Final Project Report onWORKING AND MANIPULATION OF CREDIT RATING
IN INDIASubmitted BySHAMBHU KUMARROLL NO. 58IN PARTIAL FULFILLMENT
OF THE REQUIREMENTS FORMASTER OF MANAGEMENT STUDIES2012 2014
UNDER THE GUIDANCE OFCA AJIT JOSHIUniversity of MumbaiParle
Tilak Vidyalaya AssociationsInstitute Of ManagementVile-Parle
(East), Mumbai 400 057CERTIFICATE
I, CA Ajit Joshi, hereby certify that Ms. Shambhu Kumar studying
in the 2nd year of Master of Management Studies, batch 2012-2014 at
Parle Tilak Vidyalaya Associations Institute of Management (PTVAs
IM), has completed the project on Working and manipulation of
credit rating in India under my guidance as per the norms as
prescribed by the University of Mumbai in the academic year
2013-2014.
CA Ajit JoshiDr. Harish Kumar S. PurohitGuideDirector
DECLARATIONI, Mr. Shambhu Kumar, a student of M.M.S Finance,
Semester IV of University of Mumbai, batch 2012-2014 from Parle
Tilak Vidyalaya Associations Institute of Management (PTVAs IM) do
hereby declare that this report titled Working and manipulation of
credit rating in India, carried out by me during this semester
under guidance of CA Ajit Joshi is as per the norms prescribed by
University of Mumbai & the same work has not been copied
directly without acknowledging for the part / section that has been
adopted from published/ non-published works & is true to the
best of my knowledge.
Date: Place: Mumbai----------------------------------(Signature)
Shambhu Kumar
ACKNOWLEDGEMENT
I owe my deepest gratitude to all the people who helped and
supported me during the course of this project.I feel deeply
obliged to the most respected faculty CA Ajit Joshi, who guided me
like a beacon in the dark. I would like to thank him for giving me
his valuable time, suggestions and practical views throughout my
project work, without which the completion of the project would
have been a difficult journey. I would also thank my institute
Parle Tilak Vidyalaya Associations Institute of Management and my
faculty members without whom this project would have been a distant
reality. I also extend my heartfelt thanks to my family members and
well-wishers.
SR. NO.PARTICULARSPAGE.NO
1Introduction6
2Executive Summary8
3Industry/Sector Overview10
4Literature Review 11
5Objectives of the study13
6Research methodology14
7Findings of research15
7.1Concept of credit rating15
7.2Types of credit rating 16
7.3Factors involved in credit rating16
7.4Credit rating process17
7.5Rating methodology20
7.5.1Business risk analysis20
7.5.2Financial analysis22
7.5.3Management evaluation24
7.5.4Geographical analysis24
7.5.5Regulatory and competitive environment24
7.5.6Fundamental analysis25
7.6Credit Ratings - Scales25
7.6.1Z-score30
7.7Manipulation of credit rating 33
7.7.1Credit score33
7.7.2Credit Score Rating Scale34
7.7.3Factors of calculating Credit score35
7.7.4Monitoring of Credit score and Credit rating38
7.7.5Manipulation of credit score39
7.7.6Credit rating companies in India40
8WorldCom Case study43
9Case Study44
10Conclusion48
11Bibliography, References & Websites49
TABEL OF CONTENTS1. INTRODUCTIONThe account information compiled
by a credit information company incorporating there in loans or
credit card facilities availed from one or many banks,
institutions, re-payment record, current balance on each of the
facility, new credit facilities obtained, number of new enquiries
from lenders., defaults in repayment of dues, suit filed
information etc. is referred to as credit history of a borrower or
a consumer.A credit score is a number assigned by credit reporting
companies based on information available on credit report. Like a
test score, the higher the score, the better your credit. A good
credit score shows that you have a high probability of repaying
loans on time. Therefore, a good credit score will help you take
out loans more easily and even get better interest rates. An
assessment of the credit worthiness of a borrower in general terms
with respect to a particular debt or financial obligation. A credit
rating can be assigned to any entity that seeks to borrow money an
individual, corporation, state or provincial authority, or
sovereign government. Credit assessment and evaluation for
companies and governments is generally done by a credit rating
agency. These rating agencies are paid by the entity that is
seeking a credit rating for itself or for one of its debt issues.
For individuals, credit ratings are derived from the credit history
maintained by credit-reporting agencies such as Equifax, Experian
and Trans Union. Credit ratings for borrowers are based on
substantial due diligence conducted by the rating agencies. While a
borrower will strive to have the highest possible credit rating
since it has a major impact on interest rates charged by lenders,
the rating agencies must take a balanced and objective view of the
borrowers financial situation and capacity to repay the debt.The
credit rating has an inverse relationship with the possibility of
debt default. In the opinion of the rating agency,a high credit
rating indicates that the borrower has a low probability of
defaulting on the debt; conversely, a low credit rating suggests a
high probability of default. Credit rating changes can have a
significant impact on financial markets. The credit rating is
conveyed by means of a numerical credit score that is maintained by
credit-reporting agencies. A high credit score indicates a stronger
credit profile and will generally result in lower interest rates
charged by lenders.Credit ratings are determined by credit ratings
agencies. The credit rating represents the credit rating agency's
evaluation of qualitative and quantitative information for a
company or government; including non-public information obtained by
the credit rating agencies' analysts. Credit ratings are not based
on mathematical formulasInstead, credit rating agencies use their
judgment and experience in determining what public and private
information should be considered in giving a rating to a particular
company or government. The credit rating is used by individuals and
entities that purchase the bonds issued by companies and
governments to determine the likelihood that the government will
pay its bond obligations.A poor credit rating indicates a credit
rating agency's opinion that the company or government has a high
risk ofdefaulting, based on the agency's analysis of the entity's
history and analysis of long term economic prospects.
2. EXECUTIVE SUMMARYCredit rating agencies are placed as
intermediate between investors and issuers of fixed income
securities. Their most important role is to minimize the existence
of asymmetric information in the marketplace. The role is central
in operating the financial markets. The globalization process and
development of complex financial products has provided the credit
rating agencies with a tremendous power. Despite the powerful
position, the credit rating industry subject to very weak
regulation. The credit rating agencies are by them self-supposed to
manage potential pitfalls in the rating process and rating system.
They are said to be self-controlled as no authority control how the
agencies manage to avoid potential pitfalls. The weak regulation
and self-control provides the agencies with a high level of
freedom. The mixture of power and freedom is a dangerous
combination, if not managed well. The agencies need to be fully
aware of the responsibilities that naturally follow power and
freedom. If they dont act as a responsible intermediate and perform
trustworthy, the market will lose its faith to the system. The
credit rating agencies have through the years been subject to
criticism in relation to the management of their responsibility.
The criticism has evolved in the wrong direction after focus had
been pointed to the agencies role in the corporate scandals of
Enron, WorldCom and Pharmalat. The criticism has reached a new high
level under the current financial crisis. Many players at the
financial scene look upon the credit rating agencies as a direct
scapegoat of the current crisis. The criticism has been
concentrated on numerous conflicts of interest and the dependence
of issuers. It is expected that the criticism have a negative
influence on the image of the credit rating agencies and the
investors confidence in the credit rating system. The credit rating
agencies can only exist if they have a strong reputation and enjoy
great confidence. The credit rating agencies has realized the
problem and declared that improvements are needed to restore the
confidence and image. This situation motivates an investigation of
the nature of the criticism and the influence on investors
reactions on changes in long-term corporate credit rating. Have the
investors as a result of low confidence ignored the changes or are
they reacting on information from criticized credit rating
agencies. Agencies who, by them self, have admitted the many
problems the critics have pointed out. The main findings reveal
that investors only react significant on downgrades during the
current crisis. There is no significant reaction in the months
before the crisis. This is seen as an expected result of the
criticism and an erosion of the investors trust in the credit
rating system. The sudden reaction during the crisis is much more
significant, than results in earlier studies. The investor reaction
measured as negative abnormal stock returns can be characterized as
a panic-drop. It is believed to be a psychological reaction and not
a sudden rebuild trust in the credit rating system. In the case of
upgrades, no significant reaction was found.
