rationale permitting downgrading of the rating. JPL further contented that since
it has protested against the revised rating, ICRA could not have gone ahead with its publishing as
this violates the agreement between the companies.

ICRA in response contented that while formulating the rating it has followed the rating process in
compliance with the regulations and relevant circulars issued by SEBI and has not violated any of
the rating methodologies or the CRA Regulations of the RBI Master Circular. Under the rating
agreement entered into between JPL and ICRA in 2016 based on the initial rating, JPL has already
availed funds and thus till the funds have been utilized and not repaid by JPL, ICRA would be
bound to keep a surveillance over the debt instruments.

Compiled by – Prof. Onkar Pathak (CS, M. Com, NET) Page 13

Important Issues: -
Whether a CRA has a right to publish the credit rating despite being objected to by the issuer?

Regulation 15 of the CRA Regulations provide that the credit ratings are required to be continuously
monitored unless the rating is withdrawn and the CRA is also mandated to disseminate the
information regarding newly assigned ratings through press releases and websites during the
lifetime of securities. Regulation 16 mandates periodic reviews of all published ratings during the
lifetime of the securities, unless the rating is withdrawn. Thus, if the security subsists and is pending
all published ratings are bound to be reviewed periodically even if the client does not cooperate
with the Credit Rating Agency and complies with its regulation. The CRA cannot withdraw a rating
as long as the obligations under the security rated are outstanding unless the company whose
security is rated is wound up or merged or amalgamated with another company or as may be
specified by SEBI from time to time.

The Court held that since JPL and ICRA entered into the credit rating agreement on 15th June 2016,
the initial rating was granted in that year and since then only the monitoring of such rating is being
conducted by ICRA. Thus, the change in rating in the year 2020 is the change during the surveillance
rating. It held that as per the terms of the agreement between JPL and ICRA as also the CRA
Regulations, Master Circular of RBI, ICRA was entitled to publish the initial rating once accepted,
based whereon JPL took credit facility and thereafter ICRA is mandated to conduct surveillance of
the credit rating and publish the same in the best interest of the provider of the financial facility and
the other parties.

What are the factors required to be considered by a CRA while deciding the rating?
 As per Regulation 2(q) of the CRA Regulations, to formulate an opinion on the credit rating,
the analyst and the Rating Committee are required to consider various factors, some of which
represent credit strengths and other factors which represent credit challenges. The credit rating
provided by any rating agency is an independent opinion of an expert body.

 According to ICRA, some of the main reasons to downgrade the ratings of JPL were:
1. Continued pressures on its liquidity profile and debt coverage metrics, owing to its inability
to secure incremental long-term/medium-term power purchase agreements (PPAs) as well
as to correct its receivables position. The off-take risk was heightened because of lockdowns

Compiled by – Prof. Onkar Pathak (CS, M. Com, NET) Page 14

 due to Covid-19, had adversely impacted the all-India electricity demand, in turn affecting
its sales.
2. JPL’s sizeable repayment obligations in the near medium term (annual repayments of more
than ₹ 800 crores from FY2021 onwards).
3. The main business of JPL is with Tamil Nadu Generation and Distribution Corporation
Limited (in short ‘TANGEDCO’) and since TANGEDCO is stressed, the outstanding dues to
be received by JPL are uncertain.
4. Despite increase in repayment obligations of JPL there were still high debt levels and
suboptimal capacity utilization as JPL was utilizing power only to the 1/3 rd.

Can the Court intervene in the decision of a CRA and direct it to review its ratings?
 Court held that emphasis has to be given on the data on the basis of which opinion is formed by
the expert. The Delhi High Court very clearly held in this case that if the opinion given by an
expert is intelligible, convincing, and based on reasoning, decree declaring the said opinion as
null and void, unenforceable and ineffective cannot be passed. The Court will not interfere with
the expert opinion of a CRA unless the opinion is perverse, arbitrary and mala fide.
 The Delhi High Court refused to intervene in the decision of ICRA in the JPL case holding that
the rating rationales depend on industry to industry and ICRA has taken into account the
relevant rating rationales, both positive and negative in forming the opinion of downgrading
the credit rating.

 Conclusion: -
Credit Rating Agencies are independent expert bodies which consider various factors while
formulating the credit rating of an instrument. Credit rating is merely an opinion of the CRA which
ultimately benefits the investors as it helps them make an informed choice for the investment. It is
for the investors’ interest that strict regulations have been implemented by SEBI to foresee the credit
rating process by the CRA. Although the credit rating is governed by a contract between the issuer
and CRA, greater autonomy is vested on the CRA, it being the expert body. If the rating provided
by CRA is sound, reasonable and intelligible, then even the Courts have refused to interfere with its
decision.

