Central University of

South Bihar

SCHOOL OF LAW AND GOVERNANCE

Under the guidance of D.R P.K DAS

Name : PRIYA RANJAN

Course : B.A. LL.B. (Hons)
Semester : VIII
Enrollment No.: CUSB1513125031
Subject : Financial Market Regulation
Project Topic : Role of CRA in Economic
Development in India: An
Analysis.

1
 ACKNOWLEDGEMENT

Dear Reader,
You are most welcome in my project work of Criminal Procedure
Code, 1973, on the Topic Role of CRA in Economic Development in India: An
Analysis.
which is assigned by our honourable subject DR. P.K DAS.
I would like to thank to him for giving such important topic to me .I would
like to thank to our seniors also for giving knowledge about this topic.
I would like to thank to library also from where we get the book related to
such topic.
I would like to thank to internet also from where we get idea to generate this
topic most attractive to reader..
So, I hope that if you come once inside my project you feel surely very glad.

Thanking you
PRIYA RANJAN
CUSB1513125031

2
 INDEX
S. NO Contents Page
No.
1 CREDIT RATING AGENCIES IN INDIA 4

2 THE DETERMINANTS OF RATINGS 4

3 RATING METHODOLOGY 5

4 CREDIT RATING 6

5 CREDIT RATING SYMBOLS 7

6 BENEFITS OF CREDIT RATING 7

7 LIMITATIONS OF CREDIT RATINGS 8

8 Functions of Credit rating agencies 10

9 CHARACTERISTICS OF CREDIT RATING 12

10 How CRA helps in growing Economy in 13

India.
11 Bibliography 14

3
 CREDIT RATING AGENCIES IN INDIA
The history of Credit Rating in India is only a decade and half. During this short span of time,
the major rating agencies have instilled confidence in the minds of the Investors and Regulatory
bodies. The major rating agencies in India are attracting the Global Rating Agencies, which
have entered into alliances with them for technical collaboration and equity participation. The
Indian Rating Agencies are providing training and technical assistance in setting up rating
agencies in many other countries. Moreover the Indian Rating Agencies are instrumental for
the incorporation of Association of Credit Rating Agencies of Asia (ACRAA). The Indian
Rating Agencies also provide adequate information to the Investors through their publications.
In this chapter, an attempt has been made to study the rating practices and the role paid by the
Indian Rating Agencies. Credit rating emerged in India with the birth of Credit Rating
Information Services of India Limited (CRISIL). The services rendered by these Credit Rating
Agencies are discussed in detail in this Chapter.1
The institution of credit rating as a mechanism for addressing the considerable degree of
information asymmetry in the financial markets has travelled a long way from the times of the
US rail road companies in the mid-19th century. The need for an independent rating agency
capable of assessing creditworthiness of borrowers was felt when corporates started mobilizing
resources directly from savers instead of accessing it through banks which hitherto assumed
the credit risk in such cases. The history of systematic credit rating, however, is a century old
beginning with rating of US railroad bonds by John Moody in 1909. During this one century
of growth and adaptation, CRAs progressed from rating simple debt products to rating complex
derivatives to national economies and altered their business models to cover a range of
activities/products. There are three major credit rating agencies operating internationally-
Fitch, Standard and Poor‘s, Moody‘s Investor Services: between them they share the bulk of
the $5 billion rating business globally relegating other 60 plus local/regional players into just
competitive fringes.
In India, credit ratings started with the setting up of The Credit Rating Information Services of
India (now CRISIL Limited) in 1987. CRISIL was promoted by premier financial institutions
like ICICI, HDFC, UTI, SBI, LIC and Asian Development Bank. Now CRISIL is an S&P
company with a majority shareholding. Apart from CRISIL four more rating agencies have
been registered by SEBI in India. These are ICRA, promoted by IFCI and now controlled by
Moody‘s, CARE promoted by IDBI, Fitch India a 100% subsidiary of Fitch, and a new born
Brickworks. In India, CRAs that rate capital market instruments are governed by Securities
and Exchange Board of India (Credit Rating Agencies) Regulations, 1999. The regulation
provides detailed requirements that a rating agency needs to fulfil to be registered with SEBI.2

THE DETERMINANTS OF RATINGS

The default-risk assessment and quality rating assigned to an issue are primarily determined by
three factors –
i) The issuer's ability to pay,
ii) The strength of the security owner's claim on the issue, and

1
page no. 473, Financial Markets, Institutions and Financial Services, Clifford Gomez, 5 th Edition.
2
Page no. 289, essentials of Financial Services, Dr. S. Gurusamy.

