“CREDIT RATING AGENCY IN INDIA”

A Project Submitted to

University of Mumbai for partial completion of the degree of

Bachelor of Management Studies Finance

Under the Faculty of Management

By

PRASHANT MAURYA

Roll No:- 111

Under Guidance of

Prof. Shristi Singh

SMT. KAMALADEVI GAURIDUTT MITTAL COLLEGE OF ARTS &

COMMERCE

Nahar Nagar Rd, Liberty Garden, Malad West, Mumbai, Maharashtra 400064

2023-2024
 “CREDIT RATING AGENCY IN INDIA”

A Project Submitted to

University of Mumbai for partial completion of the degree of

Bachelor of Management Studies (Finance)

Under the Faculty of Commerce

By

PRASHANT MAURYA

Roll No:- 111

Under Guidance of

Prof. Shristi Singh

SMT. KAMALADEVI GAURIDUTT MITTAL COLLEGE OF ARTS &

COMMERCE

Nahar Nagar Rd, Liberty Garden, Malad West, Mumbai, Maharashtra 400 064

2023-2024
 CERTIFICATE

This is to certify that Mr. Prashant Ravindra Maurya has worked and duly
completed his Project Work for the Degree of Bachelor of Management
studies Finance under the faculty of Management in the subject of Project
work in Finance and his project is entitled “Credit Rating Agency in India”
under my supervision.

I further certify that the entire work has been done by the learner under my
guidance and that no part of it has been submitted previously for any Degree
or Diploma of any University. It is her / his own work and facts reported by
his / her personal findings and investigations.

Seal of the College Name & Signature of

Guiding Teacher

Signature of External
Examiner:

Date of Submission:
 DECLARATION BY LEARNER
I the undersigned Mr. Prashant Ravindra Maurya hereby, declare that the work
embodied in this Project work titled “Credit Rating Agency in India” forms my
own contribution to the research work carried out under the guidance of Prof.
Shristi Singh is a result of my own Research Work and has not been previously
submitted to any other University for any other Degree / Diploma to this or any
other University. Wherever reference has been made to previous works of
others, it has been clearly indicated as such and included in the Bibliography.

I, hereby further declare that all information of this document has been obtained
and presented in accordance with rules and ethical conduct.

Name and Signature of Learner

Certified by

Name and Signature of Guiding Teacher

___________________
___________________
 ACKNOWLEDGEMENT

To list who have helped me is difficult because they are so numerous, and the
depth is so enormous.

I would like to acknowledge the following as being idealistic channels and

fresh dimensions in the completion of this project.

I take this opportunity to thank the University of Mumbai for giving me

chance to do this project.

I would like to thank my principal for providing the necessary

facilities required for completion of this project.

I take this opportunity to thank our co-ordinator.

I would also like to express my sincere gratitude towards my project Guide

Prof. Shristi Singh whose guidance and care made the project successful.

I would like to thank my College Library, for having provided various

reference books and magazines related to my project.

Lastly, I would like to thank each and every person who directly and directly
helped me in the completion of the project especially my Parents and Peers
who supported me throughout my project.
 INDEX
CHP. NO. CHAPTER SCHEME PAGE
NO.
1 INTRODUCTION

1.1 Origin and evolution of credit rating 8-12

1.2 Definitions of credit rating 13
1.3 Role and importance of credit rating 14-16
1.4 Functions of credit rating agency 17-18
1.5 Advantages of credit rating 19-20
1.6 Disadvantages of credit rating 21-22
1.7 Services of offered by credit agency rating 23-28

2 RESEARCH METHODOLOGY
2.1 Research of organization 29-32

2.2 Objective of The Study 33

2.3 Statement of The Problem 34
2.4 Need For Study 35-39
2.5 Research Methodology 40
2.6 Hypothesis 41-42
2.7 Scope of The Study 43-44
2.8 Limitation of The Study 45
2.9 Data Collection Method 46

3 LITERATURE REVIEW 47-49

4 DATA ANALYSIS, INTERPRETATION AND

PRESENTATION
4.1 Summary and Analysis About the Survey 50-58
4.2 Findings 59

5 CONCLUSION AND SUGGESTION 60-62

6 BIBLIOGRAPHY 63
II
 EXECUTIVE SUMMARY
Credit rating plays an important role in the financial life of a business, and the
importance of audit can be seen from the fact the success and survival of any business
depends upon the correctness of the documents and detection and prevention of fraud
and errors. Credit does not create wealth for the business, but ensures safety and
smoothness of process of production, exchange and distribution of wealth. In this way
it becomes effective partner in the process of achievement of the organizational
objectives hassle free and ultimately facilitating economic development and growth.

Here through this project I am going to present you importance and significance of
credit and its types, Crediting is such an examination of books of accounts and
vouchers of business, as will enable the auditors to satisfy himself that the balance
sheet is properly drawn up, so as to give a true and fair view of the state of affairs of
the business and that the profit and loss account gives true and fair view of the
profit/loss for the financial period, according to the best of information and explanation
given to him and as shown by the books; and if not, in what respect he is not satisfied.
the audit profession began to take increased responsibility to detect and report fraud
and to assess, and report more explicitly, doubts about an creditors ability to continue
in conformance with societies and regulators’ increasing concern about corporate
governance matters. Adoption of the business risk approach in turn enhances creditor’s
ability to fulfil these responsibilities. Presently, the objective of auditing is to lend
credibility to financial and non- financial information provided by management in
Annual Reports.

This project has been made with meticulous attention so that it covers in detail aspects
of the Importance of credit and its types like overview; how did credit evolve to the
position it is up to now, definitions quoted by scholars, features and characteristics of
credit, various types of credit that are in practices, how committed and integrated the
auditors are while verify documents and ensuring correctness of documents ; which I
have personally experienced and gathered this information and find glad to present you.

III
 CHAPTER 1

INTRODUCTION

1.1 ORIGIN AND EVOLUTION OF CREDIT RATING

A credit rating agency is a potential source of information for market participants who
are trying to ascertain the creditworthiness of borrowers. Essentially, rating agencies
offer judgments they prefer the word "opinions about the quality of bonds issued by
corporations, governments (including U.S. state and local governments, as well as
"sovereign" issuers abroad), and mortgage securities. These judgments come in the
form of letter grades. The best-known scale is that used by Standard & Poor's (S&P)
and some other rating agencies: AAA, AA, A, BBB, BB, etc., with pluses and minuses
as well.

John Moody published the first publicly available bond ratings (mostly concerning
railroad bonds) in 1909. Moody's firm was followed by Poor's Publishing Company in
1916, the Standard Statistics Company in 1922, and the Fitch Publishing Company in
1924. These firms sold their bond ratings to bond investors in thick rating manuals. In
the language of modern corporate strategy, their "business model" was one of "investor
pays."

This relationship between the rating agencies and the U.S. bond markets changed in
1936 when the Office of the Comptroller of the Currency prohibited banks from
investing in "speculative investment securities," as determined by "recognized rating
manuals" (i.e., Moody's, Poor's, Standard, and Fitch). "Speculative" securities were
bonds that were below "investment grade," thereby forcing banks that invested in
bonds to hold only those bonds that were rated highly (e.g., BBB or better on the S&P
scale) by these four agencies. In effect, regulators had endowed third- party safety
judgments with the force of law.

In the following decades, insurance regulators and then pension fund regulators
followed with similar regulatory actions that forced their regulated financial institutions
to heed the judgments of a handful of credit rating agencies.

