CREDIT RATING SERVICES

Introduction:
In a market economy, financial markets play the role of an efficient intermediary. They act as a link
between savers and investors, mobilizing capital on the one hand, and efficiently allocating them between
competing users on the other. As investor is in search of profitable investment avenues has recourse to
various sources of information, such as offer documents of the issuer(s), research reports of market
intermediaries, media reports etc. in addition he also base the investment decisions on the grading offered by
Credit Rating Agencies. These agencies have increasingly started to play a pivotal role as independent,
objective, well-researched and credible information providers, particularly for credit related options on the
subject of debt instruments.
Origin:
The credit rating system originated in the United States in the seventies. The high levels of default which
occurred after the Great Depression, in the U.S. Capital Markets, gave the impetus for the growth of credit
rating. The credit rating can be traced to the 1840s when following the financial crisis of 1837 the first
mercantile credit agency was setup in New York by Louis Tappan in 1841. The agency rated the ability of
merchants to pay their financial obligations. The first rating guide was published in 1859. John Bradstreet
set up a similar agency in 1849, which published its ratings book in 1857. These two agencies were later
merged to form Dun and Bradstreet in 1933, which acquired the Moodys Investors service in 1962. It is
interesting to note that Moodys have a long history in the rating business, spanning over a period of more
than a hundred years. In 1990, John Moody founded Moodys Investors Service, and in 1909 published his
Manual; of Railroad Securities. The rating of utility and industrial bonds in 1914 followed this, along with
the rating of bonds issued by U.S cities and other municipalities in early 1920s.
The default of $82 million of commercial paper by Penn Central in the year 1970 and the consequent
panic of investors in commercial papers resulted in massive defaults and liquidity crisis. This prompted the
capital issuers to get their commercial paper programs rated by independent credit rating agencies. This
according to them would give the required degree of comfort and reassurance to their investors. Moreover
the real impetus for growth came when regulatory agencies in the U.S made rating mandatory for
institutions such as Government Pension Funds and Insurance Companies, who could not buy securities
rated below a particular grade. In addition investor themselves became aware of the rating mechanism and
started using ratings extensively as a tool for risk assessment. Merchant bankers, underwriters and other
intermediaries involved in the debt market also found the rating useful for planning and pricing the debt
instruments.
Over the last two decades there have been many other factors that have contributed to the growth and
importance of the credit rating system in many parts of the world. They are.
1.
2.
3.
4.
5.
6.

The increasing role of capital and money markets consequent to disintermediation.

Increased securitization of borrowing and lending consequent to disintermediation.
Globalization of the credit market.
The continuing growth of information technology.
The growth of confidence in the efficiency of the market mechanism.
The withdrawal of Government safety nets and the trend towards privatization.