4
iii) The economic significance of the industry and market place of the issuer.
Ratio analysis is used to analyse the present and future earning power of the issuing
corporation and to get 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 favoured by rating agencies. For any given set of ratios,
different values are appropriate for each industry. Moreover, the values of every firm's ratios
vary in a cyclical fashion through the ups and downs of the business cycle. To assess the
strength of security owner's claim, the protective provisions in the indenture (legal instrument
specifying bond owners' rights), designed to ensure the safety of bondholder's investment, are
considered in detail. 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 leadershlp, production efficiency, findncial structure, etc.)

RATING METHODOLOGY
Rating is a search for long-term fundamentals and the probabilities for changes in the
fundamentals. Each agency's rating process usually includes fundamental analysis of public
and private issuer-specific data, 'industry analysis, and presentations by the issuer's senior
executives, statistical classification models, and judgement. Typically, the rating agency is
privy to the issuer's short and long-range plans and budgets. The analytical framework
followed for rating methodology is divided into two interdependent segments. d The first
segment deals with operational characteristics and the second one with the financial
characteristics. Besides, quantitative and objective factors; qualitative aspects, like assessment
of management capabilities play a very important role in arriving at the rating for an
instrument. The relative impbrtance of qualitative and quantitative components of the analysis
varies with the type of issuer. Key areas considered in a rating include the following:
i) Business Risk : To ascertain business risk, the rating agency considers Industry's
characteristics, performance and outlook, operating position (capacity, market share,
distribution system, marketing network, etc.), technological aspects, business cycles,
size and capital intensity.
ii) Financial Risk : To assess financial risk, the rating agency takes into account various
aspects of its Financial Management (e.g. capital structure, liquidity position, financial
flexibility and cash flow adequacy, profitability, leverage, interest coverage),
projections with particular emphasis on the components of cash flow and claims
thereon, accounting policies and practices with particular reference to practices of
providing depieciation, income recognition, inventory valuation, off-balance sheet
claims and liabilities, amortization of intangible assets, foreign currency transactions,
etc.
iii) Management Evaluation : Management evaluation includes consideration of the
background and history of the issuer, corporate strategy and philosophy,
organisational structure, quality of management and management capabilities under
stress, personnel policies etc.
iv) Business Environmental Analysis : This includes regulatory environment, operating
environment, national economic outlook, areas of special significance to the company,

5
 pending litigation, tax status, possibility of default risk under a variety of scenarios.
Rating is not based on a predetermined formula, which specifies the relevant variables
as well as weights attached to each one of them. Further, the emphasis on different
aspects varies from agency to agency. Broadly, the rating agency assures itself that
there is a good congruence between assets and liabilities of a company and
downgrades the rating if the quality of assets depreciates.

CREDIT RATING AGENCIES IN INDIA

In India, at present, there are four credit Rating Agencies:
i) Credit Rating and Information Services of India Limited (CRISIL).
ii) Investment Information and Credit Rating Agency of India Limited (ICRA) .
iii) Credit Analysis and Research Limited (CARE).
iv) Duff and Phelps Credit Rating of India (Pvt.) Ltd.

1) CRISIL 3: This was set-up by ICICI and UTI in 1988, and rates debt instruments. Nearly
half of its ratings on the instruments are being used. CRISIL's market share is around
75%. It has launched innovative products for credit risks assessment viz., counter party
ratings and bank loan ratings. CRISIL rates debentures, fixed deposits, commercial
papers, preference shares and structured obligations. Of the total value of instruments
rated, debentures' accounted for 3 1.196, fixed deposits for 42.3% and commercial
paper 6.6%. CRISIL publishes CRISIL rating in SCAN that is a quarterly publication
in Hindi and Gujarati, besides English. CRISIL evaluation is carried out by
professionally qualified persons and includes data collection, analysis and meeting with
key personnel in the company to discuss strategies, plans and other issues that may
effect ,evaluation of the company. The rating ,process ensures confidentiality. ,Once .
- the company decides to use rating, CRISIL is obligated to monitor the rating over the
life of the debt instrument.