John Moody is credited with initiating agency bond ratings, in the United States in
1
1909. Exactly three centuries earlier, in 1609, the Dutch revolutionized domestic and
international finance by inventing the common stock-that of the Dutch East India
Company-and founding a proto-central bank, the Wesselmann or Bank of Amsterdam.
In 1609, the Dutch had already had a government

bond market for some decades. 1 Shortly thereafter, the Dutch Republic had in place, in
one form or another, all of the key components of a modern financial system: a strong
public credit, a stable money, elements of a banking system, a central bank of sorts, and
securities markets. The Dutch Republic went on to become the leading economy of the
seventeenth century. In 1688, the English emulated the Dutch in the most flattering of
ways, by inviting the Dutch leader, William of Orange, to be their king. William
brought experienced Dutch financiers with him to England, and in short order England,
too, had all the key components of a modern financial system-the Bank of England, for
example, was founded in 1694. England, of course, went on to have the first industrial
revolution and to become the leading economy of the world in the eighteenth and
nineteenth centuries. 2 A century later in the newly independent United States,
Alexander Hamilton, the Founding Father most aware of the Dutch, English (and also
French) financial precedents, worked to put in place, in even shorter order, a similarly
modern financial system during his term as the first Secretary of the Treasury, 1789-
1795. By 1795, the United States, essentially a bankrupt country before 1789, had
strong public finances, a stable dollar based on specie, a banking system, a central
bank, and bond and stock markets in several cities. And just as the English had
succeeded the Dutch in economic and financial leadership, the Americans went on
within a century to succeed the English as the world's pre-eminent national economy.

NRSROS: BARRIER TO ENTRY

In 1975, the Securities and Exchange Commission (SEC) issued new rules that
crystallized the centrality of the rating agencies. To make capital requirements sensitive
to the riskiness of broker-dealers' bond portfolios, the SEC decided to use the ratings on
those bonds as the indicators of risk.

However, the SEC worried that references to "recognized rating manuals" were too
vague and that a "bogus" rating firm might arise that would promise "AAA" ratings to
those companies that would suitably reward it and "DDD" ratings to those that would
2
not. If a broker-dealer claimed that those ratings were "recognized," the SEC might
have difficulties challenging this assertion.

To solve this problem, the SEC designated Moody's, S&P, and Fitch as "Nationally
Recognized Statistical Rating Organizations" (NRSROs). In effect, the SEC endorsed
the ratings of NRSROs for the determination of the broker-dealers' capital
requirements. Other financial regulators soon followed suit and deemed the SEC-
identified NRSROs as the relevant sources of the ratings required for evaluations of the
bond portfolios of their regulated financial institutions.

Over the next 25 years, the SEC designated only four additional firms as NRSROs, but
mergers among the entrants and with Fitch reduced the number of NRSROs to the
original three by the end of 2000. NRSRO designation had become a significant barrier
to entry into the bond-rating business because the SEC's support was quite important
for potential entrants. Moreover, the SEC neither established criteria for a NRSRO
designation nor provided any justification or explanation as to why it "anointed" some
firms with the designation and refused to do so for others.

Also importantly, in place of the "investor pays" model established by John Moody in
1909, the agencies converted to an "issuer pays" model during the early 1970s whereby
the entity that is issuing the bonds also pays the rating firm to rate the bonds. This
change opened the door to potential conflicts of interest: A rating agency might shade
its rating upward so as to keep the issuer happy and forestall the issuer's taking its
business to a different rating agency.

In the bond-information market, experience, brand-name reputation, and economies of

scale are important features. The industry was never going to be a commodity business
of thousands (or even hundreds) of small-scale producers. Nevertheless, regulators'
actions surely contributed heavily to the dominance of the three major rating agencies.
The SEC's belated efforts to allow wider entry into the NRSRO category during the
current decade were too little and too late. The entrants could not quickly overcome the
advantages of the "big three's" incumbency.

FUELING THE SUBPRIME DEBACLE

To a large extent, subprime lending fueled the U.S. housing boom that began in the late
1990s and ran through mid-2006.1The securitization of the subprime mortgage loans,
3
in collateralized debt obligations (CDOs) and other mortgage-related securities,
encouraged subprime lending and led to the development of other financing structures,
such as "structured investment vehicles" (SIVs), whereby a financial institution might
sponsor the creation of an entity that bought tranches of the CDOs and financed its
purchase by issuing short-term "asset-backed" commercial paper (ABCP). If rating
agencies rated the CDO tranches in an SIV favorably, that favorable rating
concomitantly meant high ABCP ratings (interest-rate risk and liquidity risk were
apparently ignored in the ratings). Hence, the agencies' favorable ratings of mortgage-
related securities were crucial for the securitization process.

Favorable ratings were important for at least two reasons: First, as has been discussed
above, ratings had the force of law with respect to regulated financial institutions'
abilities and

incentives (via capital requirements) to invest in bonds. Furthermore, in addition to the

prohibition on banks and savings institutions holding sub-BBB bonds, there was
another major impact of ratings: Mortgage-backed securities including CDOs rated AA
or better and issued by non-governmental entities qualified for the same reduced capital
requirements 1.6 percent of asset value as those issued by Fannie Mae and Freddie
Mac, instead of the higher (4 percent) capital requirement that applied to mortgages and
lower-rated mortgage securities. Higher ratings on larger fractions of the tranches that
flowed from any given package of mortgage securities thus meant that regulated
financial institutions could more readily buy these larger fractions. Second, the
generally favorable reputations that the credit rating agencies had established in their
corporate and government bond ratings meant that many bond purchasers—both
regulated and non-regulated—were inclined to trust the agencies' ratings on the
mortgage-related securities, even or, perhaps, especially if the market yields on those
securities were higher than on comparably rated corporate bonds.

Meanwhile, the profits from gaining higher ratings on a larger percentage of tranches
also motivated securitizes. These higher-rated tranches carried lower interest rates,
which issuing firms would have to pay to the investors in those tranches, leaving a
greater spread for the securitizes. Consequently, securitizes would be prepared to

scenario rests on whether bond buyers can ascertain which advisors provide reliable
4
advice. If they can (which seems reasonable, since the major trans actors in the bond
markets are financial institutions), then they would be willing to pay higher prices (and
thus accept lower interest yields) on the bonds of any given underlying quality that is
rated by these reliable advisors. The competitive process would determine the outcome

of the "issuer pays" business model.

5
1.2 DEFINATIONS OF CREDIT RATING
The term credit rating has been defined by different authorities.

Credit rating is an analysis of the credit risks associated with a financial instrument or a
financial entity. It is a rating given to a particular entity based on the credentials and the
extent to which the financial statements of the entity are sound, in terms of borrowing
and lending that has been done in the past.

A credit rating is a measurement of a person or business entity’s ability to repay a

financial obligation based on income and past repayment histories. Usually expressed
as a credit score, banks and lenders use a credit rating as one of the factors to determine
whether to lend money. Individuals receive credit ratings from one of the three major
credit reporting agencies in the U.S.: TransUnion, Experian and Equifax.

A score or grade that a company or organization gives to a possible borrower and that
indicates how likely the borrower is to repay a loan.

A credit rating is an opinion of a particular credit agency regarding the ability and
willingness an entity (government, business, or individual) to fulfil its financial
obligations in completeness and within the established due dates. A credit rating also
signifies the likelihood a debtor will default. It is also representative of the credit risk
carried by a debt instrument – whether a loan or a bond issuance.

In personal finance, the term credit rating commonly refers to a score issued by the Fair
Isaac Corporation (a "FICO score"). A person's credit rating indicates how creditworthy
he or she is.