Definition:
Credit rating agency is an independent company that evaluates the financial condition of issuers of
debt instruments and then assigns a rating that reflects its assessment of the issuer's ability to make the debt
payments. Potential investors, customers, employees and business partners rely upon the data and objective
analysis of credit rating agencies in determining the overall strength and stability of a company.
Credit Rating Meaning:
A credit rating assesses the credit worthiness of an individual, corporation, or even a country.
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 Credit ratings are calculated from financial history and current assets and liabilities.
A credit rating tells a lender or investor the probability of the subject being able to pay back a loan.
A poor credit rating indicates a high risk of defaulting on a loan, and thus leads to high interest rates.
Credit is important since individuals and corporations with poor credit will have difficulty finding
financing, and will more likely have to pay more due to risk of default.
The ratings are expressed in code numbers which can be easily comprehended by lay investors.
Credit rating, as exists in India, is done for a specific security and for the company as a whole.
A credit rating does not create fiduciary relationship between the agency & the users.
CRA play a key role in the infrastructure of the modern financial system.
For investors, credit rating agencies increase the range of investment alternatives and provide
independent, easy-to-use measurements of relative credit risk; this generally increases the efficiency
of the market, lowering costs for both borrowers& lenders.
This in turn increases the total supply of risk capital in the economy, leading to stronger growth. It also
opens the capital markets to categories of borrower who might otherwise be shut out altogether: small
governments, startup companies, hospitals and universities
IMPORTANCES OF CREDIT RATING AGENCIES:
Credit Rating Agencies are the main authority to assign rate of credit for the companies who issue
debt. Any investor can measure the risk of bad debt after analysis these credit rates. These credit rates are
fixed on the basis of ability to pay back the loan. Credit Rating Agencies are also helpful to rebuild the
investor confidence which is vital to the global capital markets.
In capital market, its importance is not less than SEBI because credit rating agencies protect
different investors from risk of financial loss by providing them up to date information of credit rate. Many
other key roles can be explained with following way:
To compare the loan on the basis of quality of credit and loan. Suppose X, Y and Z are three
companies offering debentures to investors. Credit rating agencies will assign their credit rate
because these are financial expert and assign rate on the basis of analysis of past financial records
and statements. Credit rating agency will assign rate AAA to best of X, Y and Z and to invest AAA
-Credit Rating Company means low risk of loss.
Not only show AAA but it show other range of credit rate like A for medium risky company, BBB
medium risky and BB high risky and speculative company.
Credit rating agencies also assist to portfolio monitoring. In portfolio monitoring, they provide
information about which investment is most secure and provide high return of interest.
Credit quality of transparency.
Credit rating of money market securities.
MERITS AND DEMERITS OF CREDIT RATING
Benefits of Credit Rating to Investors
Helps in Investment Decision:
Credit rating gives an idea to the investors about the credibility of the issuer company, and the risk factor
attached to a particular instrument. So the investors can decide whether to invest in such companies or not.
Higher the rating, the more will be the willingness to invest in these instruments and vice-versa.
Benefits of Rating Reviews:
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The rating agency regularly reviews the rating given to a particular instrument. So, the present investors
can decide whether to keep the instrument or to sell it. For e.g. if the instrument is downgraded, then the
investor may decide to sell it and if the rating is maintained or upgraded, he may decide to keep the
instrument until the next rating or maturity.
Assurance of Safety:
High credit rating gives assurance to the investors about the safety of the instrument and minimum risk
of bankruptcy. The companies which get a high rating for their instruments will try to maintain healthy
financial discipline. This will protect them from bankruptcy. So the investors will be safe.
Easy Understandability of Investment Proposal
The rating agencies give rating symbols to the instrument, which can be easily understood by investors.
This helps them to understand the investment proposal of an issuer company. For e.g. AAA (Triple A), given
by CRISIL for debentures ensures highest safety, whereas debentures rated D are in default or expect to
default on maturity.
Choice of Instruments:
Credit rating enables an investor to select a particular instrument from many alternatives available. This
choice depends upon the safety or risk of the instrument.
Saves Investor's Time and Effort:
Credit ratings enable an investor to his save time and effort in analyzing the financial strength of an
issuer company. This is because the investor can depend on the rating done by professional rating agency, in
order to take an investment decision. He need not waste his time and effort to collect and analyze the
financial information about the credit standing of the issuer company.
Demerits of Credit Rating:
Possibility of Bias Exist:
The information collected by the rating agency may be subject to personal bias of the rating team.
However, rating agencies try their best to provide an unbiased opinion of the credit quality 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 the investigating team of the rating
agency. This can affect the quality of credit rating.
Impact of Changing Environment:
Rating is done based on present and past data of the company. So, it will be difficult 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 affect the working of the company being rated.
Therefore, 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 soundness. Therefore, it may receive lower credit
ratings. This will make it difficult to collect funds from the market.
Downgrading by Rating Agency:
The credit-rating agencies periodically review the ratings given to a particular instrument. If the
performance of a company is not as expected, then the rating agency will downgrade the instrument. This
will affect the image of the company.
Difference in Rating:

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There are cases, where different ratings are provided by various rating agencies for the same
instrument. These differences may be due to many reasons. This will create confusion in the minds of the
investor.

CREDIT RATING PROCESS:

The rating process begins with the receipt of formal request from a company desirous of having its
issue obligations rated by credit rating agency. A credit rating agency constantly monitors all ratings with
reference to new political, economic and financial developments and industry trends. The process/procedure
followed by all the major credit rating agencies in the country is almost similar and usually comprises of the
following steps.
Rating Request:
The rating process begins, with the receipt of formal request for rating from a company desirous of
having its issue obligations under proposed instrument rated by credit rating agencies. An agreement is
entered into between the rating agency and the issuer company. The agreement spells out the terms of the
rating assignment and covers the following aspects:
It requires the CRA (Credit Rating Agency) to keep the information confidential.
It gives right to the issuer company to accept or not to accept the rating.
It requires the issuer company to provide all material information to the CRA for rating and
subsequent surveillance.
Data gathering/Analysis:
To get all the information necessary for analysis, Credit-Rating agency sends a client the letter with
information requirements: a list of all the information and documents necessary for credit rating analysis.
Credit-Rating guarantees that your confidential information will be kept safe.
Management Meetings:
Meetings and consultations with client company managers and officials are very important in the process
of credit rating assignment. As a rule, we need two or three meetings. In the first meeting analysts would ask
questions about financial plans and further development prospects. This information helps us to remain
objective in assessment of clients financial position for the long-term period.
Rating committee/Assignment of Rating:
Rating team of the agency examines all the data, information and documents. It also considers all the
points presented by the client. The team then recommends the rating.
Advice to the Company/ institution:
The Company/ institution are informed about the rating proposed by the rating agencies.
Appeal:
If the Company/ institution feel that the rating can be improved and has adequate reason for it, it can
appeal so to the agency. Such appeal should be substantiated with proper reasoning and justification. On
appeal the agency may or may not revise the rating.
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Publication:
Decision about rating publication is taken by a client individually. Client may decide not to publish
assigned rating. Even if rating is not published the procedure of credit rating assignment remains useful as
conclusions of agency analysts written in the rating report may help to determine factors influencing clients
credibility. Their improvement in the future may lead to credit rating upgrade. Agency may not submit
publication of upgrades/downgrades of once published rating to clients approval.
Surveillance and Annual Review:
Rating is a dynamic activity. So rating has to be monitored continuously. Also it is mandatory.

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