3. INDUSTRY OVERVIEWA credit rating agency is a company that
objectively analyses the credit worthiness of a company or
security, and indicates that credit quality by means of a grade, or
credit rating. Issuers, lenders, fixed-income investors, and
government regulators use these risk assessments for several
purposes, including evaluating lending or investment in a company.
Beginning in 2008, the volatile movement of credit ratings on
certain fixed-income securities specifically mortgage-backed
securities called the accuracy and effectiveness of the ratings
agency. Critics of the rating agencies argue that conflicts of
interest between an issuer and an agency coupled with a lack of
transparency in the ratings process have produced an inherently
flawed system. Since issuers primarily use credit rating agencies,
a lack of competition may have also compromised the validity of
credit ratings.To ensure more efficient and fully functioning
capital markets, it is essential thatthere is areview ofthe credit
ratings process andthe quality of ratings.These are important steps
to restoring investor confidence and trust in markets. The
important role of credit ratings agencies and their credit ratings
provide in the overallfunctioningof financial markets. They support
reforms to ensure the on going quality, transparency and integrity
of the rating process. Credit rating agency also educates the
investing public and promotes the importance of independent risk
assessments.
4. LITERATURE REVIEWCredit rating serves as a valuable input in
the decision-making process of different participants in the
capital market including regulators, issuers and investors.
Therefore, it has been attracting the attention of thinkers in the
field of finance to study various dynamics of this fast emerging
subject. Various studies have been conducted in India as well as in
different parts of the world by different bodies and individuals
and thus contributing a lot to explore new insights into the
concept of credit rating. The area of concern of the studies
conducted so far has been mainly to find out the relevance of
credit rating in the Indian context as well as at the global level
and the extent of awareness among the investors, about the concept
of credit rating. The present chapter provides a brief review of
the research studies conducted on credit rating at the national and
international level. Czarnitzki and Kraft (2007)[footnoteRef:1], in
their study, tested whether the credit ratings give more specific
information about creditworthiness of the firms as compared to the
publicly available information (which is available to the potential
investors without any substantial cost). They selected a sample of
about 8000 firms of German manufacturing sector for the purpose of
study and the time period of study was 1999-00.They compared the
ratings given by leading German credit rating agency Credit Reform
with the publicly available information. The study revealed that
the young firms were more likely to default than the established
ones. Further, the lower the productivity the more would be the
probability of default. They further inferred that credit rating
has some additional informational value for lenders but the rating
agencies overemphasized the factor firm size in construction of
rating index. [1: Czarnitzki, D.; and Kraft, K. (2007), Are Credit
Ratings Valuable Information, Applied Financial Economics, Vol. 17,
pp. 1061-1070. ]
Jain and Sharma (2008)[footnoteRef:2], in their paper, attempted
to examine the working of credit rating agencies in the light of
role played by them in the capital market as information
disseminators. The authors identified conflicts of interest
affecting the rating decisions and the manner in which the
regulations have attempted to address them. Further, they also
studied the regulatory framework for credit rating agencies in
India. The authors revealed that credit rating agencies play a
central role in the capital markets through their informed and
independent analysis. The various conflicts of interest highlighted
in the study were relating to the fee charged, ancillary services
of credit rating agencies, ownership interest of credit rating
agencies in client securities and the problem of notching. The
study highlighted that despite the significant role played by
credit rating agencies in capital markets, they are not properly
regulated as not much responsibility is put on them in respect of
their rating actions. [2: Jain, T.; and Sharma, R. (2008), Credit
Rating Agencies in India: A Case of Authority without
Responsibility, Working Paper Series, Supreme Court of India and
National Law University, April, ssrn abstract id 1111553[available
at www.ssrn.com]. ]
Reddy and Gowda (2008)[footnoteRef:3], in their paper, explained
the importance and problems of credit rating in India. They also
highlighted the basis of credit rating and credit rating practices
prevalent in India. For this purpose, the opinions of sample of
investors from Hyderabad were taken. The results of the study
inferred that majority of the respondents were aware of the
existence of various credit rating agencies including CRISIL, CARE,
ICRA, etc. About 40 per cent (80 out of 200) of the respondents
depend on credit rating for their investment in debt instrument but
more than 50 percent from them (94 out of 180) rely on CRISIL for
their investment than the other credit rating agencies. The study
worked out that though there is confusion among various investors
due to existence of more than one credit rating agency but majority
of them are satisfied with the guidance of credit rating agencies.
[3: Reddy, R.B.; and Gowda, R.M. (2008), Some Aspects of Credit
Rating: A Case Study, the Management Accountant, Vol. 43, No. 6,
June. [available at www.ssrn.com] ]
Bhattacharyya (2009)[footnoteRef:4], in her paper, evaluated the
issuer rating system in India with special reference to ICRA issuer
rating model. The author identified various quantitative variables
having major impact on the issuer rating along with their relative
importance with the help of discriminant analysis. The time period
of the study is from the date when the issuer rating started in
2005 to March 2008 and the sample consists of 17 companies which
have been rated by ICRA during this period. The study highlighted
that out of the ten variables being used by ICRA for issuer rating
the PBIT & Debt plus net worth ratio, current ratio and net
sales growth rate play an important role but the qualitative
factors can also affect the ratings at any time. [4: Bhattacharyya,
M. (2009), A Study of Issuer Rating Service with an Appraisal of
ICRA Rating Model, Indian Journal of Accounting, Vol. XXXIX (2),
June. [available at www.ideas.repec.org]]
5. OBJECTIVES OF RESEARCHThe objective for doing this research
is to make myself capable for moving forward in corporate world, to
gain knowledge and to know how credit rating affect corporate
world. It will help me to gain more and more about corporate sector
which was very essential for me to do. Therefore I am doing
research on working and manipulation of credit rating in India to
improve my capabilities.The main purpose of my study was To gain
the theoretical knowledge in the credit rating. To know
manipulation of credit rating. To trained myself properly before
working with an organization To properly deal with the problems in
the company. The primary objective of this project is the study of
the working and manipulation of credit rating. Along with this one
objective is to find out how the organisation or person will
maximize their credit score. Collection of data, analysis and case
study is the main part of the study which will help to give certain
suggestion to industry regarding credit analysis.
6. RESEARCH METHODOLOGYResearch Methodology refers to search of
knowledge. One can also define research methodology as a scientific
and systematic search for required information on a specific topic.
In Research Methodology we study the various steps that are
generally adopted by a researcher in his research problem along
with the logic behind them.In a research various methods are used.
The selection of method depends on the nature and type of research.
Research was performed to gain detailed knowledge and understanding
of the credit rating in the country by using secondary data.Source
of DataFor this project secondary data is used. Secondary data is
the data compiled by someone other than the user. It includes
published data in the form of documents, research papers, web pages
and other organisational records..All secondary data used in this
project was in the electronic form, and was obtained from the
internet.Computerised databases used in this project1.
