CREDIT RATING AGENCY IN INDIA: NEED FOR REGULARISING IT by - Pratik Madrecha

INTRODUCTION

Rating agencies are key players in the financial system. They provide independent assessment on

the creditworthiness of debt issuers to make an informed decision in the financial markets. The

rating agencies have considered as the gatekeepers of financial and capital market, which is a

position of considerable power and influence. The rating agency affects the ability of a company

to borrow money. It also affects a pension fund, or a money market fund investment in a

company's bonds, and their stock price in the market. 1 Credit rating agencies (CRAs) plays an

important role in financial markets for lenders, investors and issuers in providing the information

between the different parties. It analysis the credit capability of individuals in a country. When

all the investors are positively rated, then there will be an increase in new start-ups.

Gradually income of the country increases, Employment opportunities expands and Poverty

ranks less. When there is development in all the sectors then the GDP increases and country

develops. Service sector is an important sector that majorly contributing to country’s

development. Credit rating comes under financial services, as it provides financial security with

their ratings. Presently, credit rating represents one of the most significant financial issues due to

the recent economic crises. The role and importance of credit rating agencies have increased in

the recent years of the globalisation all over the world.

IMPORTANCE OF CREDIT RATING

A good credit rating depicts a good history of paying loans on time in the past. This rating by the

agency affect the bank’s decision of approving your loan application at a considerate rate of

interest. 2

The benefit of the credit rating agency can be briefed as

I. FOR THE MONEY LENDERS

a. Better Investment Decision: No bank or money lender companies would like to give money

to a risky customer. With credit rating, they get an idea about the credit worthiness of an

individual or company borrowing the money with the factor of risk attached. Through the

evaluation of rating, an efficient decision can be made.


1 Rating the Raters, “Enron and the Credit Rating Agencies: Hearing Before the Senate Comm. on Governmental Affairs”, 107th

Cong. (2002).

2 Rheas Fonte, “Enhancing the Transparency of Japanese Financial Laws: the Case of Oversight of Credit Rating Agencies” The

Japanese Yearbook of International Law, Vol 12 (2010) 53.


b. Safety Assured: it assures about the money safety to the person going for the money lending

and paying back of the interest of the money on the time.

I. FOR BORROWERS

a. Easy Loan Approval: With high credit rating, you will be seen as low/no risk customer.

Therefore, banks will approve your loan application easily.

b. Considerate Rate of Interest: You must be aware of the fact every bank offers loan at a

particular range of interest rates. One of the major factors that determine the rate of interest

on the loan you take is your credit history. Higher the credit rating, lower will the rate of

interest. 3

HOW DO CREDIT RATINGS WORK IN INDIA

The credit rating agency has their algorithm to evaluate the credit rating. However, the major

factors to be taken into consideration by the credit rating agency are the credit history, credit type

and duration, credit use, exposure of credit, credit pay back etc. Every month, these credit rating

agencies collect the information which has credit effect on the investment from partner banks

and other financial institutions. When the person request for credit rating has been made, these

agencies take out their information and prepare a small summary based on such factor. On the

basis of the summary they grade every individual or company and give them a credit rating. This

rating is also used by the banks, NBFC and investors to take a decision of investing money,

buying bonds or providing loan. The better is the rating is being made, there is more chances of

getting money at payable interest rates.


CREDIT RATING AGENCIES IN INDIA

3 Jonathan Katz, Emanuel Salinas, and Constantinos Stephanou, ‘Credit Rating Agencies: No Easy Regulatory Solutions’, Crisis

Response, Vol. XX 8 (2009).


Credit rating agency is an organization that evaluates the credit worthiness of an individual,

business or company who wishes to borrow money or apply for a credit card in the bank. Let’s

have a look at the credit agencies in India. 4

I. CRISIL

Credit Rating Information Services of India Limited is the first credit rating agency of the

country which was established in 1987. It rates companies, banks and organizations, helping

investors make a better decision before investing in companies’ bonds. It also calculates the

credit worthiness of companies based on their strengths, market share, market reputation and

board. It offers 8 types of credit rating which are as follows:

 AAA, AA, A – Good Credit Rating

 BBB, BB – Average Credit Rating

 B, C, D – Low Credit Rating

II. ICRA

Investment Information and Credit Rating Agency of India was formed in 1991 having

headquartered in Mumbai. It offers comprehensive ratings to corporates via a transparent rating

system. Its rating system includes symbols which vary with the financial instruments. Here are

the types of credit ratings offered by ICRA like Bank Loan Credit Rating Corporate Debt Rating,

Corporate Governance Rating Financial Sector Rating, and Issuer Rating Infrastructure Sector

Rating etc.

