UNIT 13 CREDIT RATING AGENCIES

IN INDIA 9

Structure
13.0 Objectives
13.1 Introduction
13.2 Meaning of Credit Rating
13.3 Determinants of Credit Rating
13.4 Rating Methodology
13.5 Credit Rating Agencies in India
13.6 Credit Rating Symbols
13.7 Benefits of Credit Rating
13.8 Rating and Default Risk
13.9 Ratings and Yields
13.10 Limitations of Credit Ratings
13.11 Let Us Sum Up
13.12 Key Words
13.13 Useful Books
13.14 AnswersIHints to Check Your Progress
13.0 OBJECTIVES
After going through this Unit, you will be able to :
Explain the meaning and determinants of credit rating,
Illustrate the rating methodology,
Describe the advances and limitations of credit rating,
Identify the credit rating symbols, and
Discuss credit rating agencies in India.
13.1 INTRODUCTION
The removal of strict regulatory framework in recent years.
has led to a spurt in the number of companies borrowing
directly from the capital markets. There have been several
instances in the recent past where the "fly-by-nightn
operators have cheated unwary investors. In such a situation,
it has become increasingly difficult for an ordinary investor
to distinguish between 'safe and good investment
opportunities' and 'unsafe and bad investments'. Investors
find that a borrower's size or name are no longer a sufficient
guarantee of timely payment of interest and principal.
Investors perceive the need of an independent and credible
agency, which judges impartially and in a professional
manner, the credit quality of different companies and assist
investors in making their investment decisions. Credit Rating
Agencies, by providing a simple system of gradation of
corporate debt instruments, assist lenders to form an opinion
on -the relative capacities of the borrowers to meet their 5 I
Financial and Investment obligations. These Credit Rating Agencies, thus, assist and
Institutions in India form an integral part of a broader programme of financial
disintermediation and broadening and deepening of the
debt market.
Credit rating is used' extensively fqr evaluating debt
instruments. These include long-term instruments, like
bonds and debentures as will as short-term obligations,
like Commercial Paper. In addition, fured deposits, certificates
of deposits, inter-corporate deposits, structured obligations
including non-convertible portion of partly Convertible
Debentures (PCDs) and preferences shares are also rated.
The Securities and Exchange Board of India (SEBI), the
regulator of Indian Capital Market, has now decided to
enforce mandatory rating of all debt instruments irrespective
of their maturity. Let us recall that earlier only debt issues "
of over 18 months maturity had to be compulsorily rated.
13.2 MEANING OF CREDIT RATING
Credit Rating Agencies rate the aforesaid debt instruments
of companies. They do not rate the companies, but their
individual debt securities. Rating is an opinion regarding
the timely repayment of principal and interest thereon; It is
expressed by assigning symbols, which have definite
meaning.
A rating reflects default risk only, not the price risk associated
with changes in the level or shape of the yield curve. It is
important to emphasise that credit ratings are not
recommendations to invest. They do not take into account
many aspects, which influence an investment decision. They
do not, for example, evaluate the reasonableness of the
issue price, possibilities of earning capital gains or take into
account the liquidity in the secondary market. Ratings also
do not take into account the risk of prepayment by the
issuer, or interest rate risk or exchange rate risks. Although
these are often related to the credit risk, the rating essential
is an opinion on the relative quality of the credit risk.. It
has to be noted that there is no privity of contract between
an investor and a rating agency and the investor is not
protected by the opinion of the rating agency. Ratings are
not a guarantee against loss. They are simply opinions,
based on analysis of the risk of default. They are helpful
in making decisions based on particular preference of risk
and return.
A company, desirous of rating its debt instrument, needs to
approach a credit rating agency and pay a fee for this
service. There is no compulsion on the.corporate sector to
. obtain' or publicize the credit rating except for certain
instruments. A -company can use the rating as another
mlhliritv p y p r r i ~ p <if it i~ a unnd nir~ and tn nhlitpmt~ it
from its prospectus and publicity, if it is not good. The
Credit Rating Agencies regularly analyse the financial
position of corporations and assign and revise the ratings
lor their securittes. The different rating agencie.~ seldom
give different ratings for the same security. If two rating
agencies do give the same security diflerent ratings, it is
called split rating; the few differences that occur are rarely
more than one rating grade level apart. Accepted ratings are
published in media, every week. In tune with the industrial
practice in India, rating agencies do not publish ratings
which are nqt accepted by issuers.
*,
Age
Credit Rating
lncies in India '
13.3 THE DETERMINANTS OF RATINGS
The default-risk assessment qnd quality rating assigned to
an issue are primarily determined by three factors - I