Bibliographical data base is the one which is obtained from
journals, government publications, magazines, newspapers etc. Such
online publications were accessed to obtain definitions of terms
used in this article.1. Full text database was obtained from the
websites of CRISIL, CRAB, ICRA and CIBIL to get the details of
working and manipulation of credit rating.1. External secondary
data is the data which is obtained from sources external to the
organisation as commercial publications, government publications,
professional organisations, trade associations professional
marketing research agencies etc.
7. FINDINGS OF RESEARCHThe objectives of credit rating are to
provide superior information to the investors at a low cost,
provide a sound basis for proper risk return structure, subject
borrowers to a healthy discipline and assist in the framing of
public policy guidelines on institutional investment. The findings
which I got during study of credit rating are as follows.
7.1: Concept of credit ratingRatings, usually expressed in
alphabetical symbols, are a simple and easily understood tool
enabling the investor to differentiate between instruments on the
basis of their credit quality. Credit rating is the symbolic
indicator of the current opinion of the service debt obligations in
a timely fashion with specific reference to the instrument being
rated. It is focused on communicating to investors the relative
ranking of the different loss probability for a given fixed income
investment, in comparison with other rated instruments.The term
Credit Rating comprises two words: credit and rating. Credit is
trust in a persons ability and intention to pay or reputation of
solvency and honesty. Rating means to classify a persons position
with reference to a particular subject matter. In other words,
credit is an act of assigning values by estimating worth or
reputation of solvency and honesty so as to repose trust in a
persons ability and intention to repay. Thus, credit rating could
be defined as an expression of an opinion through symbols about
credit quality of the issuer of securities or company with
reference to sell that security. It provides risk which is one of
the several factors in investor decision making. It does not
indicate market risk or forecast future market price. It is always
a specific evaluation done for a particular instrument. The rating
process is itself based on certain givens. The agency, for
instance, does not perform an audit. Instead its required
information and opinion provided by the issuer and collected by
analysts from different sources, including personal interaction
with various entities. In determining rating, both quantitative and
qualitative analyses are employed. The judgment is qualitative it
nature and the use of quantitative analysis is to make the best
possible overall qualitative judgment because ultimately the rating
is an opinion.
7.2: Types of credit ratings1. Bond rating: it refers to the
rating of bonds or debt securities issued by a corporate,
governmental or quasi-governmental, body, such as rating of
debentures, public sector bonds, municipal bonds, etc.
2. Equity rating: it refers to the rating of equity shares
issued by a company. Short-term instruments rating refers to the
rating of short-term debt instruments, such as commercial papers
issued by companies.
3. Customer rating: it refers to the assessment of
creditworthiness of a customer to whom credit sales are to be
made.
4. Borrower rating: it requires the assessment of the ability to
repay of a borrower to whom a grant of loan is under consideration.
If the customer or borrower is a country in which an investment is
envisaged or to which a loan is to be given, the evaluation of the
creditworthiness of such a country is referred to as sovereign
rating.
7.3: Factors Involved in Credit Rating
Credit rating depends on several factors, some of which are
tangible and some of which are judgmental and intangible. These
factors are fundamentals and earnings capacity of the company and
volatility of the same company, Overall macro-economics and
industry environment, Liquidity position of the company,
Requirement of funds to meet commitments, Financial flexibility of
the company to raise funds from outside sources to meet temporary
financial needs, Guarantee and support from financially strong
external bodies, Level of existing leverage (borrowings) and
financial risk.
As mentioned earlier ratings are assigned to instruments and not
to companies and two different ratings may be assigned to two
different instruments of the same company. E.g. a company may be in
a fundamentally weak business and may have a poor rating assigned
for 5 year debentures while its liquidity position may be good,
leading to the highest possible rating for a 3 month commercial
paper. Very few companies may be assigned the highest rating for a
long term 5 or 7 year instrument e.g. CRISIL has only 20 companies
rated as AAA for long term instruments and these companies include
unquestionable blue chips like Videsh Sanchar Nigam, Bajaj Auto,
Bharat Petroleum, Nestle India apart from institutions like ICICI,
IDBI, HDFC and SBI.
7.4: Credit Rating ProcessThe 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 followed by all the major credit rating agencies in the
country is almost similar and usually comprises of the following
steps.
1. Receipt of the 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 is that the
Credit Rating Agency keeps the information confidential; its the
right of Issuer Company to accept or not to accept the rating and
the issuer company have to provide all information to the Credit
Rating Agency for rating and subsequent surveillance. 2. Assignment
to analytical team: the Credit Rating Agency assigns the job to an
analytical team. The team usually comprises of two analysts who
have expertise in the relevant business area and are responsible
for carrying out the rating assignments.
3. Obtaining information: The analytical team obtains the
necessary required information from the client company. Issuers are
usually provided a list of information requirements and broad
framework for discussions. These requirements are derived from the
experience of the issuers business and broadly confirms to all the
aspects which have a bearing on the rating. The analytical team
analyses the information relating to its financial statements, cash
flow projections and other relevant information etc.
4. Site visits and meeting with management: To obtain better
understanding of the clients operations, the team visits and
interacts with the companys executives. Site visits facilitate
understanding of the production process, assess the state of
equipment and main facilities, evaluate the quality of technical
personnel and form an opinion on the key variables that influence
level, quality and cost of production. A management meeting is held
with the issuer company as this enables the Credit Rating Agency to
get non-public information in a rating decision. The topics
discussed during the management meeting are competitive position,
strategies, financial policies, historical performance, risk
profile and strategies in addition to reviewing financial data.
5. Presentation of findings: After the analysis, the findings
are discussed at length in the Internal Committee, comprising
senior analysts of the credit rating agency. All the issue having a
bearing on rating is identified. An opinion on the rating is also
formed. The reports are finally presented to Rating Committee.
6. Rating committee meeting: This is the final authority for
assigning ratings. The rating committee meeting is the process in
which the issuer does not participate directly. The rating is
arrived at after composite assessment of all the factors concerning
the issuer, with the key issues getting greater attention.
7. Communication of decision: The assigned rating grade is
communicated finally to the issuer along with reasons or rationale
supporting the rating. The ratings which are not accepted are
either rejected or reviewed in the light of additional facts
provided by the issuer. The rejected ratings are not disclosed and
complete confidential.
8. Dissemination to the public: Once the issuer accepts the
rating, the credit rating agencies disseminate it through printed
reports to the public.
9. Monitoring for possible change: Once the company has decided
to use the rating, credit rating agencies are obliged to monitor
the accepted ratings over the life of the instrument. The credit
rating agency constantly monitors all ratings with reference to new
political, economic and financial developments and industry trends.
All this information is reviewed regularly to find companies for,
major rating changes. Any changes in the rating are made public
through published reports by credit rating agency. Source of above
figure- crisil
7.5: Rating methodologyRating methodology used by the major
Indian credit rating agencies is more or less the same. The rating
methodology involves an analysis of all the factors affecting the
creditworthiness of an issuer company e.g. business, financial and
industry characteristics, operational efficiency, management
quality, competitive position of the issuer and commitment to new
projects etc. A detailed analysis of the past financial statements
is made to assess the performance and to estimate the future
earnings. The companys ability to service the debt obligations over
the tenure of the instrument being rated is also evaluated. In
fact, it is the relative comfort level of the issuer to service
obligations that determine the rating. While assessing the
instrument, the following are the main factors that are analyzed
into detail by the credit rating agencies.1. Business Risk
Analysis2. Financial Risk Analysis3. Management Evaluation4.
Geographical Analysis5. Regulatory and Competitive Environment6.