2) ICRA : ICRA was promoted by IFCI in 1991. During the year 1996-97, ICRA rated
261 debt instruments of manufacturing companies, finance companies and financial
institutions equivalent to Rs. 12,850 crore as compared to 293 instruments covering
debt volume of Rs. 75,742 crore in 1995-96. This showed a decline of 83.0% over the
year in the volume of rated debt instruments. Of the total amount rated cumulatively
until March-end 1997, the share in terms of number of instruments was 28.5% for
debentures (including long-term instruments), 49.4% for Fixed Deposit programme
(including medium- term instruments), and 22.1% for Commercial Paper Programme
(including short-term instruments). The corresponding figures of amount involved for
these three broad rated categories was 23.8% for debentures, 52.2% for fixed deposits,
and 24.0% for Commercial Paper.

3
Page 13.25, Page no. 473, Financial Institutions and markets, L.M Bhole & Jitendra Mahakud.

6
 3) CARE : CARE is a credit rating and information services company promoted by IDBI
jointly with investment institutions, banks and finance companies. The company
commenced its operations in October 1993. 'In January 1994, CARE commenced
publication of CAREVIEW, a quarterly journal of CARE ratings. In additioh to the
rationale of all accepted ratings, CAREVIEW often carries special features of interest
to issuers of debt instruments, investors and other market players.

CREDIT RATING SYMBOLS 4

Credit Rating Agencies rate an instrument by assigning a definite symbol. Each symbol has a
definite meaning. These symbols have been explained in descending order of safety or in
ascending order of risk of non-payment. For example, CRISIL has prescribed the following
symbols for debenture issues:
AAA indicates highest safety of timely payment of interest and principal.
AA indicates high safety of timely payment of interest and principal.
A indicates adequate safetv of timely payment of interest and principal.

BBB offers sufficient safety of payment of interest and principal for the present.
BB offers inadequate safetv of timely payment of interest and principal.
B indicates great susceptibilitv to default.
C indicates vulnerabilitv to default. Timely payment of interest and payment is possible- nly
if favourable circumstances continue.
D indicates that the debenture is in default in payment of arrears of interest or principal or is
expected to default on maturity.
You will note that as the value of symbol is reduced say from AAA to AA, the safety of timely
payment of interest and principal is decreased. While AAA indicates highest safety of timely
repayment, D indicates actual default or expected default on maturity. Different symbols
indicate different degrees of risk of repayment of principal and interest. It is the 'assessment
of the Rating Agency based on the methodology already explained. Other ratings are given in
the Appendix to this Unit for your information.

BENEFITS OF CREDIT RATING5

Rating serves as a useful tool for different constituents of the capital market. For different
classes of persons, different benefits accrue from the use of rated instruments.
1) Investors : Rating safeguards against bankruptcy through recognition of risk. It gives an
idea of the risk involved in the investment. It gives a clue to the credibility of the issuer
4
Page no. 455, Financial Markets Services, E. Gordon & K. Natarajan, Himalaya Publication.
5
Page no. 477, Financial Markets, Institutions and Financial Services, Clifford Gomez, 5 th Edition.