i) The issuer's ability to pay,

ii) The strength of the security owner's claim on the issue, and
'

iii) The economic significance of the industry and market place

of the issuer..
Ratio analysis is used to analyse the present and future
earning power of the issuing corporation and to get insight
into the strengths and weaknesses of the firm. Bond rating
agencies have suggested guidelines about what value each
ratio should have within a particular quality rating. Different
ratios are favoured by rating agencies. For any given set of
ratios, different values are appropriate for each industry.
Moreover, the values of every firm's ratios vary in a cyclical
fashion through the ups and downs of the business cycle.
To assess the strength of security owner's claim, the
protective provisions in the indenture (legal instrument
specifying bond owners' rights), designed to ensure the
safety of bondholder's investment, are considered in detail.
The factors considered in regard to the economic significance
and size of issuer includes: nature of industry 'in which
issuer is, operating (specifically issues like position in the
economy, life cycle of the industry, labour situation, sup- p-l -y
factors, volatility, major vulnerabilities, etc.), and the
competition faced by the issuer (market share, technological
leadershlp, production efficiency, findncial structure, etc.)
13.4 RATING METHODOLOGY
kating is a search for long-term fundamentals and the
pr,obabilities for changes in the fundamentals. Each agency's
rating process usually includes fundamental analysis of public
and private issuer-specific data, 'industry analysis, and
--
Financial and Investment presentations by the issuer's senior executives, statistical
Institutions 'in India classification models, and judgement. Typically, the rating
agency is privy to the issuer's short and long-range plans
and budgets. The analytical framework followed for rating
methodology is divided into two interdependent segments.
d
The first segment deals with operational characteristics and
the second one with the financial characteristics. Besides,
quantitative and objective factors; qualitative aspects, like
assessment of management capabilities play a very important
role in arriving at the rating for an instrument. The relative
impbrtance of qualitative and quantitative components of
the analysis varies with the type of issuer.
Key areas considered in a rating include the following:
i) Business Risk : To ascertain business risk, the rating
agency considers Industry's characteristics, performance
and outlook, operating position (capacity, market share,
distribution system, marketing network, etc.), technological
aspects, business cycles, size and capital intensity.
ii) Financial Risk : To assess financial risk, the rating agency
takes into account various aspects of its Financial
Management (e.g. capital structure, liquidity position,
financial flexibility and cash flow adequacy, profitability,
leverage, interest coverage), projections with particular
emphasis on the components of cash flow and claims
thereon, accounting policies and practices with particular
reference to practices of providing depieciation, income
recognition, inventory valuation, off-balance sheet claims
and liabilities, amortization of intangible assets, foreign
currency transactions, etc.
iii) Management Evaluation : Management evaluation includes
consideration of the background and history of the issuer,
corporate strategy and philosophy, organisational structure,
quality of management and management capabilities under
stress, personnel policies etc.
iv) Business Environmental Analysis : This includes
regulatory environment, operating environment, national
economic outlook, areas of special significance to the
company, pending litigation, tax status, possibility of default
risk under a variety of scenarios.
Rating is not based on a predetermined formula, which
specifies the relevant variables as well as weights attached
to each one of them. Further, the emphasis on different
aspects varies from agency to agency. Broadly, the rating
agency assures itself that there is a good congruence between
assets and liabilities of a company and downgrades the
rating if the quality of assets depreciates.
The rating agency employs qualified professionals to ensure
consistency and reliability. Reputation of the Credit Rating
Agency creates confidence in the investor. Rating Agency
earns its reputation by assessing the client's operational
performance, managerial competence, management and
organizational set-up and financial structure. It should be
an independent company with its own identity. It should
have no government interference. Rating of an instrument
does not give any fiduciary status to the credit rating agency.
It is desirqble that the rating be done by more than one
agency for the same kind of instrument. This will attract
investor's confidence in the rating symbol given.
A rating is a quality label that conveniently summarizes the
default risk of an issuer. The credibility of the issuer's
, proposed payment schedule is complemented by the
credibility of the rating agency. Rating agencies perform
this certification role by exploiting the economies of scale in
processing information and monitoring the issuer. There is
an ongoing debate about whether the rating agencies perform
an information role in addition to a certification role. Whether I
I