Fundamental Analysis
7.5.1: Business Risk AnalysisBusiness risk analysis aims at
analyzing the industry risk, market position of the company,
operating efficiency and legal position of the company. This
includes an analysis of industry risk, market position of the
company, operating efficiency of the company and legal position of
the company.
a. Industry risk: The rating agencies evaluates the industry
risk by taking into consideration various factors like strength of
the industry prospect, nature and basis of competition, demand and
supply position, structure of industry, pattern of business cycle
etc. Industries compete with each other on the basis of price,
product quality, distribution capabilities etc. Industries with
stable growth in demand and flexibility in the timing of capital
outlays are in a stronger position and therefore enjoy better
credit rating.
b. Market position of the company: Rating agencies evaluate the
market standing of a company taking into account:i. Percentage of
market shareii. Marketing infrastructureiii. Competitive
advantagesiv. Selling and distribution channelv. Diversity of
productsvi. Customers basevii. Research and development projects
undertaken to identify obsolete productsviii. Quality Improvement
programs etc.
c. Operating efficiency: Favorable location advantages,
management and labor relationships, cost structure, availability of
raw-material, labor, compliance to pollution control programs,
level of capital employed and technological advantages etc. affect
the operating efficiency of every issuer company and hence the
credit rating.
d. Legal position: Legal position of a debt instrument is
assessed by letter of offer containing terms of issue, trustees and
their responsibilities, mode of payment of interest and principal
in time, provision for protection against fraud etc.
e. Size of business: The size of business of a company is a
relevant factor in the rating decision. Smaller companies are more
prone to risk due to business cycle changes as compared to larger
companies. Smaller companies operations are limited in terms of
product, geographical area and number of customers. Whereas large
companies
7.5.2: Financial Risk Analysis Financial risk analysis involves
thorough evaluation of the financials of the small and medium
enterprises. Careful analysis of the audited financials,
observations of auditors in the auditors report and notes to
accounts, consistent treatment of financials play an important
role. Key ratio analysis, trend ratios, and financial disclosures
and off Balance sheet items and their impact on the profitability
is studied and analyzed in depth. Further the source of financial
funding and their impact on the capital employed structure needs to
be analyzed.
Availability of liquid investments, unutilized lines of credit,
financial strength of group companies, market reputation,
relationship with financial institutions and banks, enterprise
perceptions and experience of tapping funds from different sources
also play an important role in financial analysis. Past performance
of the company, level of financial transparency i.e. quality of
documents and future plans plays an important role in the
determination of rating.
a. Asset quality: Asset quality plays an important role in
indicating the future financial performance of a company. The Focus
of asset quality evaluation is on lifetime losses, variability in
losses under various scenarios, the impact of likely credit costs
on profitability, and the cushions available (in the form capital
or provisions) to protect the debt holders from unexpected
deterioration in asset quality. In evaluating the quality of the
companys credit appraisal ,the process and lending norms, the
riskiness of its loan mix, its risk appetite, the availability of
data to facilitate credit decision making, and its track record in
managing its loan book through lifecycles. b. Liquidity: It is
important for a company to maintain a favourable liquidity profile
for the smooth functioning of its funding activity (fresh asset
creation) and to honour its debt commitments in a timely manner. It
is also important that an NBFC manage its interest rate risk, as
the same could impact its future profitability. In assessing
company liquidity profile, rating company evaluates the companys
policy on liquidity, the maturity profiles of its assets and
liabilities, the asset-liability maturity gaps, and the backups
available to plug such gaps. The evaluation also focuses on the
diversity of the company funding sources and their quality (i.e.
availability of these sources in a stress situation).
C. profitability: A company ability to generate adequate returns
is important from the perspective of both its shareholders and debt
holders. The purpose of credit rating Companys evaluation here is
to assess the level of future earnings and the quality of earnings
of the company concerned, which is done by looking closely at the
building blocks: interest spreads, fee income, operating expenses,
and credit costs.The evaluation of a company profitability starts
with the interest spreads and the likely trajectory of the same in
the light of the changes in the operating environment, the companys
liquidity position, and its strategy. A large income allows greater
diversification, which in turn can improve the resilience of
earnings, thereby improving a company risk profile. After assessing
the income stream, Credit Rating Company evaluates the company
operating efficiency (operating expenses in relation to total
assets, and cost to income ratio) and compares the same with that
of its peers.The credit costs are estimated on the basis of the
companys asset quality profile, and the profitability indicators to
compare across peers. Importantly, a very high return on equity may
not necessarily translate into a high credit rating, given that the
underlying risk could be very high as well, and being so it could
be more volatile or difficult to predict.d. Accounting Quality:
Consistent and fair accounting policies are a prerequisite for
financial evaluation and peer group comparisons. By virtue of being
incorporated under the Companies Act, 1956, NBFCs are required to
follow the Accounting Standards prescribed by the Institute of
Chartered Accountants of India. Further, the RBI has also issued
prudential norms for NBFCs specifying the accounting methods to be
used for income recognition, provisioning for bad and doubtful
advances, and valuation of investments. In evaluating an NBFCs
accounting quality, Credit Rating Company reviews the companys
accounting policies, notes to the accounts, and auditors comments
in detail. Deviations from the Generally Accepted Accounting
Practices are noted and the financial statements of the NBFC
adjusted to reflect the impact of such deviations.
e.capital Adequacy: An NBFCs capital provides the second level
of protection to debt holders (earnings being the first) and
therefore its adequacy (in relation to the embedded credit, market,
and operational risk) is an important consideration for ratings.
Riskiness of the product and granularly of the portfolio is factor
that has a significant bearing on the amount of capital required to
provide the desired degree of protection to an NBFCs debt holders.
The requirement of risk capital varies with the concentration and
the riskiness of the product mix.
7.5.3: Management EvaluationQuality of management, systems and
policies, shareholder expectations and the strategy followed to
manage these expectations, and accounting quality are the
foundation stones on which an NBFCs credit risk profile is built.
The importance of these factors is even higher for a new NBFC, one
with a shorter track record, or one with a changing business
profile.
In evaluating an NBFCs management, systems and strategy, credit
rating company assesses the companys competitive position (ability
to change lending norms and/or yields), reliance on outsourcing,
pace of growth and responsiveness to market changes, track record,
and management experience (in relation to growth plans and the
lifecycle of the loans extended), besides the extent of
diversification in its loan book.
7.5.4: Geographical AnalysisGeographical analysis is undertaken
to determine the locational advantages enjoyed by the issuer
company. An issuer company having its business spread over large
geographical area enjoys the benefits of diversification and hence
gets better credit rating. A company located in backward area may
enjoy subsidies from government thus enjoying the benefit of lower
cost of operation. Thus geographical analysis is undertaken to
determine the locational advantages enjoyed by the issuer
company.
7.5.5: Regulatory and Competitive EnvironmentCredit rating
agencies evaluate structure and regulatory framework of the
financial system in which it works. While assigning the rating
symbols, Credit rating companies evaluate the impact of
regulation/deregulation on the issuer company.
7.5.6: Fundamental AnalysisFundamental analysis includes an
analysis of liquidity management, profitability and financial
position, interest and tax rates sensitivity of the company.
7.6: Credit Ratings - Scales1. Credit Ratings - Long Term
Scale:It contain rating of sectors, including financial and
non-financial corporations, sovereigns and insurance companies, are
generally assigned Issuer Default Ratings (IDRs). IDRs opine on an
entity's relative vulnerability to default on financial
obligations. The "threshold" default risk addressed by the IDR is
generally that of the financial obligations whose non-payment would
best reflect the uncured failure of that entity. As such, IDRs also
address relative vulnerability to bankruptcy, administrative
receivership or similar concepts, although the agency recognizes
that issuers may also make pre-emptive and therefore voluntary use
of such mechanisms.AAA: Highest credit quality. 'AAA' ratings
denote the lowest expectation of default risk. They are assigned
only in cases of exceptionally strong capacity for payment of
financial commitments. This capacity is highly unlikely to be
adversely affected by foreseeable events.AA: Very high credit
quality. 'AA' ratings denote expectations of very low default risk.