Credit Rating can be defined as the assessment of the ability of the borrower, to
discharge their financial obligations. It is an approximation of the creditworthiness of
an individual, entity or commercial instrument, considering various factors,
representing the capability and willingness to pay financial commitments in time.

6
1.3 ROLE AND IMPORTANCE OF CREDIT RATING
1. Business Analysis

A credit rating company will analyze 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 analyzed.

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

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 labor 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 willful 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

7
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 understatement 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
criterion.

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. Goal’s philosophy and strategy

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

8
organization by rating agency.

14. Labor turnover

How far the nonalignment is looking after the welfare of its labor? What is the extent of
punctuality, discipline and morale of the labor 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,
substandard, doubtful and bad assets will also be taken into account while granting
credit rating.

9
1.4 FUNCTIONS OF CREDIT RATING AGENCY

10
Credit rating has gained wide significance among investors and in Indian financial
market in the last two decades. Credit rating is simply an opinion on the credit quality
of a firm i.e. The ability of debt issuing firm to service the instrument. Want to learn
more about the system of credit rating? Join our course on the Credit Analysis Process
at Elearnmarkets.com.

Assessment of credit quality calls for expertise which credit rating agencies should
possess. The rating issued by a rating agency serves as summary information about
credit quality for economic decision makers. As long as the agency assigning the rating
is perceived as being credible, economic decision-makers would not evaluate the inputs
that go into the rating process.

Some of the key functions of credit rating agencies are discussed below:

➢ Low-cost information: - The credit rating agency collects, analyses, interprets

and makes a proper conclusion of any complex data and transforms it into a
very lucid and easily understandable manner.

➢ Provides a basis for suitable risk and return: - The instruments rated by rating
agency gets greater confidence amongst investor community. It also gives an
idea regarding the risk associated with the instrument.

➢ Helps in the formulation of public policy: - If debt instruments are

professionally rated, it becomes very easy to judge the eligibility of various
securities for inclusion in the institutional portfolio with greater confidence.

➢ Provides superior information: - Credit rating agency being an independent

rating agency, due to highly trained and professional staffs and with the access
to information which is not publicly available information, these agencies are
able to deliver superior information.

➢ Enhances corporate image: - Better credit rating for any credit investment
enhances visibility and corporate image in the industry.

11
1.5 ADVANTAGES OF CREDIT RATIONING

Benefits of Credit Rating to Company as summarized below:

(1) 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 though yielding marginally lower rate of return.

(2) 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.

(3) 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.

12
(4) 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.

(5) Motivation for growth:

Rating provides motivation to the company for growth as the promotors feel confident
in their own efforts and are encouraged to undertake expansion of their operations or
new projects. With better image created though 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.

(6) 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’.

(7) Benefits to brokers and financial intermediaries:

Highly rated instruments put the brokers at an advantage to make less efforts in
studying the company’s credit position to convince their clients to select an investment
proposal. This enables brokers and other financial intermediaries to save time, energy,
costs and manpower in convincing their clients about investment in any particular
instrument.

13
1.6 DISADVANTAGES OF CREDIT RATING
Disadvantages of Credit Rating are as follows:

(1) Biased rating and misrepresentations:

In the absence of quality rating, credit rating is a curse for the capital market industry,
carrying out detailed analysis of the company, should have no links with the company
or the persons interested in the company so that the reports impartial and judicious
recommendations for rating committee. The companies having lower grade rating do
not advertise or use the rating while raising funds from the public. In such cases the
investor cannot get information about the riskiness of instrument and hence is at loss.

(2) Static study:

Rating is done on the present and the past historic data of the company and this is only
a static study. Prediction of the company’s health through rating is momentary and
anything can happen after assignment of rating symbols to the company.

Dependence for future results on the rating, therefore defeats the very purpose of risk
inductiveness of rating. Many changes take place in economic environment, political
situation, government policy framework which directly affect the working of a
company.

(3) Concealment of material information:

Rating Company might conceal material information from the investigating team of the
credit rating company. In such cases quality of rating suffers and renders the rating
unreliable.

(4) Rating is no guarantee for soundness of company:

Rating is done for a particular instrument to assess the credit risk but it should not be
construed as a certificate for the matching quality of the company or its management.
Independent views should be formed by the user public in general of the rating symbol.

(5) Human bias:

Finding off the investigation team, at times, may suffer with human bias for
unavoidable personal weakness of the staff and might affect the rating.

14
(6) Reflection of temporary adverse conditions:

Time factor affects’ rating, sometimes, misleading conclusions are derived. For
example, company in a particular industry might be temporarily in adverse condition
but it is given a low rating. This adversely affects the company’s interest.

(7) Down grade:

Once a company has been rated and if it is not able to maintain its working results and
performance, credit rating agencies would review the grade and down grade the rating
resulting into impairing the image of the company.
(8) Difference in rating of two agencies:

Rating done by the two different credit rating agencies for the same instrument of the
same issuer company in many cases would not be identical. Such differences are likely
to occur because of value judgement differences on qualitative aspects of the analysis
in two different agencies.

15
1.7 SERVICES OF OFFEERD BY CREDIT AGENCY RATING
Corporate Debt Rating

Rating of corporate debts is the commonest form of rating product offered by CRAs. It
is a symbolic representation of CRA’s opinion on the relative capability of the
corporate entity concerned to timely service its debt obligations with reference to the
instrument rated. Debt instruments may range from short-term Fixed Deposit and
Commercial Paper to long-term Bonds or Debentures. For the purpose of bringing
about greater disclosure standard in the debt market, SEBI made the rating of any issue
of debt securities mandatory vide circular No. SEBI.MRD/SE/AT/36/2003/30/09 dated
September 30, 2003. The model listing agreement for listing of debt securities
(SEBI/CFD/DIL/CIR-39/2004/11/01, Nov.1, 2004) also requires that a half-yearly
communication countersigned by debenture trustees containing, among other
particulars, credit rating must be made by the issuer to its debenture holders.
Amendment to the SEBI (Disclosure and Investor Protection) Guidelines, 2000
[Circular No SEBI/CFD/DIP/ 29/2007/03/12 (date 3-12-2007)] further clarifies that the
issuer is allowed to make public issue of a debt instrument, which has been rated below
investment grade. While SEBI regulates most of the 53 corporate debt instruments,
RBI is responsible for the regulation of Commercial Paper and few other debt
securities. The RBI by its circular IECD.3.15.01/2000-2001, dated October 10, 2000,
has made it compulsory for all eligible participants to obtain a minimum specified
credit rating for issuance of Commercial Paper (see for detail, chapter 5B).

IPO Grading

IPO grading is an independent and professional assessment of equity issues of the

companies accessing the equity market for the first time, where there is no track record
of their market performance. A potential investor has limited access to information
about an unlisted company and may find it difficult to appropriately assess its business
prospects and risks. IPO ratings address this critical issue. The grade assigned by a
CRA to any individual IPO is a symbolic representation of rating agency’s assessment
of ‘fundamentals’ of the issuer concerned relative to other listed securities. The IPO
grading does not take into consideration the price of securities; nor is it an investment

16
recommendation. Rather, it is one of the inputs to the investors for their decision-
making. According to CRISIL, “Investment decisions in the equity markets are at

present based on voluntary, non-standard and sometimes complex disclosure

documents that are a challenge to the investors to interpret on their own and take
informed decisions”

Equity Grading

Although IPO grading has become a familiar name, the concept of equity rating has not
much taken off in India. However, international rating agencies like Moody’s and
Standard & Poor’s have long been giving opinion on the quality of equity issued by
various companies. While making portfolio allocations, an agent of household sector
may find it difficult to judiciously trade-off between risk and return associated with a
particular option. Moreover, a cautious investor shows greater inclination towards a
recognized player, i.e., a name, which has already earned reputation. But, a wide
information asymmetry towards the prospective investors jeopardizes the effective
functioning of capital market. The rating agencies undertake the task of making a
skilled evaluation of relative quality of an equity issue, which the investors with
heterogeneous background may not be able to do. In 1995, ICRA first started rating
equity issues in the form of Earning Prospects and Risk Analysis (EPRA). It covers the
(i) grading of primary market and (ii) assessment of secondary market.