Compiled by – Prof. Onkar Pathak (CS, M. Com, NET) Page 15

CREDIT RATING AGENCY

A Credit Rating Agency (CRA) is one of the capital market intermediaries. It is a body corporate,
which is engaged in the business of rating of securities offered by way of public issue or rights issue.
Rating means an opinion regarding securities, expressed in the form of standard symbols (numeric,
alphanumeric and alphabets) or any other standardized manner assigned by a CRA and used by
the issuer of such securities. Rating is compulsory for issue of Commercial Paper, Debentures and
Public Deposits.
The first Mercantile Credit Rating was established in New York in 1841, under the guidance of
Robert Dun. Another agency was started by John Bradstreet. Later, these two agencies merged to
form Dun and Bradstreet in 1933. Another credit rating agency ‘Moody’s’ formed in 1900 was
acquired by Dun and Bradstreet in 1962. World renowned Rating Agency is ‘Standard and Poor’
created in 1941. In India, the first credit rating agency was CRISIL (1987), followed by ICRA Limited
(1991) and CARE (1993).

Following are the SEBI registered Credit Rating Agencies:

1. Credit Rating and Information Services (India) Limited [CRISIL]
2. Investment Information and Credit Rating Agency of India Limited [ICRA]
3. Credit Analysis and Research Limited [CARE]
4. India Ratings and Research Private Limited. (Fitch Ratings India Pvt. Ltd)
5. Brickwork Ratings Private Limited.
6. SME Rating Agency of India Limited (SMERA)

Compiled by – Prof. Onkar Pathak (CS, M. Com, NET) Page 16

Credit Rating and Information Services (India) Limited (CRISIL)
CRISIL is India’s first credit rating agency, which started its operations in 1988. CRISIL was jointly
promoted by India’s leading financial institutions such as ICICI, UTI and others financial
institutions. Today, CRISIL is a global analytical company providing ratings, research, and risk and
policy advisory services. Their major shareholder is Standard and Poor's, which is the world's
foremost provider of credit ratings. CRISIL provides services such as ratings, global research and
analysis, IPO grading and other corporate advisory services.

Investment Information and Credit Rating Agency of India Limited (ICRA)

ICRA is the second rating agency in India. ICRA was set up in 1991 and promoted by IFCI Ltd. and
other financial institutions such as banks, insurance companies and few foreign institutions. The
international CRA Moody’s Investors Service is ICRA’s largest shareholder.

Credit Analysis and Research Limited (CARE)

CARE has been promoted in 1993, by IDBI jointly with Canara bank, UTI, Private sector banks and
insurance companies. It commenced operations in October, 1993.

RATING SYMBOLS (illustration)

Long Term Debt Instruments

Timely payment of Principal and interest CRISIL ICRA CARE
Highest safety AAA LAA CARE AAA
High Safety AA LAA CARE AA
Adequate Safety A LA CARE A
Moderate Safety BBB LBBB CARE BBB
Inadequate Safety BB LBB CARE BB
High Risk B LB CARE B
Substantial Risk C LC CARE C
Likely to Default D LD CARE D

Compiled by – Prof. Onkar Pathak (CS, M. Com, NET) Page 17

Short term Debt Instruments
Timely payment of Principal and interest CRISIL ICRA CARE
Highest Safety P1 A1 +/A1 PR-1
High Safety P2 A2 + /A2 PR-2
Adequate Safety P3 A3+/A3 PR-3
Inadequate Safety P4 --- PR-4
High Risk --- A4 + /A4 --
Default P5 A5 PR-5

SEBI (CREDIT RATING AGENCIES) REGULATIONS, 1999

SEBI regulations for Credit Rating Agencies (CRA) cover rating of securities only. They do not cover
rating of fixed deposits, foreign exchange, country rating, real estate etc.

Definitions:
a) Rating – means an opinion regarding securities expressed in the form of a standard symbols or
in any other standardized manner, assigned by a CRA.
b) Client – means any person whose securities are rated by a CRA.
c) Credit Rating Agency – means a body corporate engaged in the process of rating of securities
offered by way of public issue and/or rights issue.
d) Net-worth – means the aggregate of paid up capital and free reserves, as reduced by the
accumulated losses and miscellaneous expenditure not written off.

Registration of Credit Rating Agency

Any person proposing to commence any activity of credit rating shall get first itself registered with
SEBI under SEBI (Credit Rating Agencies) Regulations, 1999. Every CRA shall able abide by the
code of conduct contained in the Third Schedule to SEBI (Credit Rating Agencies) Regulations, 1999.
Any person intending to commence credit rating activity should submit an application (with fees of
Rs. 50,000) to SEBI for grant of registration certificate.

Compiled by – Prof. Onkar Pathak (CS, M. Com, NET) Page 18

Promoters of Credit Rating Agency (CRA)
As per SEBI guidelines, following entities are allowed to promote a Credit Rating Agency:
1. Public financial institutions within the meaning of Section 4A of the Companies Act, 2013;
2. Scheduled Commercial Bank;
3. Foreign banks operating in India with RBI approval;
4. Foreign credit rating agencies (recognized under Indian law) having minimum 5 years of
experience
5. A body corporate having net worth of Rs. 100 crores in each of the immediately preceding 5
years

Eligibility criteria
The following eligibility criteria shall be fulfilled by the applicant, in order to get registered with
SEBI:
a. The applicant shall be a company registered under the Companies Act, 2013,
b. The Memorandum of Association of the applicant company shall mention credit rating as its
main object,
c. The applicant shall have a minimum net worth of Rs. 5 crores,
d. The applicant shall have the necessary infrastructure for providing such services,
e. The applicant and its promoters, management shall have professional competence, financial
soundness and general reputation of fairness and integrity in business transactions.
f. Neither the applicant nor its promoters shall be involved in any legal proceedings connected
with securities market, nor be convicted of any offence involving moral turpitude, and
g. Grant of certificate to the applicant is in the interest of investors and securities market.