They indicate very strong capacity for payment of financial
commitments. This capacity is not significantly vulnerable to
foreseeable events.A: High credit quality. 'A' ratings denote
expectations of low default risk. The capacity for payment of
financial commitments is considered strong. This capacity may,
nevertheless, be more vulnerable to adverse business or economic
conditions than is the case for higher ratings.BBB: Good credit
quality. 'BBB' ratings indicate that expectations of default risk
are currently low. The capacity for payment of financial
commitments is considered adequate but adverse business or economic
conditions are more likely to impair this capacity.BB: Speculative.
'BB' ratings indicate an elevated vulnerability to default risk,
particularly in the event of adverse changes in business or
economic conditions over time; however, business or financial
flexibility exists which supports the servicing of financial
commitments.B: Highly speculative. 'B' ratings indicate that
material default risk is present, but a limited margin of safety
remains. Financial commitments are currently being met; however,
capacity for continued payment is vulnerable to deterioration in
the business and economic environment.C: Exceptionally high levels
of credit risk. Default is imminent or inevitable, or the issuer is
in standstill. Conditions that are indicative of a 'C' category
rating for an issuer include:D: Default. 'D' ratings indicate an
issuer that entered into bankruptcy filings, administration,
receivership, liquidation or other formal winding-up procedure, or
which has otherwise ceased business.Default ratings are not
assigned prospectively to entities or their obligations; within
this context, non-payment on an instrument that contains a deferral
feature or grace period will generally not be considered a default
until after the expiration of the deferral or grace period, unless
a default is otherwise driven by bankruptcy or other similar
circumstance, or by a distressed debt exchange.2. Credit Ratings -
Short Term ScaleA1: lowest credit risk. Instruments with this
rating are considered to have very strong degree of safety
regarding timely payment of financial obligations. Such instruments
carry lowest credit risk.A2: low credit risk. Instruments with this
rating are considered to have strong degree of safety regarding
timely payment of financial obligations. Such instruments carry low
credit risk.A3: higher credit risk. Instruments with this rating
are considered to have moderate degree of safety regarding timely
payment of financial obligations. Such instruments carry higher
credit risk as compared to instruments rated in the two higher
categories.A4: very high credit risk. Instruments with this rating
are considered to have minimal degree of safety regarding timely
payment of financial obligations. Such instruments carry very high
credit risk and are susceptible to default.D: default. Instruments
with this rating are in default or expected to be in default on
maturity.3. Credit Ratings - Long Term Structured Finance
ScaleRatings of individual securities or financial obligations of a
corporate issuer address relative vulnerability to default on an
ordinal scale. In addition, for financial obligations in corporate
finance, a measure of recovery given default on that liability is
also included in the rating assessment. This notably applies to
covered bonds ratings, which incorporate both an indication of the
probability of default and of the recovery given a default of this
debt instrument. AAA (SO): Highest Safety. Instruments with this
rating are considered to have the highest degree of safety
regarding timely servicing of financial obligations. Such
instruments carry lowest credit risk.AA (SO): High Safety.
Instruments with this rating are considered to have high degree of
safety regarding timely servicing of financial obligations. Such
instruments carry very low credit risk.A (SO): Adequate Safety.
Instruments with this rating are considered to have adequate degree
of safety regarding timely servicing of financial obligations. Such
instruments carry low credit risk.BBB (SO): Moderate Safety.
Instruments with this rating are considered to have moderate degree
of safety regarding timely servicing of financial obligations. Such
instruments carry moderate credit risk.BB (SO): Moderate Risk.
Instruments with this rating are considered to have moderate risk
of default regarding timely servicing of financial obligations.B
(SO): High Risk. Instruments with this rating are considered to
have high risk of default regarding timely servicing of financial
obligations. C (SO): Very High Risk. Instruments with this rating
are considered to have very high likelihood of default regarding
timely payment of financial obligations.D (SO): Default.
Instruments with this rating are in default or are expected to be
in default soon.4. Credit rating Short-term structured finance
scaleA1 (SO): lowest credit risk. Instruments with this rating are
considered to have very strong degree of safety regarding timely
payment of financial obligations. Such instruments carry lowest
credit risk.A2 (SO): low credit risk. Instruments with this rating
are considered to have strong degree of safety regarding timely
payment of financial obligations. Such instruments carry low credit
risk.A3 (SO): higher credit risk. Instruments with this rating are
considered to have moderate degree of safety regarding timely
payment of financial obligations. Such instruments carry higher
credit risk as compared to instruments rated in the two higher
categories.A4 (SO): very high credit risk. Instruments with this
rating are considered to have minimal degree of safety regarding
timely payment of financial obligations. Such instruments carry
very high credit risk and are susceptible to default.D (SO):
default. Instruments with this rating are in default or expected to
be in default on maturity.5. Mutual Fund Long term Credit Ratings
Scale AAAmfs: highest degree of safety. Schemes with this rating
are considered to have the highest degree of safety regarding
timely receipt of payments from the investments that they have
made.AAmfs: high degree of safety. Schemes with this rating are
considered to have the high degree of safety regarding timely
receipt of payments from the investments that they have made.Amfs:
adequate degree of safety. Schemes with this rating are considered
to have the adequate degree of safety regarding timely receipt of
payments from the investments that they have made.BBBmfs: moderate
degree of safety. Schemes with this rating are considered to have
the moderate degree of safety regarding timely receipt of payments
from the investments that they have made.BBmfs: moderate risk of
default. Schemes with this rating are considered to have moderate
risk of default regarding timely receipt of payments from the
investments that they have made.Bmfs: high risk of default. Schemes
with this rating are considered to have high risk of default
regarding timely receipt of payments from the investments that they
have made.Cmfs: very high risk of default. Schemes with this rating
are considered to have very high risk of default regarding timely
receipt of payments from the investments that they have made.
6. Mutual Fund Long term Credit Ratings ScaleA1mfs: very strong
degree of safety. Schemes with this rating are considered to have
very strong degree of safety regarding timely receipt of payments
from the investments that they have made. A2mfs: strong degree of
safety. Schemes with this rating are considered to have strong
degree of safety regarding timely receipt of payments from the
investments that they have made. A3mfs: moderate degree of safety.
Schemes with this rating are considered to have moderate degree of
safety regarding timely receipt of payments from the investments
that they have made.A4mfs: minimal degree of safety. Schemes with
this rating are considered to have minimal degree of safety
regarding timely receipt of payments from the investments that they
have made.
Source of above figure- riskencyclopedia.com
7.6.1: Z-ScoreWhen a company is at risk of corporate collapse,
to detect any signs of loomingbankruptcy, investors calculate and
analyse all kinds of financial ratios:working capital,
profitability, debt levels and liquidity. The trouble is, each
ratio is unique and tells a different story about a firm's
financial health. At times they can even appear to contradict each
other. Having to rely on a bunch of individual ratios, the investor
may find it confusing and difficult to know when a stock is going
to the wall.To resolve this conundrum, Professor Edward Altman
introduced theZ-score formula in the late 1960s. Rather than search
for a single best ratio, Altman built a model that distils five key
performance ratios into a single score. As it turns out, the
Z-score gives investors a pretty good snapshot of corporate
financial health. Here we look at how to calculate the Z-score and
how investors can use it to help make buy and sell decisions. It
determines how likely a company is to fail. The formula does this
by evaluating seven simple pieces of data, all of which should be
available in the company's public disclosure.