7
company. Rating symbols give information on the quality of instrument in a simpler way that
can be understood by lay investor and help him in taking decision on investment without the
help from broker. Both individuals and institutions can draw up their credit risk policies and
assess the adequacy or otherwise of the risk premium offered by the market on the basis of
credit ratings.
2) Issuers of Debt Instruments : A company whose instruments are highly rated has the
opportunity to have a wider access to capital, at lower cost of borrowing. Rating also facilitates
the best pricing and timing of issues and provides financing flexibility. Companies with rated
instruments can use the rating as a marketing tool to create a better image in dealing with its
customers, lenders and creditors. Ratings encourage the companies to come out with more
disclosures about their accounting systems, financial reporting and management pattern. It also
makes it possible for some category of investors who require mandated rating from reputed
rating agencies to make investments.
3) Financial Intermediaries : Financial intermediaries like banks, merchant bankers, and
investment advisers find rating as a very useful input in the decisions relating to lending and
investments. For instance, kith high credit rating, the brokers can convince their clients to
select a particular investment proposal more easily thereby saving on time, cost and manpower
ill convincing their clients.
4) Business Counter-parties : The credit rating helps business counter-parties in establishing
business relationships particularly for opening letters of credit, awarding contracts, entering
into collaboration agreements, etc.
5) Regulators : Regulators can, with the help of credit ratings, determine eligibility criteria
and entry barriers for new securities, monitor financial soundness of organizations and
promote efficiency in debt securities market. This increases transparency of the financial
system leading to a healthy development of the market.

LIMITATIONS OF CREDIT RATINGS6

There are several limitations of credit ratings. First, credit ratings are changed when the
agencies feel that sufficient changes have occurred. The rating agencies are physically unable
to constantly monitor all the firms in the market. The opinions of rating agencies may turn
wrong in the context of subsequent events that may have an adverse impact on asset quality of
the issuer. Second, the use of credit ratings imposes discrete categories on default risk, while,
in reality default risk is a continuous phenomenon. Moody's recognised this way back in 1982
by adding numbers to the letter system, thereby increasing its number of rating categories from
9 to 19. Nevertheless, this limitation still pertains. The letter grades assigned by rating agencies
serve only as a general, somewhat coarse form of discrimination. Third, owing to time and
cost constraints, credit ratings are unable to capture all characteristics for an issuer and issue.
A borrowing company can reduce the cost of borrowing, if it obtains a higher rating for its
contemplated issue. The stakes and pressures, consequently, to get a good quality rating are
high. If the company comes to know that its issue is going to get a low quality rating, it may
approach another agency and then use the best rating among them since it is not under
obligation to disclose all ratings. According to the practice in the rating industry in India, a

6
Page no. 493, Financial Markets, Institutions and Financial Services, Clifford Gomez, 5th Edition.

8
corporate entity has the option of not agreeing to the first rating given to its debt issue and can
choose not to get rated by that agency at all. In such a situation, the rating agency cannot
divulge its assessment to anybody, and the corporate entity is free to go to any other agency.
But once the corporate entity agrees with the first rating, it has no option of getting out 't of
,the-rating discipline imposed by the rating agency. This may tempt rating agencies to woo
clients with the help of an initial favourable rating, but the freedom may eventually be misused
by the rating agency because corporate client doesn't have the option to differ with the agency,
once it initially agrees to get rated by it. To ensure that corporate clients are not dependent on
one rating agency, the system of compulsory dual ratings of all instruments could be ,
considered. Sometimes, the rating agency may reduce the rigor of their criteria on their own
to enlarge the business and improve profits especially if they are a listed company. Investors
should, therefore, not follow blindly the ratings of different agencies in regard to the safety of
fixed income . instruments. The investors should explore other alternative evaluation sources
so that they become aware of the true risks involved. The rating agencies have to be alert to
ensure that their rating decisions are not driven by volume and profitability with a view to
ensure favourable impact on the price of its share. It may be asserted that the rating agencies
should be judged by overall performance and not by one or two defaults. There are instances
of default in the instruments rated as investment grade of high safety by top agencies of the
world. Once the corporate agrees with the first rating, the rating agency is obliged to assess
the debt issue till its maturity and publish the rating as part of its surveillance system. It has
been observed that rating agencies have miserably failed in predicting the brewing crisis and
have continued to give investment grade rating to companies, which have eventually defaulted.
It has been argued that CRB scam would not have taken place if we had a better credit rating
agency that would have cautioned in time on the status of the company. After the crisis, rating
agencies became overcautious and resorted to drastic downgrades of ratings in respect of
specific companies. For instance, CRISIL, ICRA, and CARE downgraded respectively 140,
35 and 50 companies in 1997. Of the rating changes effected by CRISIL, ICRA, and CARE-
36%, 40% and 64% respectively were by three or more notches.