Mutual Fund Rating

Mutual funds have become a popular vehicle of investment for both retail and
institutional investors worldwide. It has flooded Indian market as well. A large variety
of mutual fund schemes with different investment styles and objectives are available in
the market. Fund managers can plan their portfolios in a variety of ways. The
increasing importance of mutual fund has led to greater focus on their performance
evaluation. The system of ranking mutual funds is in vogue since long. But such
rankings do not take into consideration the critical qualitative aspects that are essential
indicators of the health of the fund. Given their scheme- oriented objective of
evaluation, the factors such as organizational structure, quality of management and
operational practices are not given due weights. To bridge this gap, credit rating 59
agencies came up with mutual fund rating products. CRISIL names it ‘Fund
17
Governance and Process Quality Rating’. CARE terms, it ‘Fund Credit Quality Rating’
while Fitch India’s ‘Asset Management Rating’ is composed of ‘Bond Fund Rating’
and ‘Volatility Rating’. ICRA calls it by the simple name ‘Mutual Fund Rating’.
Whatever be the nomenclature, it is basically an assessment of the overall credit quality
and relative sensitivity of the total return to a broad array of assumed changes in the
market-conditions. Rating agencies evaluate the organization-level qualitative factors
covering all aspects of operational practices, quality of management, strength of
organization and promoters etc. While assessment of organizational factors does not
guarantee sustainability of future performance, it may be expected that good
governance practices and well- structured processes will be reflected in superior and
consistent performance on key parameters. They focus, besides management quality,
on diversification of asset portfolio, track record in fund management, strength of
management information system and risk management systems at various operational
areas, disclosure levels and regulatory compliance records. Qualitative assessment and
benchmarking on key parameters may provide an insight into the potential future
performance leading to the success of asset management companies. Thus, mutual fund
rating is aimed at providing investors with an opinion on the relative credit quality of
the portfolio. At the same time, intermediaries are provided with guidance as to
offering the investors products that best match the specific risk-return preference of
investors. It also enhances the marketability of various schemes. Rating agencies obtain
data for the purpose of their analysis from both public and non-public sources. They
usually scan prospectus and other related documents to 60 extract debt portfolio data
including periodic investors’ reports and public filings, industry survey reports, in-
house documents describing the AMC structure, investment philosophy and
performance track record. CRAs use Credit Matrix as a tool for analyzing the
investment portfolio by measuring their aggregate credit quality. A credit score is
assigned to each rating category. The score is essentially a function of the credit quality
or rating of the security and its residual maturity. Credit scores are usually arrived at
using historical data on defaults adjusted for data limitations. Credit scores are lower
for higher ratings and vice-versa. The portfolio’s weighted average credit quality is
measured against appropriate benchmark credit score. Long- term mutual funds are
usually rated on 8-point scale, while short-term ones are rated on 5-point scale.
18
Bank Loan Rating

Bank loan rating (BLR) is CRAs’ opinion on the relative degree of risk associated with
timely payment of interest and repayment of principal on a specified bank facility.
Banks need to use BLR for determining the risk weights for their loan exposures as
required by the RBI Guidelines for implementation of the new Capital Adequacy
Framework. The RBI Guidelines 2007 offers a significant relief in the capital a bank
must hold against their corporate loan exposures. Rated corporate exposures (both
fund-based and non-fund-based) are to be weighted in accordance with the ratings
assigned by the rating agencies. Thus, banks with ‘AAA’ rating enjoy 80% relief

while the ones with lower rating grades can avail smaller degree of relief (refer to
Table 3.1). One with ‘BBB’ rating or below enjoys no relief with 100 percent risk
weights. Similarly, short- term risk weights are also linked with ratings obtained (refer
to Table 3.2). Thus, higher the credit rating, higher the capital release and hence, larger
the savings. Therefore, BLR helps in pricing of credit risk by banks. Borrowers enjoy
the share of relief due to the banks in the form of lower pricing of loans. Thus, BLR
may provide a higher level of comfort to the prospective and existing investors and
lenders. It also helps to develop a secondary market for loans by providing a uniform
scale for analyzing credit risk of bank loans. This may, over time, lead to the
development of credit default swap market in which BLR will be an essential element.
Besides, BLR is expected to expedite the loan-approval process. BLR products may be
tailored to suit the specific need of the transactions. It may be either an issue-specific
long-term rating or a rating of cash credit facilities or rating of other working capital
facilities (fund-based or non-fund-based). CRAs use an 8-point scale for long-term
loans and a 5-point scale for the short-term loans. Rating criteria for bank loan rating
feature all the factors considered for bond or debenture ratings. 62 Therefore, all
relevant factors that have bearing on the future cash generation and debt servicing
ability of the issuers are considered as useful inputs. These include industry
characteristics, regulations, competitive position of the issuer, operational efficiency,
management quality, commitment to new projects etc. Past financial statements as well
as future earning prospect over 3-5 years are also paid due weights.

19
Structured Finance Rating

Structured Finance Rating (SFR) is a CRA’s opinion on the likelihood of the rated
structured instrument servicing its debt obligations in accordance with the terms. SFR
involves the assessment of the risks associated with the individual components of the
structured instrument. It is an estimation of expected loss on rated instruments.
Expected loss is a product of probability of default and severity of loss, once the default
occurs. It takes into consideration credit quality of the underlying assets as also the
legal risks associated with it. An SFR is different from the credit rating of the obligor
as it is based on the strength of the underlying assets and structures. Structured finance
rating may entail the securities such as Asset-Backed Securitization (ABS), Mortgage-
backed Securitization (MBS), Collateralized Debt Obligation (CDO), Future Flow
Transaction or Partial Guarantee Structures (PGS). The symbols used for SFR are
similar to credit rating symbols, except that it carries a suffix of ‘SO’ within the
parentheses alongside. As per S&P, in structured finance “either an issuer or an
investment bank as the arranger presents a proposed structure. The rating analysts give
their preliminary views as to what the rating will be based upon. The arranger in
response may change aspects of the transactions to achieve a better rating or accept the
lower rating—or will not proceed with the rating on the transaction. Some corporate
issuers may 63 change their business or capital structure (often their funding plans) in
order to achieve a particular rating in the same way that structured finance issuer may
adjust the transaction structure to achieve a certain rating. It is also worth pointing out
that this type of interaction between corporate issuers and rating agencies is precisely
what the international regulatory community has been urging on the agencies.” Thus,
rating of structured finance initially begins with advisory function and finally takes the
shape of rating. Given the inherent complexities in the structured finance space, a
greater dialogue between the CRAs and the issuer’s acts as a prelude to the rating that
helps in better management of clientele. 70 CARES devised a rating system that
encompasses all the main players of the real estate sector. The players in the sector to
be graded are: (i) Project Developer/ Sponsor (ii) Consultant (iii) Construction
Contractor and (iv) The Project. CRISIL offers (i) Developer Rating and (ii) Project

20
Ratings. Most of the housing developers rated by the CRAs are in the premium
segment, catering to the higher end of the market. CRISIL uses a 5-point scale for both
the ratings.