The StandardZ-ScoreThe formula for theZ-Score(which incorporates
those seven simple pieces of data) is:Z-Score= ([Working Capital/
Total Assets]x1.2) + ([Retained Earnings/ Total Assets] x 1.4) +
([Operating Earnings/ Total Assets] x 3.3) + ([Market
Capitalization/ Total Liabilities] x 0.6) + ([Sales/ Total Assets]
x 1.0)In general, the lower the score, the higher the chance
ofbankruptcy. For example, aZ-Scoreabove 3.0 indicates financial
soundness; below 1.8 suggests a high likelihood
ofbankruptcy.Z-Scorefor Private CompaniesIn 2002, Altman advocated
a revisedZ-Scoreformula for private companies. Theprivate company
version weights the variables differently and usesbook
valueofequityin place of market capitalization. The formula
is:Z-Score= ([Working Capital / Total Assets] x 0.717) + ([Retained
Earnings / Total Assets] x 0.847) + ([Operating Earnings / Total
Assets] x 3.107) + ([Book Value of Equity / Total Liabilities] x
0.420) + ([Sales / Total Assets] x 0.998)Z-Scorefor
Non-manufacturersAltman originally developed theZ-Scorefor
manufacturers, primarily because those were the companies in his
original sample. However, the emergence of large, public service
companies prompted him to develop a secondZ-Scoremodel for
non-manufacturing companies. The formula is essentially the same as
before; it just excludes the last component (sales / total assets)
because Altman wanted to minimize the effects of
manufacturing-intensive asset turnover.Z-Score= ([Working Capital /
Total Assets] x 1.2) + ([Retained Earnings / Total Assets] x 1.4) +
([Operating Earnings / Total Assets] x 3.3) + ([Market
Capitalization / Total Liabilities] x 0.6)
In the above given formula the first ratio (working capital /
total assets)is a good indicator of a firm's ability to make good
on what it owes in the next few months. The second ratio is a good
indicator of how indebtthe company is and whether it has a history
of profitability. The third ratio is a measure of efficiency in
that it indicates how many cents the company generates
inearningsfor every dollar of assets it owns. The fourth ratio is a
fluid measure of themarket's "confidence" in the company. The fifth
ratio is similar to the third ratio in that it measures the
company's efficiency in delivering sales from its assets. Why
Z-Scoreis important:TheZ-Scorehas proved to be one of the most
reliable predictors ofbankruptcy. So much so thatanalystsoften
equate certainZ-Scoreswith correspondingbond ratings. In fact, when
Altman reevaluated his methods by examining 86 distressed companies
from 1969 to 1975 and then 110 bankrupt companies from 1976 to 1995
and later 120 bankrupt companies from 1996 to 1999, the Z-Scorewas
between 82% and 94% accurate. The old "garbage in, garbage out"
motto applies, however: if the company financials are misleading or
incorrect, theZ-Scorewillbe, too.To keep an eye on their
investments, investors should consider checking their companies'
Z-score on a regular basis. A deteriorating Z-score can signal
trouble ahead and provide a simpler conclusion than the mass of
ratios. Given its shortcomings, the Z-score is probably better used
as a gauge of relative financial health rather than as a predictor.
Arguably, it's best to use the model as a quick check of financial
health, but if the score indicates a problem, it's a good idea to
conduct a more detailed analysis.
7.7: Manipulation of credit ratingOur credit history, other than
our income, is the single most important tool used by a Loan
provider to evaluate our application for any loan or credit card
application. Naturally, its important that we understand our Credit
Information Report (CREDIT REPORT) and what it takes to maintain a
credit history, so that is viewed favorably by Loan provider. Some
time we are not able to maintain our credit report, as a result we
think about bankruptcy. Bankruptcy is often a painful decision.
When many folks think about bankruptcy, they think about losing
their personal effects. They wonder what it would be like to lose a
car, say good-bye to a house, or put their family heirlooms up for
sale.
However, bankruptcy can also lead to less tangible losses. Many
people may need to dip into retirement accounts or savings that
were intended to pay for a child's education. While these are all
real-life consequences of abankruptcy filing, bankruptcy does offer
more protection than we might think. Bankruptcy can also affect the
credit scores, People with a 780 score could find their score drop
240 points after filing for bankruptcy,accordingto Consumer
Affairs. But someone with a score of 680 would likely experience
only a 150-point decrease.
Ourcredit scorecan dramatically affect our life, and, luckily,
we hold the power to change it. Knowing how to improve our score
has become an important skill in today's credit-dependent society.
To learn how to improve it, we need to understand what it means and
how it's calculated. Our score is based on ourdebthistory and our
existing lines of credit. The companies we do business with report
information about our account activity tocredit reporting agencies.
The agencies gather your information and pull it together in
acredit report. Before manipulation here is explanation about the
base of credit rating that is credit score.
7.7.1: Credit ScoreA credit score is a number which is assigned
to borrower, generated by the credit bureaus by reviewing their
past credit history. It helps the lenders in determining whether
borrower have the financial strength to return the money within the
given time period. In a nut shell it is like a synopsis of your
credit worthiness.When borrower applies for a loan, their credit
score plays a vital role in the approval of the loan. This is
because credit score reflects their ability to repay their credit.
Our credit score is the most important feature of our credit
health. The approval of a loan depends on an individuals credit
history. This again is relevant in terms of interest rate, fees,
and other charges which are usually charged and varies from one
person to another.
7.7.2: Credit Score Rating ScaleA credit score is a statistical
figure used to determine the probability of an individual, paying
back the money he has borrowed, within a specific period of time
from a financial institution. When we borrow money, our lender
sends detailed information to the credit rating agency, to create a
credit report that analyzes how well we handle our debts. The
credit bureaus that issue these ratings have various evaluation
systems, which depend upon many factors.Whether we apply for a
credit card or mortgage, our credit score report is always checked.
Accordingly, a lender can analyze what risk we pose to him.
Increased credit risk implies that a risk premium has to be added
to the price at which the money is being borrowed. For example, if
we have a poor credit score, our lender will lend us at a higher
rate than somebody with a better credit score. ScoreDescription
800 -850Incredibly Good
750 -799Excellent
700 -749Really Good
650 -699Good/Average
600 -649Fair
550 -599Poor
500 -549Very Poor
300 -499Exceedingly Poor
Source of above data is CRISIL
Source of this scale -FICO
7.7.3: Factors for calculating Credit ScoreVarious types of
account information related to borrower credit accounts, loan
accounts, and finance company accounts are taken into
consideration.Public records: This type of payment information is
considered very serious because this deal with reports of
bankruptcies, wage attachments and judgments etc. Hence, any recent
report of larger amounts will decrease our score heavily.Accounts
reflecting no late payments: If the accounts which borrower owe
show no late payments then it will definitely improve his credit
score.Late payments detail: Information on borrower late payment
accounts like the amount borrower owe, age of those accounts,
number of those accounts are considered for evaluating credit
score.Amount: Borrower may have credit accounts but that does not
mean that his credit score will be lowered or the lender will
undertake greater risk, if lender approves loan. The risk factor
arises when the credit amounts go beyond borrower affordability
level. This might give some red signal to the lender about loan
repayment credibility. In determining credit score the credit
bureaus consider the amount borrower owe on specific type of
accounts such as credit card accounts, and installment loans. The
basic principle considered for determining credit score is how much
excess money borrower owe when compared to his income.Duration of
your credit history: Credit score as an individual will increase if
borrower has a long credit history which will borrower at the time
borrower seek to avail another loan.Availing new credit: Its our
general tendency among us to open many credit accounts. We have the
desire to open or own multiple credit accounts but that may affect
our credit score. This happens because this aspect increases our
credit risk especially if we do not have a long credit history. If
we have multiple credit requests then it increases our credit risk
further.In general while determining our credit scores the credit
bureaus does consider the type of accounts we have opened, the age
of those accounts etc.Credit Mix: our score will bring into
consideration our credit cards; retail accounts; installment loan
accounts; finance company accounts and mortgage loan accounts. For
the purpose of increasing our credit score it is not a good idea to
open credit accounts which we have not intend to use.