agencies have access to superior (private) information, or if

agencies are superior processors of information; security
I ratings provide information to investors, rather than merely
summarizing existing information. Empirical research
confirms the information role of rating agencies by
i demonstrating that news of actual and proposed rating
I changes affects the price of issuer's securities. Most studies I document numerically
larger price elfects for downgrades
than for upgrades, consistent with the perceived predilection
,of management for delaying bad news.
-5
Check Your Progress 1
IY
1) Discuss the meaning and significance of Credit Rating of
debt instruments.
...........................................................................................
2) . Identify the determinants of rating.
3) Which operational areas of the firm are taken into
consideration for security rating by the rating agencies?
Credit Rating
Agencies in India
i

Financial and Investment

...........................................................................................
Institutions in India
CREDIT RATING AGENCIES IN INDIA
In India, at present, there are four credit Rating Agencies:
i) Credit Rating and Information Services of India Limited
(CRISIL).
ii) Investment Information and Credit Rating Agency of India
Limited (ICRA) .
iii) Credit Analysis and Research Limited (CARE).
I

iv) Duff and Phelps Credit Rating of India (Pvt.) Ltd.

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

the company decides to use rating, CRISIL is obligated to

monitor the rating over the life of the debt instrument.
ii) ICRA : ICRA was promoted by IFCI in 1991. During the
year 1996-97, ICRA rated 261 debt instruments of
manufacturing companies, finance companies and financial
institutions equivalent to Rs. 12,850 crore as compared to
293 instruments covering debt volume of Rs. 75,742 crore
in 1995-96. This showed a decline of 83.0% over the year
in the volume of rated debt instruments. Of the total amount
rated cumulatively until March-end 1997, the share in terms
of number of instruments was 28.5% for debentures
(including long ternr'instruments), 49.4% for Fixed Deposit
programme (including medium- term instruments), and
22.1% for Commercial Paper Programme (including shortterm
instmments). The corresponding figures of amount
involved for these three broad rated categories was 23.8%
Credit Rating
Agencies in India
for debentures, 52.2% for fixed deposits, and 24.0% for
Commercial Paper.
The factors that ICRA takes into consideration for rating
depend on the nature of borrowing entity. The inherent
protective factors, marketing strategies, competitive edge,
competence and effectiveness of management, human
resource development policies and practices, hedging of risks,
trends in cash flows and potential liquidity, financial flexibility,
asset quality and past record of servicing of debt as well as
government policies affecting the industry are examined.
Besides determining the credit risk associated with a debt
instrument, ICRA has also formed a group under Earnings
Prospects and Risk Analysis (EPRA). Its goal is to provide
authentic information on the relative quality of the equity.
This requires examination of almost all parameters pertaining
to the fundamentals of the company including relevant
sectoral perspectives. This qualitative analysis is reinforced
and completed by way of the unbiased opinion and informed
perspective of one analyst and wealth of judgement of
committee members. ICRA opinions help the issuing
company to broaden the market for their equity. As the
name recognition is replaced by objective opinion, the lesser
know compapies are also able to access the equity market.
iii) CARE : CARE is a credit rating and information services
company promoted by IDBI jointly with investment
institutions, banks and finance companies. The company
commenced its operations in October 1993. 'In January
1994, CARE commenced publication of CAREVIEW, a
quarterly journal of CARE ratings. In additioh to the
rationale of all accepted ratings, CAREVIEW often carries
special features of interest to issuers of debt instruments,
investors and other market players.
13.6 CREDIT RATING SYMBOLS
Credit Rating Agencies rate an instrument by assigning a
definite symbol. Each symbol has a definite meaning. These
symbols have been explained in descending order of safety
or in ascending order of risk of non-payment. For example,
CRISIL has prescribed the following symbols for debenture
issues:
AkM indicates highest safety of timely payment of interest
and principal.
AA indicates high safety of timely payment of interest and
principal.
A indicates adequate safetv of timely payment of interest
and principal.
Financial and Investment BBB offers sufficient safety of payment of interest and
Institutions in India principal for the present.
BB offers inadequate safetv of timely payment of interest
and principal.
B indicates great susceptibilitv to default.
C indicates vulnerabilitv to default. Timely payment of
interest and payment is possible- nly if favourable
circumstances continue.
D indicates that the debenture is in default in payment of
arrears of interest or principal or is expected to default on
maturity.
You will note that as the value of symbol is reduced say
from AAA to AA, the safety of timely payment of interest and
principal is decreased. While AAA indicates highest safety
of timely repayment, D indicates actual default or expected
default on maturity. Different symbols indicate different
degrees of risk of repayment of principal and interest. It is