Healthcare Grading

Healthcare grading is a dynamic and continuous rating system to check deficiency in

services in the health care sector. “This is being done to bring accountability in
hospitals,” says PK Hota, Union Health Minister, in his address at a seminar organized
by the National Consumer Dispute Redressal Commission, in April 2006. Hospitals,
both private and public, are invited to register themselves and get accredited depending
on their technical capabilities, prevalent expertise and protocol. A committee headed by
Union Health Minister was assigned the charge of monitoring the accreditation process
of hospitals

21
 CHAPTER 2

RESEARCH METHODOLOGY

2.1 Research Organization

CRISIL

The basic concept of 'Default is not defined and remains a subjective term. Con-
sistency demands that it needs to be defined, so as to be reliably measured and
understood in the same sense by all the concerned stakeholders. Also, it is observed
that some sudden downgrades are taking place to the extent of greater than 1 notch,
within a short time span. This is a matter of concern and needs to be addressed.

It is learnt that the choice of the rating agency is, to an extent, guided by the investors,
especially institutional investors and lenders. This tends to reduce the instances of
conflict of interest in the appointment of rating agencies, who also offer advisory
services to the rated entity.

Sometimes, a tendering' process is followed for choice of a rating agency. This may

not be the best method for selecting an agency, as comparison of capabilities is lost

The number of management declarations being relied upon by the auditors could be a
metric for ascertaining the robustness of the audit process. There is a need to come up
with a comprehensive set of metrics, open to all stake-holders.

Rating symbols need to be standardized. The way the rating committee is formed also
needs to be understood, in order to determine the robustness of the rating process,
Brickworks awards an AAA+, a symbol not hitherto not used or awarded. Such
practices, like AAA+ or AAAA need to be standardized. A study of the business model
for rating agencies is required. There is no common website for CRA information and
comparison. All ratings are not public. Competence reduces asymmetric information
when adverse information is not shared by the issuer. Regulation will facilitate a
commonly accepted matrix. A rating exercise generally raises the competence of the

22
issuer company in de-risking the business. Advisory services shifted to a separate
company.

ICRA

Assignments can be completed in 3 weeks if all information is received Rating criteria

are published After sales services are important. In constant touch with investors
Dissemination of information is free of cost Analysts disclose their interests as per the
SEBI Code.

Rating transitions published Surveillance is on an annual basis or earlier, if situation

demands A reasonable due diligence is carried out. Third party confirmation is more an

Exception:

Constantly adding manpower resources Cannot assign ratings based on unconfirmed

Can reduce information asymmetry if both issuer and investors keep ICRA in the No
fixed weights for rating criteria loop Ratings could change since they are based on the
judgement of the team. Due to subjectivity, judgement could vary. Bankers of
borrowers are more concerned if ratings are downgraded, since they have to set aside
more capital to cover additional credit risk.

CRAS depend on the audit report and their job is not to police. The primary
responsibility for financial statements is on the managements of issuer companies
Issuers shop for informal ratings and get the final rating done by the most favorable
CRA. The solution to this is to get all ratings published Advisory services shifted to a
separate company.

CARE

The business is manned by Finders, Minders and Grinders Press releases contain the
names of analysts and contact persons A Quarterly review is carried out on all ratings

A detailed review is carried out if there is a specific reason Event driven also Ratings
are completed in 3 to 4 weeks provided the clients cooperate Clients usually cooperate,
since it is relevant to their working capital enhancements and banks insist on them for
the Basel II compliance norms Rating committee meeting every week.

23
Due to competition and economic slowdown, there are instances of fee undercutting A
150-strong analyst team provides comprehensive inputs and serve as a cross check.
(However, this may bring in the view of analysts who do not have an arm's length
relationship with the issuer). There is an external committee consisting of 6 members

DFIs take ratings as one of the inputs. They do their own DDR Rating scale uniformity
required across CRAS An operational audit, in addition to a financial audit, will enable
better housekeeping and sprucing up of systems. CRAS have provided early warnings
to the financial markets by giving non-investment grade ratings to Collective
Investment Schemes (CIS) and IPOs

SEBI and other regulators could take the initiative to prevail upon issuers to display
better governance and disclosure standards.

Fitch India

No external committee members. Everything is internal Minimum quorum for a

meeting is 4. Not overawed by the reputation of the issuer Have international experts
and expertise intertwined with operational personnel International best practices
ingrained in day-to-day operations Look at origination standards critically

Provide draft Press Release to issuers only to rectify factually incorrect details Juniors
vote first so as to avoid influence of seniors (this is a special procedure for Asia)

All dissents and rationale to be recorded in writing to remove emotional bias Rationale
for Appeals to be structured, logical and in writing the issuer decides which CRA is to
be appointed. Investors sometimes have a say Decline assignment upfront if it is found
that client's information is inadequate.

As a matter of policy, no advisory services are rendered Surveillance is on a rolling

basis. It is a part of the tracking analyst's job to keep ratings fresh and current. There is
also a provision for event-driven review of ratings Review meetings schedule to be
adhered to strictly to keep ratings current Internal teams share information with each
other.

The rating agency is the bridge between the issuer and investor Generally, the audited
results are trusted Both qualitative and quantitative factors are taken into consideration.
24
Ratings are based on a simple EXCEL spreadsheet, to prevent model risk.

Brickworks

New CRA, having expertise from former employees of CRISIL and ICRA Basic
Research teams as well as sector specialist teams All surveys are done by a minimum
team size of 2 members Reduced dependence on external experts Consensus developed
at each stage of rating Investors can seek clarifications on ratings Evidence is collected
from sources other than Financial Statements also Attempts made to build direct lines
of information with issuers to reduce asymmetry Identifies who is responsible in an
issuer organization, for taking the onus of repayment Ratings are subjective despite the
availability of sufficient numerical information Delays are counted as defaults.

25
2.2 Objectives Of the Study

1. To assess an individual's or a company's creditworthiness

2. To Adequacy of cash flow

3. To provides market position of the company within the industry

4. To helps individual and institutional investors in making inform investment

decisions

5. To enable intermediaries to place Debt instruments with investors by providing them

with an effective marketing tool.

6. To create awareness about credit rating amongst merchant brokers, corporations,

brokers, regulatory authorities and others

7. To helps in public policy formation

8. Does an evaluation of industrial risk.

9. To provides a solid basis for Risk and return.

10. Two facilitates the protection of earnings.

26
2.3 Statement Of the Problem

• The information pertaining to the history, origin and evolution of credit rating and its
types will remain the same but there would be certain updates in future depending upon
upgradations and automations.

• The data shown in the swot analysis is subjected to certain changes in future there
would be certain additions to strengths and weakness as upgradations may takes place
in credit rating standards.

• The secondary data is collected from websites, journals and books and may differ
from region to region depending upon the prevailing laws and from organization to
organization depending upon the nature.

• Documents may lack authenticity parts of the document might be missing because of
age, and we might not even be to verify who actually wrote the document, meaning we
cannot check whether its biased or not.

• Due constraint of time it was not practically possible to include all possible element
though major elements are covered that justifies the topic of study

27
2.4 Need For Study

1. Their projects are helpful in knowing the concept of credit rating, its features its
advantages and disadvantages and helps in in depth study of credit rating as whole.

2. This project is helpful to the new researchers as it will act guide and a firm
reference on which they can rely and commence with research work.