The above factors are depicted in graphic images
Risks associated with Credit ScoreOur credit score reflects our
financial status and our credibility for future financial
privileges. We need to be very careful about our credit score as it
is the most important financial document. With a low credit score
our credibility factor becomes risky. A respectable credit score is
considered as 650 and above.
7.7.4: Monitoring Credit Score and Credit Report
Bad credit can result in unfavorable interest rates that cost
thousands when we take out a mortgage, a car loan or a student
loan. It could block us from leasing that apartment youve been
pining for. And it can be a black mark on our record that even
prevents us from landing our dream job.So it pays to know the
essentials of our credit report and related score, the behaviors
that can make our score rise or plummet, and the services that help
us monitor our credit.Credit report is a summary of our borrowing
and repayment historyany new accounts, closed accounts, unpaid
bills, late bills, and other activity. If we have a loan, mortgage
or credit card, it will show up here. Our credit report provides
the basis for our credit score.Our credit score is a three-digit
number between 300 and 850 calculated from a formula thats designed
to gauge your creditworthiness. The bureaus use our personal data
and crunch the numbers differently, so our score will vary slightly
at each agency. When a lender considers our application for credit,
they turn to one of the credit agencies for our score, which
indicates our reliability as a borrower.
7.7.5: Manipulation of Credit Score1. We should pay our bills on
time. Late payments are viewed negatively by Loan providers and may
affect the chances of our loan getting approved.2. We should review
our credit reports at least once every year/every 12 months.
3. We should clean up our own credit report by disputing
inaccurate information for free!We havent fall for any promises to
improve our credit report or credit scores overnight. We can
dispute the in accurate information ourselves for free!4. Dont
close existing credit accounts. Instead, we keep credit cards away
in a safe and secure place and stop accumulating debt.5. We have to
create a debt worksheet and include the information like: annual
percentage rate, name of the creditor and address, last four
numbers of our account number, telephone number, limit, and amount
owe by borrower, minimum payment and billing date.6. We should
contact our creditors to work out a plan to rebuild our credit
issues if we can afford the payment: we can ask our bank or credit
union if they offer a secured credit card or secured loan and
verify that our on time payment history will be reported to the
three major credit reporting agencies. We may be able to make a
deposit to our account and have a credit limit or loan in the
amount of our deposit.7. Use the Snowball Effect to completely pay
off one debtor at a time.8. We have to know our credit limits and
pay down our credit card balances to no more than 30% of total
available credit limit.9. We need to get our yearly credit report
and make sure it doesnt have any errors. If it does have errors, we
need to challenge them. We might also consider challenging some
items on our credit report, such as a collection thats been paid
off already, to see if we can get the company to remove it.
7.7.6: Credit rating companies in India
1. Crisil Limited CRISIL is the largest and first credit rating
agency in India. It was established in 1987. Its corporate office
is in Mumbai, maharshatra.The worlds largest rating agency Standard
& Poor's now holds majority stake in CRISIL. It is a global
leader in research, ratings and risk & policy advisory
services. It is one of the top credit rating agencies in India
which has won many prestigious awards in the credit rating category
and had assessed more than 61000 entities.
2. Credit Information Bureau India Limited (CIBIL)CIBIL was
established in 2000.its corporate office is at Mumbai Maharashtra.
it is an Credit Information Company which maintains records of an
individuals payments related to credit cards and loans. The
information about users credit cards and loans is later used by the
CBIL to generate Credit information reports which are used to
approve loan applications.3. Fitch Ratings India Private Ltd.Fitch
Ratings, a Fitch Group company is among the top credit rating
agencies in India incorporated in 1913 in New York, USA. Fitch
Ratings provides financial information services in more than 30
countries and has over 2000 employees working at 50+ offices
worldwide.4. Equifax Equifax Inc started operations in 1899 and has
managed to be among the top credit rating agencies in India and at
global level. Equifax Inc provides information management services
that process thousands of records of its members which can be used
by them for various purposes and to supply risk management
solutions, credit risk management and analysis, fraud detection
triggers, decision technologies, marketing tools etc. 5. Credit
Analysis & Research Ltd. (CARE) CARE Ratings is second-largest
among the credit rating agencies in India as far as Indian Origin
Company is concerned. It is established in 1993 having corporate
office in Mumbai, Maharashtra. CAREs rating businesses can be
divided into various segments like for banks, IPO grading and
sub-sovereigns. Companys shareholders include leading domestic
banks and financial institutions in India.
6. ICRA LimitedICRA limited is a joint venture between Moodys
Investors and various financial services companies is a part of
ICRA group which was founded in 1991. It is a Credit rating agency
listed on the National Stock Exchange and Bombay Stock Exchange.
ICRA has four subsidiaries ICRA Management Consulting Services Ltd,
ICRA Techno Analytics Ltd, ICRA Online Ltd, PT. ICRA Indonesia and
ICRA Lanka Ltd.its corporate office in Gurgaon, Haryana.
7. ONICRAOnicra Credit Rating Agency is a Credit and Performance
Rating company based in Gurgaon and founded in 1993. Onicra is
among the top 10 credit rating agencies in India offering smart and
innovative solutions like risk assessment, analytical solutions and
ratings to MSMEs, corporate and individuals.
8. High Mark Credit Information Services High Mark Credit
Information Services is a recognized credit rating company in
India. It provides bureau services, analytic solutions and risk
management to banks and financial institutions operating in
Micro-finance, Retail consumer finance, MSME, Rural &
Cooperative Sectors.
9. SME Rating Agency of India Ltd. (SMERA) MERA Ratings Ltd a
Mumbai based company now expanded to 13 more locations was founded
in year 2005. SMERA a joint venture of SIDBI, several private
sector banks in the country and Dun & Bradstreet Information
Services India Pvt. Ltd. (D&B). Since 2005 SMERA rated over
23,000 MSMEs pan India. 10. Brickwork Ratings India Private
LtdBrickwork Ratings was established in 2007 by Sangeeta Kulkarni
as a credit rating firm. The company is registered with SEBI, RBI
& NSIC and operates in wide range of areas such as NCD, Bank
Loan, Commercial paper, MSME ratings. It is among the leading
credit rating companies in India having already rated Rs 200,000
corers of bonds and bank loans. Its corporate office is in
Bengaluru, Karnataka.
8: WorldCom Test case studyTo demonstrate the power of the
Z-score, let's look at how it holds up with a tricky test case.