the 'assessment of the Rating Agency based on the
methodology already explained. Other ratings are given in
the Appendix to this Unit for your information.
13.7 BENEFITS OF CREDIT RATING
Rating serves as a useful tool for different constituents of
the capital market. For different classes of persons, different
benefits accrue from the use of rated instruments.
1) Investors : Rating safeguards against bankruptcy through
recognition of risk. It gives an idea of the risk involved in
the investment. It gives a clue to the credibility of the issuer
company. Rating symbols give information on the quality
of instrument in a simpler way that can be understood by
lay investor and help him in taking decision on investment
without the help from broker. Both individuals and
institutions can draw up their credit risk policies and assess
the adequacy or otherwise of the risk premium offered by
the market on the basis of credit ratings.
2) Issuers of Debt Instruments : A company whose instruments
are highly rated has the opportunity to have a wider access
to capital, at lower cost of borrowing. Rating also facilitates
the best pricing and timing of issues and provides financing
flexibility. Companies with rated instruments can use the
rating as a marketing tool to create a better image in dealing
with its customers, lenders and creditors. Ratings
encourage the companies to come out with more disclosures
about their accounting systems, financial reporting and
management pattern. It also makes it possible for some
categoiy of investors who require mandated rating from
reputed rating agencies to make investments.
3) Financial Intermediaries : Financial intermediaries like
banks, merchant bankers, and investment advisers find
rating as a very useful input in the decisions relating to
lending and investments. For instance, kith high credit
rating, the brokers can convince their clients to select a
particular investment proposal Inore easily thereby saving
on time, cost and manpower ill convincing their clients.
4) Business Counter-parties : The credit rating helps business
counter-parties in establishing business relationships
particularly for opening letters of credit, awarding contracts,
entering into collaboration agreements, etc.
5,1 Regulators : Re~wlatorsc an, with the help of credit ratings,
determine eligibility criteria and entry barriers for new
securities, monitor financial soundness of organizations and
promote efficiency in debt securities market. This increases
transparency of the financial system leading to a healthy
development of the market.
13.8 RATING AND DEFAULT RISK
Most investors prefer to use credit ratings to assess default
risk. Internationally acclaimed credit rating agencies such
as Moody's, Standard and Poor's and Duff and Phelps have
been offering rating services to bond issuers over a very long
time. The bond issuers pay the rating agency to evaluate
the quality of the bond issue in order to increase the
information flow to investors and hopefully increase the
demand for their bonds. The rating agency determines the
appropriate bond rating by assessing various factors. For
example, Standard and Poor's judges the credit quality of
corporate bonds largely by looking at the bond indenture,
asset protection, financial resources, future earning power,
and management. More specifically, Standard and Poor's
focuses on cash flows to judge a firm's financial viability.
The bond categories are assigned letter grades. The highestgradc:
bonds, whose risk of default is felt to be negligible,
are rated triple A (Aaa or AAA). The rating agencies assign
pluses or minuses (e.g. Aa + A+) when appropriate to show
the rclative standing within the major rating categories.
The following table glves the rating symbols and their
explanation as employed by Moody's and S & P, the wellknown
rating agencies.
Credit Rating
Agencies in India
Financigl and Investment Table 13.1 : Rating Category of Credit Agency Firms
Institutions in India
Moody's Explaination
Aaa Best quality
Aa High quality
A Higher-medium grade
Baa Medium grade
- Ba Possess speculative elements
B Generally lack characteristics of
desirable investment
Caa Poor standing; may be in default
Ca Speculative in a high degree; often
in default
C Lowest grade
Standard &b Poor's Explaination
AAA Highest grade
AA High grade
A Upper medium grade
BBB Medium grade
BB ~ower medium grade
B Speculative
CCC-CC Outright speculation
C' Reserved for income bonds
DDD-DD In default, with rating indicating
relative salvage value
Not all bonds are rated by the agencies. Small issues and
those placed privately are generally not rated. For those
bonds that are rated, the competing services generally rank
the same bond in the same rating category; seldom do they
disagree by more than one grade. The research has shown
that there is a high degree of correlation between bondquality
ratings and actual defaults. Large number of firms
with low rationgs usually default. This suggests that
knowledge about credit rating does help in assessing the
financial risks that can lead to default.
13.9 RATINGS AND YIELDS
The ratings assigned to a bond issue directly affects its
yield. Issuers of high-risk securities have to pay higher
rates of return than issuers of low risk securities. Jpnk
bonds, for instance, are a high risk and a high yield
instrument. Investment may be limited in such instruments.
A study of the average yields to maturity for different
categories of bonds (bond index) over various time periods
' (1955-67, 1968-79 and 1981-85) reveals that market yields