CRISIL Business Divisions:

1. CRISIL Advisory Services (CAS)
2. Credibility First Rating and Evaluation Services
3. CRISIL Training Services
4. Subsidiaries CRIS – In fact Global Data Services of India Limited CRIS - RISK and
Information Solutions Company Ltd (CRIS - RISC) CRISIL is the market leader having rated
more than 1800 companies and 3600 instruments amounting to a debt volume of over $62.1 1
billion since its inception in 1987. At present CRISIL is having the strategic alliance with the
global market leader Standard 8 Poor's, USA (SBP).'

CRISIL's Rating Process

9
Request of the company: The rating process begins at the request of a company desirous of
having its issue obligations under proposed instrument rated by CRISIL. Assignment toanwcal
team : On receipt of the above request, CRISIL assigns the job to an analytical team that will
be responsible for carrying out the rating assignment.
Obtaining and processing of data : The analytical team, which generally contains two
experts, obtains requisite information from the client company and analyses the same. To
obtain clarification and better understanding of the client's operations, the team meets and
interacts with company's executives.
Readings presentation: The findings of the team completion of investigation process are
presented to Rating Committee (which comprises some directors not connected with any
CRISIL shareholder), which then decides on the rating.
Communication of decision: The decision of the Rating committee is communicated to tho
client company with remarks that the company, if it so likes, may present some additional
information for reconsideration of rating grade assigned to this instrument. In case the company
has nothing to produce as additional fact, the rating grade is fonnally confirmed to the company
by CRISIL.
Monitoring of change of ratio: Once the company has decided to use the rating, CRISIL is
obliged to monitor the rating, over the life of the instrument. Depending upon new information,
or developments concerning the company, CRISIL may change the rating. Any change, so
effected, is made public by CRISIL.

Functions of Credit rating agencies:7

1. Business Analysis
A credit rating company will analyse the business condition of the borrowing company not
merely by the profits the borrowing concern has made, but by the use of capital in a more
productive purpose. The return on capital and the cost of capital will be analysed.
2. Evaluation of industrial risks
Every industry will have its risks which are due to natural or market conditions such as
competition or due to the substitutes that have arrived in the market. The extent of risks and
measures to overcome them will be taken into account while judging the credit rating of the
company.
3. Market position of the company within the industry
What is the share of the market of the company seeking credit rating? A higher percentage of
market share will involve more risks as the company has to be vigilant to maintain its share.
So, a credit rating agency will give due weightage for the market share of the borrowing
concern.
4. Operating efficiency

7
Page no. 485, Financial Markets Services, E. Gordon & K. Natarajan, Himalaya Publication.

10
This is judged from the point of view of utilization of the capacity. When full capacity is
utilized, the company has an advantage over others. This may be possible due to location
advantage or better labour relations. These will be looked into by the credit rating agency.
5. Legal position in terms of prospectus
The statements made in the prospectus, should be true and factual. If tall claims are made, they
will hamper the growth of the company and the credit rating agency will not rely on
the prospectus of the company. It may also be construed as a wilful fraud for attracting more
funds. So, the contents of prospectus will also be a factor for credit rating considerations.
6. Financial analysis based on accounting quality
If accrued incomes are taken for making a window-dressing of balance sheet, it will not reflect
well on the quality of accounting of the borrowing concern. Companies relying on realized
income, will be in a better position to provide a realistic balance sheet. So, the true financial
position of the company will be judged not merely on the books of accounts but also on their
market conditions in meeting their debt commitments.
7. Statement of profits
There may be over statement or under statement of profits depending upon the purpose for
which the statement is prepared. Here, again the credit rating agency has to scrutinize the
realistic position of the company.
8. Earnings protection
To what extent, the earnings of the companies are consistent? Does it show any growth? What
is the extent of profitability? All these will be judged under this criteria.
9. Adequacy of cash flow
Is the cash flow sufficient to meet its current commitments as well as any other contingencies?
This factor is taken into consideration by the rating agencies.
10. Financial flexibility
How far the company is in a position to arrange for alternative financial plans for raising its
funds, if its existing idea does not work out successfully? Rating agencies adjudge the financial
flexibility of companies.
11. Management evaluation
What is the track record of management? How far they are successful in steering the company
under difficult conditions? Evaluation of management is one of the important functions of
credit rating agencies.
12. Capacity to overcome adverse situations (catastrophe management)
Rating agency studies the available mechanism for recovery with the company for meeting any
sudden unforeseen calamities.
13. Goals philosophy and strategy