Consider the infamous collapse of telecommunications giant WorldCom
in 2002. WorldCom's bankruptcy created $100 billion in losses for
its investors after management falsely recorded billions of dollars
ascapital expendituresrather thanoperating costs.When I calculate
Z-score for WorldCom by using annual report for year 1999, 2000 and
2001.Indeed, WorldCom's Z-score suffered a sharp fall. Also note
that the Z-score moved from the gray area into the danger zone in
2000 and 2001, before declaring bankruptcy in 2002.InputFinancial
ratio199920002001
X1Working capital/Total Assets-0.09 -0.080
X2Retained earnings/Total Assets-0.020.030.04
X3EBIT/Total Assets.09.08.02
X4Market Value/Total Liabilities3.71.2.50
X5Sales/Total Assets0.510.420.3
Z-score2.51.4.85
9. Case study Five years ago Mr Kumar took a loan of 4 lacs
which he paid with interest on a fix duration given by bank, also
he secure a good credit score. Again Mr Kumar needs an auto loan of
6.29 lacs. He applied for a loan in bank A, who offered him a quote
of 11.70% for a 5 year period; the EMI would be 13,897.he summated
all documents and security regarding loan, also Mr Kumar credit
history, credit score and financial discipline earned good repo and
he got the auto loan.Payment History (35% IMPACT)-In previous loan
Mr. Kumar paid all his EMI on time, but in this loan he is paying
in irregular manner at Rs 13,897 per month.Interpretation: As we
know that 35 percent of credit score comes from payment history
once a payment is 30 days late, a creditor can report the payment
to the credit bureau. Late payments create a negative hit to score
and take time to repair.OUTSTANDING BALANCES(30% IMPACT) -: In
previous loan Mr Kumar took loan of amount of 4 lacs and paid all
due on time, but this time he owes a loan of 6.29 lacs and also
facing some problem during payment as it is huge amount for him.
Interpretation: This factor marks the ratio between the outstanding
balance and available credit. Ideally, Mr. Kumar should make an
effort to keep balances as close to zero as possible, and
definitely below 30% of the available credit limit. As in previous
loan he maintain the ratio and secure a good percent of score that
is 30%.this time he is not able to maintaining it, it may create a
negative hit to score.CREDIT HISTORY (15% IMPACT): The previous
loan of 4 lacs was taken by Mr. Kumar for first time as a personal
loan, but after clearing first loan dues, there is a gap of six
months when Mr. Kumar took a loan of 6.29 lacs.Interpretation: In
general, a more seasoned credit history will increase our credit
score. Lenders want to see that borrower can responsibly manage
their credit accounts over time. However, even those borrowers who
have not used credit for an extended period of time may get high
scores, depending on how the other information in their credit
report appears.TYPE OF CREDIT (10% IMPACT): The previous loan taken
by Mr Kumar was personal loan. But this time after paying first
loan he took auto loan. Back to back he uses credit from financial
institution.Interpretation: Opening several credit accounts in a
short period of time can represent a greater risk, especially for
those with newer credit histories. A mix of auto loans, credit
cards and mortgages may create a negative hit to score.INQUIRIES
(10% IMPACT): This percentage of the credit score quantifies the
number of inquiries made on a Mr Kumar credit within a twelve-month
period.Interpretation: Each hard inquiry can cost from three to
fifteen points on a credit score, depending on the amount of points
left in this factor. If Mr Kumar pulls his credit report himself,
it will have no effect on his score.
The credit score is a computerized calculation; Personal factors
are not taken into consideration when a credit report is generated.
It is merely a snapshot of today's credit profile for any given
borrower, and it can fluctuate dramatically within the course of a
week.
In the above case study Mr.kumar able to score a good credit
score in his previous loan of 4 lacs that is 750 by maintaining
every aspect of credit rating during payment of credit amount with
interest. As a result of good credit score, bank offered him the
loan of 6.29 lacs at 11.70%.But during the payment of EMI of auto
loan worth 6.29 lacs; he faced some financial problem and loses the
continuity of EMI payment every month. As a result the credit score
is minimize that is 620.Interpretation: the credit score reflects
Mr. Kumar financial status and credibility for future financial
privileges. He need to be very careful about his credit score as it
is the most important financial document. With a low credit score
Mr. Kumar credibility factor becomes risky.As due to low credit
score when Mr. Kumar is going to apply for any loan in coming
future, maybe he will charges more interest by lenders or may be
lenders deny for loan. Interpretation: If anyone has low scores or
problematic reports, lenders will either deny you flat out or
penalize you with such exorbitant rates that the outcome ranges
from completely undesirable to impossible. If anyone has lower
credit scores, he will have to pay a lower interest rate on his
loan.What Mr. Kumar should do to improve his credit score?1. Mr.
Kumar should always try to maintain a good track record of paying
his bills on time. This will help him to enhance the credit
score.2. Mr. Kumar should be aware of the fact that when he miss a
payment on any collection accounts and try to close the account the
report of the account will always be there on his credit report. So
try to avoid it.3. Visiting a credit counsellor will not affect his
credit score or make him lose some points. Instead if he can manage
his credit well then surely his score will be improving in due
course of time.4. He should always try to keep a gap in taking
loan. He should minimize the rate of taking loan.5. Try to pay off
his debts instead of postponing the payment. Stop closing unused
credit accounts with a view to increase his score.6. Avoid applying
for a number of new credit which he do not need in order to
increase his score as this may put him in trouble later on.
Conclusion: After taking loan and maintaining proper discipline
during paying EMI, taking care of credit history and of course on
other activity regarding loan can maximize the credit score,
whereas negligence in paying EMI of loan may tend to suffer lender
as it minimize the credit score. In above case study Mr. Kumar got
his auto loan because of only good credit score earn during his
first loan. As he done some carelessness during payment of second
loan, it will affect his credit score and in future it may create
problem during loan or credit need.Whereas those who have bad
credit, it may seem like it is impossible to improve credit report
but it can be improve. By ignoring the problem, that credit report
will continue to stay poor, and person will face the repercussions
of bad credit. With time and effort there can be an improvement.
Remember, the credit report did not get damaged overnight and will
not improve overnight.
10: Conclusion
A credit rating is a useful tool not only for the investor, but
also for the entities looking for investors. An investment grade
rating can put a security, company or country on the global radar,
attracting foreign money and boosting a nations economy. Indeed,
for emerging market economies, the credit rating is key to showing
their worthiness of money from foreign investors. And because the
credit rating acts to facilitate investments, many countries and
companies will strive to maintain and improve their ratings, hence
ensuring a stable political environment and a more transparent.They
can best serve markets when they operate independent, adopt and
enforce internal guidelines to avoid conflicts of interest and
protect confidential information received from issuers. Credit
rating agencies cannot afford to commit too many mistakes as it the
investors who pays the price for their mistakes. Credit rating
agencies should be made accountable for any faulty rating by
panellizing them or even de-recognizing them, if needed.
11: Bibliography
www.crab.comwww.crisil.comwww.icra.comwww.fitchratings.comwww.cibil.comwww.careratings.comhttp://shodhganga.inflibnet.ac.in/bitstream/10603/4466/11/11_chapter%202.pdfhttp://www.investinganswers.com/financial-dictionary/financial-statement-analysishttp://www.buzzle.com/articles/credit-score-rating-scale.htmlhttp://guides.wsj.com/personal-finance/credit/how-to-monitor-your-credit-score-and-credit-report/For
literature Review
Czarnitzki, D.; and Kraft, K. (2007), Are Credit Ratings
Valuable Information, Applied Financial Economics, Vol. 17, pp.
1061-1070.
Jain, T.; and Sharma, R. (2008), Credit Rating Agencies in
India: A Case of Authority without Responsibility, Working Paper
Series, Supreme Court of India and National Law University, April,
ssrn abstract id 1111553.
Reddy, R.B.; and Gowda, R.M. (2008), Some Aspects of Credit
Rating: A Case Study, the Management Accountant, Vol. 43, No. 6,
June.
Bhattacharyya, M. (2009), A Study of Issuer Rating Service with
an Appraisal of ICRA Rating Model,Indian Journal of Accounting,
Vol. XXXIX (2), June.
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