increase with increased risk. Investors dislike risk. Risk

avoidance is visible not only in the long-run but also in
short-run. Bonds rated poorly must pay higher yield in the
market place to attract risk-averse investors. The higher the
rating, the lower is the bond's yield. The difference in yield
is termed as the yield spread. The yield spread between two
rating categories provides a measure of the default risk
premium. While yield spreads related to default risk are
not constant over time, they do remain in the appropriate
relative pattern. That is, AAA rated bonds always sell at
lower yields than Aa bond, which in turn sell at lower yields
than A-rated bonds, and so forth. Investors often use the
highest rating category as a benchmark yield and compute
yield spreads for lower-rated bonds.
In India, one can say, the relationship between ratings and
I cost of funds is, at best, tenuous. It has been observed that
many times similar rated companies are accessing funds at
widely disparate rates of interest. This signifies that the
market perception of the investment risk of such companies
' is different even though credit rating agency has placed

them in the same category (symbol). One can conclude that

as ratings fail to capture the market's perception of risk,
lhere is indeed something wrong with ratings assigned to
! these companies.
I
A number of research studies suggest that the determinants
of credit rating and yield spread for corporate bonds include:
i) debt ratios,

ii) earnings-levels, I iii) earnings-variability,

iv) interest coverage, and
I v) pension obligations.
I

r L
t Since about 75% of yield spread and ratings variability are
explained with these variables, other subjective factors may
i play an important role. The yield-spread pattern also
changes in magnitude over the business cycle; yield spreads
I widen (narrows) during recessions (prosperous periods). A

reasonable explanation of expanding and contracting yield

spreads is that during recession, default risk rises more
~hanpr oportionally for lower-quality firms because of reduced
cash flows. Also, investors may become risk-averse as their
wealth decreases during recessions.
Credit Rating
Agencies in India
Financial and Investment
Institutions in India 13.10 LIMITATIONS OF CREDIT RATINGS
There are several limitations of credit ratings. First, credit
ratings are changed when the agencies feel that sufficient
changes have occurred. The rating agencies are physically
unable to constantly monitor all the firms in the market.
The opinions of rating agencies may turn wrong in the
context of subsequent events that may have an adverse
impact on asset quality of the issuer.
Second, the use of credit ratings imposes discrete categories
on default risk, while, in reality default risk is a continuous
phenomenon. Moody's recognised this way back in 1982 by
adding numbers to the letter system, thereby increasing its
number of rating categories from 9 to 19. Nevertheless, this
limitation still pertains. The letter grades assigned by rating
agencies serve only as a gcneral, somewhat coarse form of
discrimination.
Third, owing to time and cost constraints, credit ratings are
unable to capture all characteristics for an issuer and issue.
A borrowing company can reduce the cost of borrowing, if
it obtains a higher rating for its contemplated issue. The
stakes and pressures, consequently, to get a good quality
rating are high. If the company comes to know that its
issue is going to get a low quality rating, it may approach
another agency and then use the best rating among them
since it is not under obligation to disclose all ratings.
According to the practice in the rating industry in India, a
corporate entity has the option of not agreeing to the first
rating given to its debt issue and can choose not to get rated
by that agency at all. In such a situation, the rating agency
cannot divulge its assessment to anybody, and the corporate
entity is free to go to any other agency. But once the

