Chapter – 1

Introduction

A) MEANING OF CREDIT RATING

Credit Rating Credit rating is the opinion of the rating agency on the relative ability
and willingness of tile issuer of a debt instrument to meet the debt service obligations
as and when they arise. Rating is usually expressed in alphabetical or alphanumeric
symbols. Symbols are simple and easily understood tool which help the investor to
differentiate between debt instruments on the basis of their underlying credit quality.

Credit rating is the analysis of the possible credit risks associated with granting a financial
instrument to an individual or a company. The rating is provided based on the
creditworthiness and the credentials of an individual or a company. The creditworthiness of
an individual or a company is decided based on the lending and borrowing transactions done
in the past. Credit rating is determined after weighing the statements of liabilities and assets,
and their ability to meet the debt obligations.
In simple words, Credit rating is an analysis of an organisation’s creditworthiness and credit
quality. A credit rating agency performs a detailed analysis of financial instruments of an
entity. The rating scales range from AAA to D based on how safe the instruments for
investing. Credit ratings of financial instruments are very important for borrowers of money
as it helps them raise money for their projects. At the same time, investors benefit from it as it
helps them in making sound financial decisions. In this article, we have covered credit rating,
its importance and different ratings scales and agencies in India.

Credit rating is an analysis of financial instruments, more specifically debt instruments

offered by corporations, governments, entities, organisations, individuals etc. In other words,
it is assessing the creditworthiness of an organisation. The process of rating an instrument
involves analysing business risk, financial risk, and credit risk of the entity being rated.
Credit rating agencies do the credit rating of various organisations and their financial
instruments. Few of the financial instruments that they rate are Non Convertible Debentures
(NCD), company deposits, fixed deposits etc. They consider the statements of assets,
liabilities, and cash flows along with previous lending and borrowing transactions to assess
their ability to repay financial obligations. SEBI has the sole right to regulate and authorise
rating agencies. Also, the rating system in India under the SEBI Regulations, 1999 of the
SEBI Act, 1992.
The process of credit rating involves qualitative and quantitative assessment of the
organisation. It shows the risk associated with investing in debt instruments. Hence this gives
investors a clear picture to make clear decisions. Moreover, it also helps companies to raise
money to finance their projects.
The highest rating in India is AAA. Financial instruments with AAA rating are the ones that
have the least risk. Moreover, the companies issuing these financial instruments are less
likely to default their payments. Hence the interest rate or rate of return on these instruments
is low.
The lowest rating on the rating scale is D. Also, a rating of ‘D’ is a very poor credit rating (bad credit
rating), and the company with such rating is more likely to default or is already in default.
There are different types of credit ratings. Two of them are short term credit rating and long-
term credit rating. Short term rating is a type of rating that determines the probability of a
borrower to default within one year. On the other hand, long-term ratings indicate the
probability of a borrower to default in the extended future. Mostly, the credit ratings are for
medium to long term. However, with the current scenario, investors are more inclined
towards short term rating than long-term ratings.

B) Definition of Credit Rating by various

institutes and companies
Definition by SEBI :- Credit assessment of the probability of default on payment of interest.
and principal on a debt instrument. It is not a recommendation to buy, sell or hold a debt
instrument. On then basis of credit rating

Definition by RBI:- credit rating may be defined as an opinion of a CRA as to the issuer's (i.e.
borrower of money) capacity to meet its financial obligations to the depositor or bondholder (i.e.
lender of money) on a particular issue or type of instrument (i.e. a domestic or foreign currency :
short-term or medium or long-term, etc.)