3. This project is also useful to the government organization as its show’s statistics
pertaining to different types of credit rating, average periodicity, major documents
verified, and type of approach adopted by credit rating agency.

4. The project will give overall view of the credit rating and its various aspects and
may be useful to credit rating firm as it will help new recruit or interns to have a
general knowledge about credit rating function.

Duration of study: The study was conducted roughly for period of 1 months in which
secondary data was gathered from various resources such as research report published
by scholar and business analysts, websites, journals, books Etc.

IMPORTANT ELEMENTS THAT ARE COVERED:

This study document emphasizes on various aspects of auditing such as its

1. Origin and evolution - John Moody is credited with initiating agency bond ratings,
in the United States in 1909. Exactly three centuries earlier, in 1609, the Dutch
revolutionized domestic and international finance by inventing the common stock-that
of the Dutch East India Company- and founding a proto-central bank, the Wissel bank
or Bank of Amsterdam. In 1609, the Dutch had already had a government bond market
for some decades. 1 Shortly thereafter, the Dutch Republic had in place, in one form or
another, all of the key components of a modern financial system: a strong public credit,
a stable money, elements of a banking system, a central bank of sorts, and securities

28
markets. The Dutch Republic went on to become the leading economy of the

seventeenth century. In 1688, the English emulated the Dutch in the most flattering of
ways, by inviting the Dutch leader, William of Orange, to be their king. William
brought experienced Dutch financiers with him to England, and in short order England,
too, had all the key components of a modern financial system-the Bank of England, for
example, was founded in 1694. England, of course, went on to have the first industrial
revolution and to become the leading economy of the world in the eighteenth and
nineteenth centuries. 2 A century later in the newly independent United States,
Alexander Hamilton, the Founding Father most aware of the Dutch, English (and also
French) financial precedents, worked to put in place, in even shorter order, a similarly
modern financial system during his term as the first Secretary of the Treasury, 1789-
1795. By 1795, the United States, essentially a bankrupt country before 1789, had
strong public finances, a stable dollar based on specie, a banking system, a central
bank, and bond and stock markets in several cities. And just as the English had
succeeded the Dutch in economic and financial leadership, the Americans went on
within a century to succeed the English as the world's pre-eminent national economy.

2. Various definition quoted by scholars - Credit rating is an analysis of the credit risks
associated with a financial instrument or a financial entity. It is a rating given to a
particular entity based on the credentials and the extent to which the financial
statements of the entity are sound, in terms of borrowing and lending that has been
done in the past.

A credit rating is a measurement of a person or business entity’s ability to repay a

financial obligation based on income and past repayment histories. Usually expressed
as a credit score, banks and lenders use a credit rating as one of the factors to determine
whether to lend money. Individuals receive credit ratings from one of the three major
credit reporting agencies in the U.S.: TransUnion, Experian and Equifax.

3. Role and importance-

Evaluation of industrial risks

Every industry will have its risks which are due to natural or market conditions such as

29
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.

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

Operating efficiency

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 labor relations. These will be looked into by the credit
rating agency.

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 willful fraud for
attracting more funds. So, the contents of prospectus will also be a factor for credit
rating considerations.

4. Function of credit rating-

Low-cost information: - The credit rating agency collects, analyses, interprets and
makes a proper conclusion of any complex data and transforms it into a very lucid and
easily understandable manner.

Provides a basis for suitable risk and return: - The instruments rated by rating agency
gets greater confidence amongst investor community. It also gives an idea regarding
the risk associated with the instrument.
Helps in the formulation of public policy: - If debt instruments are professionally rated,
it becomes very easy to judge the eligibility of various securities for inclusion in the
institutional portfolio with greater confidence.
30
5. Advantages and disadvantages-

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 though 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.

Concealment of material information:

Rating Company might conceal material information from the investigating team of the
credit rating company. In such cases quality of rating suffers and renders the rating
unreliable.

Equity Grading -Although IPO grading has become a familiar name, the concept of
equity rating has not much taken off in India. However, international rating agencies
like Moody’s and Standard & Poor’s have long been giving opinion on the quality of
equity issued by various companies. While making portfolio allocations, an agent of
household sector may find it difficult to judiciously trade-off between risk and return
associated with a particular option. Moreover, a cautious investor shows greater
inclination towards a recognized player, i.e., a name, which has already earned
31
reputation.

Mutual Fund Rating -Mutual funds have become a popular vehicle of investment for
both retail and institutional investors worldwide. It has flooded Indian market as well.
A large variety of mutual fund schemes with different investment styles and objectives
are available in the market. Fund managers can plan their portfolios in a variety of
ways. The increasing importance of mutual fund has led to greater focus on their
performance evaluation. The system of ranking mutual funds is in vogue since long.

32
2.5 Research Methodology
Research methodology can be defined as “A system of model, procedures and
techniques used to find the result of a research problem. It is used in the investigation
of nature and matter to effectively analyze and interpret ate the data scientifically.

The data is collected using to methods

• Primary data: To gain the in-depth knowledge and insight a well-structured

questionnaire was prepared and was presented to the auditors of a charted
accountant and audit firm. In addition, discussion and interview was also
conducted to obtain the necessary first-hand information to fulfil the objectives
of the study.

• Secondary data: Factual, accurate and reliable statistical data regarding history
and evolution, features and characteristics of credit, importance and types of
credit were collected from online medium such as company magazines,
research reports, company sites and newspaper sites and journals published by
accounts and credit experts and was critically evaluated.

33
2.6 Hypothesis
1. The values of the key financial variables, of the select companies (sample) belonging
to the

same rating class/grade, should not be different from each other for all the rating
agencies

covered in the study (which implies the variance should be minimum, this highlights
the

internal consistency that exits). This confirms that rating methodology followed by
each

agency is consistent internally.

H0

: There is no difference in the values of the nine important financial variables of select

companies (sample) that belong to same grade/class of CRISIL, CARE, ICRA and
INDIA

RATINGS (Internal Consistency exists)

H1

: There is a difference in the values of the nine important financial variables of select

companies (sample) that belong to same grade/class of CRISIL, CARE, ICRA and
INDIA

RATINGS (Internal Consistency does not exists)

2. The key financial variables of select companies (sample) belonging to different

rating grades/

classes should differ from each other for all the rating agencies covered in the study
(Variance

should be maximum, external inconsistency exists) which implies that the rating
agencies have

34
considered different values of the key financial ratios in assigning the credit rating, and
hence

these financial factors become the important discriminating factors in deciding the
rating

H02: There is no difference in the values of the nine key financial variables of select
companies

(sample) that belong to different grade/class of CRISIL, CARE, ICRA and INDIA
RATINGS

H2

: There is a difference in the values of the nine key financial variables of select
companies

(sample) that belong to different grade/class of CRISIL, CARE, ICRA and INDIA
RATINGS

35
2.7 Scope of The Study
The scope of this study is to provide an insight into concept of credit rating and its role
and importance. This study also provides insight of the function of credit rating,
advantages of credit rating, disadvantages of credit rating, types of services provided by
credit rating agency. The objective of a credit rating is a measurement of a person or
business entity’s ability to repay a financial obligation based on income and past
repayment histories. Usually expressed as a credit score, banks and lenders use a credit
rating as one of the factors to determine whether to lend money. A credit rating is an
opinion of a particular credit agency regarding the ability and willingness an entity
(government, business, or individual) to fulfil its financial obligations in completeness
and within the established due dates. A credit rating also signifies the likelihood a
debtor will default. It is also representative of the credit risk carried by a debt
instrument – whether a loan or a bond issuance. The importance of credit rating stems
from the various reasons viz. 1 Evaluation of industrial risks 2. 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.3. Operating efficiency-
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 labor relations. These will be looked into by the credit
rating agency.4. 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 willful fraud for attracting more funds. So,
the contents of prospectus will also be a factor for credit rating considerations.