All necessary information must be submitted to SEBI along with the application form. SEBI may
grant the certificate of registration (with regn. fees of Rs. 5 lakhs) if it is satisfied with the application
and supporting data. A registered CRA must comply with all guidelines, circulars, instructions,
rules and regulations of SEBI made thereunder. The period of certificate shall be three years and
same can be renewed thereafter (with renewal fees Rs. 10 lakhs). Such renewal shall be applied
within three months of its expiry.

Compiled by – Prof. Onkar Pathak (CS, M. Com, NET) Page 19

Agreement with the client
Every CRA shall enter into written agreement with each client whose securities it proposes to rate
and every such agreement shall include the following provisions:
a) Rights and liabilities of each party in respect of rating of securities shall be defined;
b) Fee to be charged by CRA shall be specified.
c) Client shall agree to a periodic review of the rating by the CRA during the tenure or rated
instruments;
d) Co-operation of the client with the CRA during all future reviews;
e) Providing adequate, timely and true information to the CRA;
f) The credit rating agency shall disclose to the client, the rating assigned to the securities;
g) The client shall agree to disclose the rating assigned to it by CRA.

Monitoring of Ratings
Every CRA shall, during lifetime of securities rated by it, continuously monitor the rating of such
security. It should also distribute such information regarding newly assigned ratings and changes
in earlier ratings promptly through press releases and websites. In the case of securities issued by
listed company, such information shall also be provided simultaneously to all concerned Stock
Exchanges, where such securities are listed.

Review of Ratings
Every CRA shall carry out periodic reviews of all published ratings during the lifetime of the
securities. If the client does not co-operate with the CRA so as to enable the CRA to comply with its
obligations, the CRA should carry out the review on the basis of the best available information and
CRA shall disclose this fact to the investors.

Internal Procedures to be framed

Every CRA must appoint a Compliance Office to monitor compliances of various laws. Every CRA
shall frame appropriate procedures and systems of monitoring the trading of securities by its
employees, in the securities of its clients, in order to prevent contravention of the following laws:
a) SEBI (Prohibition of Insider Trading) Regulations, 1992;
b) SEBI (Prohibition of Fraudulent and Unfair Trade Practice relating to the Securities Market)
Regulations, 2003;
c) Other laws relevant to trading of securities.

Compiled by – Prof. Onkar Pathak (CS, M. Com, NET) Page 20

Disclosure of Rating Definitions
Every CRA shall make public the definition of concerned rating along with the symbols. It must
also state that the ratings do not constitute recommendations to buy, sell or hold any security. A
Credit Rating Agency shall not rate any security which is issued by any of its Promoters and any
related parties.

INITIAL PUBLIC OFFER (IPO) GRADING

Meaning – IPO Grading service facilitates the assessment of equity issues offered to the public. The
grade assigned to the issue is based on the ‘Fundamentals’ i.e. the strength/weakness parameters
of the issue as compared to the industry and economy.

Purpose – IPO Grading states the opinion of the rating agency about the issue. IPO grading is based
on 5-point scale (higher scale implying strong fundamentals) and it is a relative comparison of the issue
to other listed equity securities in India. Thus, IPO grading is not an investment recommendation,
but IPO grading is a tool for investors’ decision making.

Regulation – Earlier, as per SEBI (ICDR) Regulations, 2009, a company could not make an IPO,
unless it had obtained IPO grading from at-least one CRA registered with SEBI. Also, such IPO
grading was to be obtained prior to registering its prospectus with the ROC. However, as per
amendments to regulations done later, IPO grading is now optional and companies may or may not
opt for it. Further if company opts for it, every unlisted company intending to make an IPO, must
disclose all the grades obtained from credit rating agencies. Such disclosure shall be made in their
prospectus, issue advertisement and any other place where the issue company is advertising for the
IPO. Thus, IPO Grading is an important step towards ensuring investor protection and investor
awareness.

Compiled by – Prof. Onkar Pathak (CS, M. Com, NET) Page 21

Process – IPO Grading can be done only by CRA registered with SEBI. Such grading is an
independent and unbiased opinion of the CRA. The assigned grade would be a one-time assessment
done at the time of IPO and it does not have ongoing validity.
a. Collect information required for grading from the company,
b. Discuss with company management, visit company premises, factories, branches etc.,
c. Prepare analytical assessment report,
d. Present analysis report to committee of senior executives for further discussions and grade
finalizing,
e. Communicate the grade to the company along with assessment report, with rationale for such
grade.

Compiled by – Prof. Onkar Pathak (CS, M. Com, NET) Page 22