Definition by economics time’s:- Credit rating is an analysis of the credit risks associated with a
financial instrument or a financial entity. ... These ratings based on detailed analysis are published
by various credit rating agencies like Standard & Poor's, Moody's Investors Service, and ICRA
 C) How credit rating stated?
Credit ratings trace their roots back to 1850 and the creation of a large market in US railroad
companies bonded debt. While bond markets had already existed for about three centuries,
prior to 1850 bonds mostly comprised the sovereign debt of a few countries with
representative governments whom investors trusted as being willing and able to meet their
commitments – primarily the Dutch, English and later the American governments. European
businesses raised money by bank loans and stock issues.
The US economy, on the other hand, was fundamentally different from the European
economies. For one thing the scale of domestic operations was vast – the country was
virtually a continent and their most pressing capital need was that of trying to connect the
country from end to end. The connectivity technology of the time was railroads, introduced in
the 1820s. Railroad companies were primarily private corporations which initially located in
settled parts of the US and raised capital via bank loans and equity issues.
By 1850, the railroad companies were pressed to expand into “the wild west”. The scale and
uncertainty presented by the expansion meant that the railroad companies were no longer able
to raise sufficient capital from banks and equity investors.
The solution to the capital needs of the railroad companies was the rapid development of a
huge market in railroad company bonded debt. Indeed, by the early 1900s the railroad
corporate bond market was several times larger than that of the Dutch, English or US
sovereign debt bond markets. (The US actually paid off its entire national debt in 1836!)
This new wave of corporate bond activity created a pressing need – transatlantic European
investors demanded to know critical credit information about the companies in which they
were being invited to invest on an unprecedented scale. The traditional means of obtaining
information via family, business and banking relationships became insufficient. Investors
wanted independent, third party information upon which to make investment and pricing
decisions.
In response to this market need, a gentleman by the name of Henry Varnum Poor, who took
over as editor of the American Railroad Journal in 1849, started to publish systematic
information on the property of railroads, their assets, liabilities and earnings. This proved so
popular with investors that after the American Civil War ended in 1865, Poor and his son
started their own publication, Poor’s Manual of the Railroads of the United States. This
annual volume remained the industry’s authoritative information source for several decades.
These statistics were the forerunner of modern-day credit ratings.
In 1909, another gentleman, John Moody, took the publication of credit information a step
further and assigned the first credit rating by publishing an opinion on the creditworthiness of
the corporate debt paper issued by railroad companies. His opinions were based on extensive
company and industry information and rigorous analysis. The Poor company followed suit in
1916. It later merged with Standard Statistics, another information and ratings company, to
form Standard & Poor’s. Fitch Publishing Company started publishing financial information
in 1913 and in 1924 introduced the now familiar “AAA” to “D” rating scale.
With three companies providing opinions on creditworthiness and the US bond market
expanding to include increasing issues by local and state governments, public utilities and
industrial corporations, the credit rating industry was well and truly established. The rating
agencies themselves became known for independence, integrity and reliability.
Interestingly, the US stock market crash of 1929 sparked even greater demand for credit
ratings as investors worried about high bond default rates and credit risk. By the end of the
1920s the vast majority of bond issues were rated by the rating agencies.
There is a key event that signals the importance of the role of the credit rating agency by the
1930s. In
1931 the US Treasury Department, through the Comptroller of Currency, adopted credit
ratings as appropriate measures of the quality of the bond accounts for the national banks.
This was the first formal rule incorporating credit ratings. Indeed, the importance of the rating
agency’s independent role is further highlighted by court decisions that relied explicitly on
ratings to assess whether fiduciaries had satisfied their duties in exercising due care and
prudence when investing the funds in their trust.
The next boom of the credit rating industry is owned to another recession, this time in 1970
during which the infamous default of Penn Central Railroad on $82 million of commercial
paper obligations occurred. Investors recognized anew the need to have independent
evaluation of credit risk available. This renewed and extensive demand by investors allowed
the rating agencies to adopt the current business model of charging issuers in order to provide
a valuable service to investors.
We can see from this brief history lesson how today’s ratings were a response to the market’s
need for independent credit information. The ratings themselves started first as credit
reporting, the publication of statistics and specialized publications on financial data only to
rapidly evolve into the future oriented opinions on creditworthiness that they are today. The
reason that credit ratings were innovated in 1909 is the same reason that they remain relevant
today: the demand of investors for a reliable opinion on the creditworthiness of investments.
 D) History of Credit Rating in India
India was the first amongst developing countries to set up a credit rating agency in 1988.
The function of credit rating was institutionalized when RBI made it mandatory for the
issue of Commercial Paper (CP) and subsequently by SEBI, when it made credit rating
compulsory for certain categories of debentures and debt instruments.
In June 1994, RBI made it mandatory for Non-Banking Financial Companies (NBFCs) to
be rated. Credit rating is optional for Public Sector Undertakings (PSUs) bonds and
privately placed non-convertible debentures up to rupees 50million
In India the rating activities started with the incorporation of the Credit Rating Information
Services of India Ltd. (CRISIL) in 1987 which commenced its operations of rating of
companies in 1987-1988 and was promoted by Industrial Credit and Investment Corporation
of India Ltd. (ICICI) and Unit Trust of India (UTI).
The second rating agency Investment Information and Credit rating Agency of India Ltd.
(ICRA) was incorporated in 1991 and was jointly sponsored by Industrial Finance
Corporation of India (IFCI) and other financial institutions and banks. The other rating
agency, Credit Analysis and Research Ltd. (CARE), incorporated in April 1993, is a credit
rating information and advisory services company promoted by Industrial Development Bank
of India (IDBI) jointly with Canara Bank, Unit Trust of India (UTI), private sector banks and
financial services companies.
Another rating agency Onicra Credit Rating Agency of India Ltd., which was incorporated in
1993, is recognized as the pioneer of the concept of individual credit rating in India. Further
Duff and Phelps Credit Rating (India) Private Ltd. (DCR) was established in 1996, which is
presently known as Fitch Ratings India Private Ltd. One more rating agency SME Rating
Agency of India Limited (SMERA), which was a joint venture of SIDBI, Dun & Bradstreet
Information Services (D&B), Credit Information Bureau of India Limited (CIBIL), and 11
other leading banks in the country, was established in 2005.
A new rating agency, Brickwork Ratings (BWR) which is based in Bangalore was
incorporated in 2007. Besides CRISIL (Standard & Poor), ICRA (Moody’s), CARE and
Fitch, Brickwork Ratings is the fifth Credit Rating Agency to be recognized by SEBI.
E) OBJECTIVE OF THE STUDY OR
RESEARCH

1)To study credit Rating

2)To study process of credit rating

3)To study various credit Rating agencies in India