36
THE GENERAL PURPOSE OF RESEARCH STUDY IS AS FOLLOWS:

❖ To evaluate the importance of credit rating agency to organization diverse in

nature.

❖ To have in-depth knowledge regarding different services offered by crediting

Agency.

❖ To analyses the challenges faced by credit rating while performing function.

37
2.8 Limitation of The Study
LIMITATIONS OF THE CREDIT RATING:

Possibility of Blas Exist: The information gathered by the rating agency may be subject
to person of the rating team. However, rating agencies try their best to provide an
unbiased opinion of the city of the company and/or instrument, if not, they will not be
trusted.

Improper Disclosure May Happen: The company being rated may not disclose certain
material facts to t investigating team of the rating agency. This can have impact on the
quality of credit rating.

Impact of Changing Environment: Rating is done on basis of present and past data of
the company so it will be typical to predict the future financial position of the company.
Many changes take place due to changes in economic, political social technological,
legal and other environments All this will have its impact on the working of the
company being rated Hence, rating is not a guarantee for financial soundness of the
company Problems for New Companies There may be problems for new companies to
collect funds from the market

This is because a new company may not be in a position to prove its financial
foundries. Thus, it may receive lower credit ratings. This will make it typical to collect
funds from the market.

Downgrading by Rating Agency: The credit rating agencies periodically review the
ratings provided to a particular instrument. If the performance of a company is not as
expected, then the rating agency will downgrade the instrument. This will have its
impact on the image of the company Difference in Rating: There are cases, where
different ratings are provided by different rating agencies for the same instrument.
These differences may be due to many reasons This will create confusion in the minds

of the investor.

38
2.9 Data Collection Method

The data will be collected using both by primary data collection methods as well as
secondary sources.

➢ PRIMARY DATA— Most of survey information will be gathered

through primary sources by questionnaire method which was enclosed at the end of
project. The methods that will be used to collect primary data by questioning to
selectedsample.

➢ SECONDARY DATA — Articles, internet websites, news report, and

different reports published various agencies etc. are the source of secondary data of this
project of a study of Credit rating agencies in India will be collected from internet from
various websites from Google search engine

39
 CHAPTER 3

LITERATURE REVIEW
There are various research studies and report related to competition among rating
agencies. Becker, B., Milbourn, T. (2008) show that competition between the rating
agencies after the entry of Fitch to the market controlled previously by the duopoly of
Moody’s and S&P led to more issuer-friendly and less informative credit rating in the
bond market. However, there is little empirical evidence on the extent of rating
shopping in the structured finance market. Becker, B., Milbourn, T. (2011) in the
journal how did increased competition affect credit ratings? States that the credit
rating industry has historically been dominated by just two agencies, Moody’s and
Standard & Poor’s, leading to long-standing legislative and regulatory calls for
increased competition. The material entry of a third rating agency (Fitch) to the
competitive landscape offers a unique experiment to empirically examine how
increased competition affects the credit ratings market.

Dittrich (2007) analysis the credit rating economics and states that large credit rating
agencies have cost advantages, reputation over small agencies and face higher demand.
Factors such as official recognition and the structure of demand limit the strategic
options of rating agencies. As a result, the competition within the rating industry
can best be described as a collusive oligopoly. Doherty, Kardashev and Phillips
(2008) analyze why a rating agency pools different credit risks in one credit grade, and
how information disclosure depends on the value of information to the market. It
empirically tests the qualitative predictions of the model. Standard and Poor’s entry to
the insurance market that was previously covered by a monopoly agency, A.M. Best,
is used as a natural experiment to study the impact of competition on the information
content of ratings.

Ekins and Calabria (2012) in their study and analysis on regulation, Market Structure,
and Role of the Credit Rating Agencies present evidence that suggests the Securities
and Exchange Commission’s designation of NRSROs inadvertently created a de facto

40
oligopoly, which primarily propped up three firms: Moody’s, S&P, and Fitch.
Although CRAs were indirectly constrained by their reputation among investors, the
lack of competition allowed for greater market complacency. Regulators should work
to eliminate regulatory reliance on credit ratings for financial safety and soundness.
These regulatory reforms will, in turn, reduce CRA oligopolistic power and the
artificial demand for their ratings. Securities Exchange Commission (SEC) in its
Annual report on NRSRO (2015) analyses NRSRO statistics for competition, industry
concentration, revenue growth and market share developments. It also discusses
barriers to entry, transparency, disclosure requirements, and conflicts of interest for all
the NRSRO in the credit rating industry.

ESMA (2015) states that the Article 8d of the CRA Regulation requires the European
Securities and Markets Authority (ESMA) to publish a list of registered CRAs and the
types of credit ratings they issue together with a calculation of CRAs’ market shares
each year. The market shares are calculated using CRAs’ revenues from credit rating
activities and ancillary

Journal of Accounting and Finance services at group level. ESMA (2015) in its
technical advice provide its views on the functioning of the credit rating industry and
the impact of specific provisions of the CRA Regulation regarding conflicts of interest,
competition and structured finance instruments (SFIs). European Commission (2014)
in a study on the state of the credit rating market focused on enhancing competition in
the credit rating market, while addressing conflicts of interest and enhancing disclosure
on structured finance instruments. Potential measures that could improve competition
such as a harmonized credit rating scale across CRAs, developing a track record score,
making amendments to the ECB’s selection of approved CRAs, and issuers appointing
CRAs by competitive tender were identified.

Hirth(2013) in the theoretical framework analyzes the interaction of credit rating

agencies on a market to find how honest rating behavior can be achieved. A market
with solely honest rating agencies can be achieved in the hypothetical case of perfect
competition. Alternatively, it can be implemented by regulatory measures such as
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abolishing the current “issuer pays” model or by a centralized monitoring of ratings
quality. Scrota and Veldkamp (2009) in their equilibrium model state that when assets
are simple, agencies ratings are similar and the incentive to ratings shop is low. An
increase in the complexity of recently-issued securities create a systematic bias in
disclosed ratings, despite the fact that each ratings agency produces an unbiased
estimate of the asset's true quality. It is also illustrated how more competition in ratings
markets could make the distortions in ratings even more severe.

NISM (2009) in its Assessment of Long-Term Performance of Credit Rating Agencies

in India attempts to assess the performance of CRAs, particularly in the light of the
significant events in the global financial system and the criticism being faced by CRAs
in USA. The hearing conducted by OECD (2010) discusses the role of CRAs in the
financial crisis and the need of reform in the credit rating market. Existing regulation in
USA and Europe post financial crisis have been discussed. There is convergence in
regulation of CRAs by ESMA and SEC. The credit rating market is a natural oligopoly,
with three Credit Rating Agencies (CRAs) accounting for more than 90% of the
market. Various regulatory reforms and initiatives taken up

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 CHAPTER 4
DATA ANALYSIS & INTERPRETATION

4.1 Summary and Analysis About the Survey

In the following questions, the respondents were asked the purpose of

investment, to which 48.8% responded that for tax exemption is the purpose of
investment ,48.8% responded that for security purpose is the purpose of investment,
37.5% responded that for capital appreciation is the purpose of investment and 40%
responded that for returns on investment is the purpose of investment.