11
Here, what kind of organizational goals are adopted? What are the strategies adopted for
achieving the goals, etc.? Such aspects are considered when evaluation of an organization by
rating agency.
14. Labour turnover
How far the nonalignment is looking after the welfare of its labor? What is the extent of
punctuality, discipline and morale of the labour force? To what extent they continue with the
employment in the company? A rating agency looks for all these issues.
15. Regulatory and competitive environment
If there are more regulations, restricting competition, then there will be more protection to the
company, whereas under condition of deregulation, providing more scope for competition, the
efficiency of the company will be tested. A rating agency studies the regulatory and competitive
environment from these angles.
16. Asset quality
Here, the value of assets and the price of the assets according to the market conditions and the
provisions made for these assets will be taken into account credit rating authorities.
Performance of assets will also be taken. The extent of standard, sub standard, doubtful and
bad assets will also be taken into account while granting credit rating.
17. Financial position — interest / tax sensitivity
If there is increase in the interest rate due to the market condition, how far the company will be
able to bear it? What will be the impact on the company’s earnings? Similarly, if the
government increases tax on income, what will be the tax burden? What impact it will have on
the company’s earnings. These factors are taken into consideration.
These are some of the functions of credit rating agencies in rating a company.

CHARACTERISTICS OF CREDIT RATING 8

1. Assessment of issuer's capacity to repay: It assesses issuer's capacity to meet its financial
obligations i.e., its capacity to pay interest and repay the principal amount borrowed.
2. Based on data: A credit rating agency assesses financial strength of the borrower on the
financial data.
3. Expressed in symbols: Ratings are expressed in symbols e.g. AAA, BBB which can be
understood by a layman too.
4. Done by expert: Credit rating is done by expert of reputed, accredited institutions.
5. Guidance about investment-not recommendation: Credit rating is only a guidance to
investors and not recommendation to invest in any particular instrument.

8
Page 13.25, Page no. 473, Financial Institutions and markets, L.M Bhole & Jitendra Mahakud.

12
How CRA helps in growing Economy in India.
An independent company that evaluates the financial condition of issuers of debt instruments
and then assigns a rating that reflects its assessment of the issuer's ability to make the debt
payments. Potential investors, customers, employees and business partners rely upon the data
and objective analysis of credit rating agencies in determining the overall strength and
stability of a company.

 Economic growth is an increase in the production of goods and services in an

economy.
 Increases in capital goods, labour force, technology, and human capital can all
contribute to economic growth.
 Economic growth is commonly measured in terms of the increase in aggregated
market value of additional goods and services produced, using estimates such as GDP.

CRA Provides information about the companies to the public by rating those companies.
Public get the information about the companies and accordingly they invest money into those
companies.
CRA also helps in stopping Fraud done by the Companies to the public. After getting rating,
those companies who had been highly rated gains trust and then public invest money into
those companies which directly helps in growth of economy.
CRA helps in gaining credibility by its ratings. Because of Good rating or Bad Rating, it
highly effect the domestic investment and when it is good in increases the domestic
investment which help in increase in National Investment which lead to the economy growth.
Our economy get boosted up and it helps in overall development.
Another benefit of CRA is, it generate economic growth is to grow the labour force. All else
equal, more workers generate more economic goods and services and peoples wanted to
works in those companies which is rated good ranking. This means laborers become more
skilled at their crafts, raising their productivity through skills training, trial and error, or
simply more practice. Savings, investment, and specialization are the most consistent and
easily controlled methods. It increases human capital and national economy.

13
BIBLIOGRAPHY

BOOKS:
1) Financial Institutions and markets, L.M Bhole & Jitendra
Mahakud.
2) Financial Markets Services, E. Gordon & K. Natarajan,
Himalaya Publication.
3) Financial Markets, Institutions and Financial Services,
Clifford Gomez, 5th Edition.

14