't
corporate en 'ty agrees with the first rating, it has no option of getting out of ,the
-rating discipline imposed by the rating
agency. T.hii may tempt rating agencies to woo clients with
the help of an initial favourable rating, but the freedom may
eventually be misused by the rating agency because corporate
client doesn't have the option to differ with the agency, once
it initially agrees to get rated by it. To ensure that corporate
clients are not dependent on one rating agency, the system

of compulsory dual ratings of all instruments could be , considered. Sometimes, the

rating agency may reduce the
rigor of their criteria on their own to enlarge the business
and improve profits especially if they are a listed company.
Investors should, therefore, not follow blindly the ratings of
different agencies in regard to the safety of fixed income
. instruments. The investors should explore other alternative
evaluation sources so that they become aware of the true
risks involved. The rating agencies have to be alert to
ensure that their rating decisions are not driven by volume
and profitability with a view to ensure favourable impact on
he price of its share. It may be asserted that the rating
agencies should be judged by overall performance and not
by one or two defaults. There are instances of default in the
instruments rated as investment grade of high safety by top
agencies of the world.
Once the corporate agrees with the first rating, the rating
agency is obliged to assess the debt issue till its maturity
and publish the rating as part of its surveillance system. It
has been observed that rating agencies have miserably failed
in predicting the brewing crisis and have continued to give
investment grade rating to companies, which have eventually
defaulted. It has been argued that CRB scam would not
have taken place if we had a better credit rating agency that
would have cautioned in time on the status of the company.
After the crisis, rating agencies became overcautious and
resorted to drastic downgrades of ratings in respect of specific
companies.
For instance, CRISIL, ICRA, and CARE downgraded
respectively 140, 35 and 50 companies in 1997. Of the
rating changes effected by CRISIL, ICRA, and CARE-36%,
40% and 64% respectively were by three or more notches.
Table 13.2 : Downgrades of Ratings (in percentage) in 1997
CRISIL ICRA CARE
By one ndtch 35.0 28.6 22.0
By two notches 29.3 31.4 14.0
~y three notches 12.9 8.6 20.0
By four notches 7.9 8.6 4.0
By more than four notches 15.0 22.9 40.0
Total downgrades 140 35 50
The high proportion of companies whose investment grade
rating was overnight changed to non-investment grade is
not conducive for enhancing the faith of investors in ratings.
In India, as in the developed countries, rating changes often
lag the variations in stock prices. Of the 157 rating
downgrades made by the three rating agencies in 1997, in
130 companies, the change in ratings lagged the decline in
share prices. Despite evidence that stock price movements
do eventually lead to a change in ratings, there is reason
to believe that further changes are urgently needed when
the ratings of companies and their stock prices are compared.
This need is more prominent in the case of the investm'ent
grade ratings granted to NBFCs by CRISIL and ICRA than
to the companies which are trading below par, yet command
investment grade rating.
Credit Rating
Agencies in India
r-F
Financial and ~nvestmenttCi heck Your Progress 2
Institutions in .1ndia /'
1) Distinguish between AAA, AA and A b-atings given by CRISIL
2) State whether following are advantage or limitation of credit
rating:
i) Credit Ratings are unable to capture all characteristics
of an issuer or issue.
...........................................................................................
ii) Rating provides best financing flexibility.
........................................................................................... -.
iii) Rating age,ncies are unable to monitor all types of firms
,..
in the market.
3) State the following sentences are true or false:
i) The issuers of high-risk securities pay lower rate of
return. (TI F)
ii) Higher the rating of a security, higher the chances of its
default. (TI F)
iii) All types of bonds including small issues are rated by
-=A credit rating agencies. (T/ F)