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 In the following questions the respondents were asked which factor do you
consider before investment, to which 48.8% responded that they are ready to bear high
risk to get higher returns, where as 42.5% responded that they are ready to bear
moderate risk to get moderate returns back and 8.8% responded that they are ready to
bear low risk to get lower returns back.

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 In the following questions the respondents were asked in which sector you have
invested in the instruments of banking sector or corporate sector, to which 50 % people
responded that they have invested in corporate sector where as 56.3% people responded
that they have invested in the instruments of banking sector. From this we can conclude
that a greater number of people are interested to invested in banking sector as compared
to corporate sector.

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 In the following question the respondents were asked that do they have
knowledge about credit rating agencies out of which 67.5% people responded that
“YES” they have knowledge about credit rating agencies where as 16.2% do not have
any knowledge about credit rating agencies.

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 In the following questions respondents were asked about their opinions about
credit rating agencies to which 27.5% responded that it’s simply a grading system
where as 32.5% responded that it shows the exact final position of the company, 18.8%
responded that it’s an indicator of credit risk where as 13.8% responded that it’s just a
marketing strategy of the issuing company.

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 In the following question respondents were asked that whether they think that
number of credit rating agencies in India are enough or not to which 52.5% of the
respondents responded “yes” that credit rating agencies in India are enough where as
21.3% responded that number of credit rating agencies in India should be increased.

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 In the following question the respondents were asked their choice of investment
to which 52.5% responded that they would like to invest in bank term deposits where
as 51.2% responded that they would like to invest in bonds, 58.8% responded that they
would like to invest in fixed deposits, 43.8% responded that they would like to buy
debentures, 31.3% responded that they would like to invest in Government Securities
and 20% responded that they would like to invest in commercial papers.

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 In the following question respondents were asked that what are the sources of
your knowledge about credit rating agencies to which 53.8% respondents responded
that they come to know through newspapers,46.3% respondents responded that they
came to know from market source, 41.3% respondents responded that they came to
know about credit rating agencies through Prospectus,26.3% respondents responded
that they got the knowledge from magazines, 31.3% responded that they came to know
from Credit Rating Agency Guides and 30% respondents responded that they came to
know from Friends and fellow company.

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 In the following question the respondents were asked which credit rating
agency will they prefer to which 33.8% responded that they will prefer CRISIL,18.8%
responded that they will prefer ICRA, 25% responded that they will prefer CARE and
10% respondents responded that they will prefer FITCH.

In the following question the respondents were asked that they are satisfied with
the ratings given by the agencies to which 31.3% responded that they are highly
satisfied with ratings given by the agencies,62.5% respondents responded that they are
satisfied with the ratings given by the agencies where as 3.7% are dissatisfied with the
ratings given by the agency and 2.5% respondents responded that they are highly
dissatisfied with the ratings given by the agencies.

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Findings:

The data was collected from primary sources as well as secondary sources. For the only
primary a survey was done online and 80 responses were collected by the researchers
whereas secondary data was collected from multiple websites and journals.

• Majority of the respondents i.e., 48.8% like to invest to exempt tax and for security
purpose

• Majority of the respondents i.e., 48.8% are ready to bear high risk to get higher
returns back.

• It is observed that the majority of the respondents i.e., 56.3% invest in banking
sectors as compared in corporate sector only 50% of respondents invest

• From the following research we can see that majority of the respondents have
knowledge about credit rating agencies.

• Majority of the respondents i.e., 32.5% tells that credit rating shows the exact
financial position of the company.

• Majority of the respondents i.e., 52.5% says that there are enough number of Credit
rating Agencies in India.

• Majority of the respondents i.e., 52.5% would like to invest in bank term deposits.

• Majority of the respondents i.e., 53.8% came to know about credit rating agencies
from the newspapers.

• From the following survey it is observed that respondents prefer CRISIL as a

Credit Rating Agency.

• Majority of the respondents i.e., 62.5% are satisfied with the ratings given by the
agencies.

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 CHAPTER5

CONCLUSION AND SUGGESTION

CONCLUSION
Credit Rating is as very important since investors should be equipped with easy
methods to make their investment decisions. If ratings are assigned in a proper,
systematic, transparent way, then it will be a boon for investors and will go a long way
in making the investment world a safe place.

It is an undisputed fact that Credit Rating Agencies play a vital role in financial
markets by to reduce the informative gap between lenders and investors, on one side,
and issuers on the other side, about the creditworthiness of companies or countries an
investment grade rating can put a security, company or country on the global radar,
attracting foreign money and boosting a nation's economy. Indeed, for emerging market
economies, the credit rating is the key to showing their worthiness of money from
foreign investors. Credit rating helps the market regulators in promoting stability and
efficiency in the securities market. Ratings make markets more efficient and
transparent.

But at the same time the Credit Rating Scenario took to turmoil in the early Summer of
2007 where the investor first started to lose their faith on such companies at a massive
scale. Ratings being as opinionated, and objective should not be granted with a
business purpose in a mind. Which indeed was the real cause behind the Crash of 2007,
that could have been averted with a simple downgrade of instruments held and issued
by Lehman as well as other Companies and which would have saved the US Federal
Reserve to infuse an extra 4.1 trillion Dollars in the US Economy and bail out
everyone. But it always stays as an undisputed fact that Credit Rating Agencies still
have a huge role to play in the financial markets and one cannot just do away with the.
Rating agencies play an important role in the world markets, they can best serve
markets when they operate ethically, independently, adopt and enforce internal
guidelines to avoid conflict of interest, and provide confidential information from
issuers.

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SUGGESTIONS

A. FOR INVESTORS

1. An investor should always keep in mind that nothing comes along guarantee or
without risk not even promised returns on Life Insurance Policies and hence should
always keep in mind the principle of “Caveat Emptor” which means let the buyer
beware.

2. Investor themselves are too responsible for their money. Hence one should always be
cautious and thoroughly examine the facts, creditworthiness before zeroing down on
any investment decision and most importantly compare it with other options as well.

3. It is also very important for an investor or any other person for the matter concerned
to always maintain a goo as well as healthy credit track record and have a good credit
score along with timely payment of taxes and any other obligations to ensure safe and
smooth future borrowings in times of need.

4. Investors must always invest on one’s guts rather just following someone and should
always align their investments with the way markets are going as at the end of the day
markets are the one providing them returns on their investment and not others.

B. FOR CREDIT RATING AGENCIES

1. CRISIL, ICRA & CARE, the three major rating agencies are handling 90%- 95% of
the business of credit rating promoted by financial institutions who while advancing
loans take the help of credit rating agencies to get the company rated. All these
agencies have continued to expand their activities in recent years. They must also be
updated about the reforms in the financial sector which can have an impact on the
businesses of these agencies as the market is volatile in nature especially in case of debt
instrument like bonds and Commercial Papers as well.
2. Nevertheless, Credit Rating Agencies have always found out ways and methods to
evade regulations and are far from sight of control under the government authorities as
they escape with a simple subject matter of line that these are our opinions and are no
way intended to be an assurance. Hence there shall be stringent laws and each rating
54
should be fair enough and truly based on the facts and figures of the company rather
than how big billables they are to the agency. This has become very important after the
recent IL and FS case in India. Also, at the end of the day it is their responsibility to be
ethical and true to the outside people because there are many investors who invest just
on their reports based on faith.

3. Another aspect is regarding the procedure or the methodology that these rating
agencies follow for rating. Sometimes companies not satisfied with rating of one
agency approach use another rating agency for better rating. For this purpose, the rating
process or procedure followed for rating must be relevant, accurate and regulated.
Rating agencies should not only take into consideration past & present performance;
the projected future performance must not be ignored.

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