13.11 LET US SUM UP

The term Credit Rating refers to evaluation of debt
instruments. Debt instruments include both long-term
instruments like bonds and debentures, and short-term
obligations like Commercial Paper. Apart from these, fuzed
deposits, certificates of deposits, inter-corporate deposits,
structured obligations, etc. are also rated. Now Securities
and ~ x c h a n ~Boea rd of India (SEBI) has decided to enforce
mandatory rating of all debt instruments irrespective of
their maturity. Rating serves as a useful tool for different
constituents of the capital market namely investors, issuers
of debt instruments, financial intermediaries, business
enterprises, regulators, etc. High degree of correlation has
been observed between bond quality ratings and actual
defaults. The ratings assigned to bond issue directly affects
its yield.> Issuers of high-risk securities have to pay higher
rates of return than issuers of low risk securities. A number
of difficulties arise in the quality rating assigned to an
issue. Primarily the issuerls ability to pay, the strength of
the security owner's claim, the economic significance and
size of the issuer are taken into consideration in Credit Rating
determination of rating. The ratings assigned by the credit Agencies in India
rating agencies have many limitations. Important among
these are : (i) credit rating change infrequently. (ii)Any
rating reflects default risk and not the price risk associated
with changes in the level or shape of the yield curve, etc.
However, the reputation of an agency creates a confidence
in investor.
In India, at present, there are four credit rating agencies of
which the following three are well-known :
i ) Credit Rating and Information Services of India (CRISIL)
ii) Investment Information and Credit Rating Agency of India
Ltd. (ICRA)
iii) Credit Analyses and Research Limited (CARE)
13.12 KEY WORDS
Business Risk : Risk which is inherent in the nature
of business of a company.
Credit Risk : Risk associated with a debt instrument
due to the non-payment by the
issuer of the instrument.
Convertible
Debentures
: The debentures which are convertible
into equity shares of a company,
either wholly or partially, at the
option of the debenture-holders, are
called convertible debentures.
Financial Risk : Risk which is associated with the
pattern of financing a business, e.g.
greater proportion of debt.
Fly by Night : The promoters of those companies
Operators which want to get rich quickly by
any means are called fly by night
operators.
Inter-corporate : Deposits of money made by one
Deposits ' company in another company.
Letter of Credit : It is a letter issued by the banker of
the buyer in favour of the seller
giving an undertaking that the
seller's claims against the buyer will
be met by the banker, if the former
fails to do so.
Ratio Analysis : It means interpretation of the balance
Financial and Investment
Institutions in India
sheet and profit and loss account of
a company by computing ratios
between different figures contained
therein.
Split Rating : When two rating agencies give the '
same security different ratings, it is
called split rating.
13.13 SOME USEFUL BOOKS
Clark, J. (1976): "Some Recent Trends in Municipal and .
Corporate Securities Markets: An Interview with Brenton W.
Harries, President of Standard and Poor's Corporation,"
Financial Management.
Francis, J.C. (1993) : Management of Investments, 3'* Edition,
McGraw Hills, New Delhi
Jaffee, D. (19751, "Cyclical Variations in the Risk Structure of
Internet Ratesn, Journal of Monetary Economics (July, 1975).
Krishnamurthy, Suresh (1998), "Rating Agencies", Shooting
Themselves in the Footn Business Line, June 28, 1998.
Reserve Bank of India, Report on Currency & Finance 1996-
97, Mumbai. - I .
Sherwood, H (1976) How Corporate and Municipal Debt is
Rated : An Inside Look at Standard and Poor's Rating System,
Wiley, New York.
M.Y. Khan (2000): Financial Services, Vikas Publishing
House, New Delhi.
13.13 ANSWERS/HINTS TO CHECK YOUR
PROGRESS
Check Your Progress 1
1) Credit Rating refers to evaluation of debt instruments by
assigning a quality rating to an issue. Ratings are simply
opinions based on analysis of the risk of default. Credit
ratings are helpful in making decisions based on pafticular
preference of risk and return.,
2) The determinants aFe: (i)'the issuer's ability to pay the
strength of the security owner's claim on the issue, and (ii)
the economic significance of the industry and market place
of the issuer.
3) Industry's capacity, its market share, distribution system
00
and marketing network.
Check Your Progress 2
1) AAA rating reflects the highest safety of timely payment of
interest and pr'incipal amount. AA indicates high safety,
whereas A indicates adequate safety of timely payment of
interest and principal.
2) (i) Limitation (ii) Advantage (iii) Limitation
3) (i) False (ii) False (iii) False