III. SMERA

Small Medium Enterprises Rating Agency of India Limited has two divisions – SME Ratings

and Bond Ratings. It was established in 2011 and is a hub of financial professionals. It offers

credit ratings in the following format:

 AAA, AA, A – Low Credit Risk

 BBB, BB – Moderate Credit Risk

 B, C – High Credit Risk

 D- Defaulted

JUDICIAL APPROACH TO RATING AGENCIES LIABILITY

The judicial authority in India consider as rating services as contract under section 10 of the

contract act. 5 It provides by credit rating agencies at the invitation of companies or businesses


4 Ministry of Finance, Capital Markets Division, Report of the Committee on Comprehensive Regulation for Credit Rating Agencies,

12 (2009.)


against realisation of fees for rating and surveillance. It is entered into at the invitation of the

concerned company. The rating of financial programmes and instruments was optional for non-

banking finance companies till December 1997. However, since January 1998 the Reserve Bank

of India has made it compulsory for non-banking finance company to have the same rated.

Although the Reserve Bank of India has made it compulsory for non-banking companies to

engage a rating agency, such non-banking finance company is not obliged to engage the services

of any particular agency and is not prevented from engaging the services of more than one

agency at the same time. 6

 In magma leasing case, the plaintiff entered into a contract with a different rating agency being

Credit and Analysis Research Limited for rating its programme. Ultimately, the plaintiff

informed the defendant that it had decided not to either accept or use the respondent's credit

rating and asked the defendant not to continue the purported rating of the plaintiff or to publish

the result thereof.

Under such circumstances, the plaintiff cannot be forced to accept the rating of the defendant

even though it has made allegation of bias of the defendant towards non-banking financial

companies. 

Therefore, if the plaintiff decides to take assistance of another recognized rating agency in place

of defendant, the defendant cannot stand in the way of the plaintiff. It can however claim

damages for the loss it has suffered due to illegal termination of the agreement.

The court in the case of informatics valuation case pointed the key features of the Credit rating

regulation as

 Regulations pertaining to the registration of credit rating agencies, application for grant of

initial and permanent certificate, eligibility criteria for promoter of the credit rating agency,

furnishing of information, clarification and personal representation by the promoter, grant of

certificate by SEBI, its conditions, and procedure for refusal of certificate and its effect.

 General obligations of credit rating agencies, code of conduct, agreement with client,

monitoring and process of rating and the procedure for review of rating, appointment of

compliance officer, maintenance of proper books of accounts and records, etc.

 Restrictions on rating of securities issued by promoter or by person.


5 Section 10, Indian Contract Act, 1872.

6 Magma Leasing Limited v. Credit Rating Information Services of India Limited, (2001) 3 CHN 654.


 Procedure for inspection and investigation.

 Procedure for action in case of default. 7

ISSUES OR PROBLEMS RELATED WITH CREDIT RATING AGENCIES 

The CRA Regulations in India currently recognize only the issuer-pays model, under which, the

rating agencies charge issuers of bond and debt instruments a fee for providing a ratings opinion.

Thus, this model has an inbuilt conflict of interest.

The example of conflict of interest is non-rating services such as risk consulting, funds research

and advisory services given to issuers for which ratings have been provided.

Rating shopping: It is the practice of an issuer choosing the rating agency that will either assign

the highest rating or that has the laxest criteria for achieving a desired rating. Hence, the system

does not permit publishing a rating without the issuer’s consent. 8

Less competition: Credit-rating market in India is oligopolistic, with high barriers to entry. Lack

of competition in the market enables CRAs to have longer, well- established relationships with

the issuers which can hamper their independence.

Poor Rating Quality: Often ratings are provided on limited information. The issuer decides not

to answer some determinant questions; the rating may be principally based on public

information. Many rating agencies don’t have enough manpower which often leads to poor

quality. 9

NEED FOR ROTATION OF CREDIT AGENCY

The Securities and Exchange Board of India plans to bring in new rules mandating rotation of

credit rating agencies after market participants sought an overhaul of governance requirements

and levels of accountability for this industry.

Sebi has received strong suggestions from market participants that rating should be done on a

rotational basis. We are going by that and the work has begun,” a regulatory official said on

condition of anonymity.

The capital market regulator had put up a draft paper for public consultation on September 8 and

sought comments from various stakeholders as part of its review of the regulatory framework

governing the ratings business 

7 Securities & Exchange Board of India v. Informatics Valuation,

8 Securities and Exchange Commission, “Report on the Role and Function of Credit Rating Agencies in the Operation of the Securities

Markets” (2003).

9 Shreya Prakash, “Regulation Of Credit Rating Agencies In India, Centre for legal theory”, July, 2017 see at

https://static1.squarespace.com/static/551ea026e4b0adba21a8f9df/t/597f262915d5dbc171f504fb/1501505083636/17

0731_CRAReport.pdf


Ratings downgrades by agencies for companies such as Reliance Communications NSE -4.21 %

and Jindal Steel and Power NSE 1.96 % took investors by surprise as their credit profile plunged

from investment grade to default in a matter of months after delayed ratings actions. 

ANALYSIS

The response of the SEBI response towards the alarming call to regulate the increase role of the

credit rating agency in India with the global trend for reform to the credit rating agency laws.

Still, in line with the other countries regulation, the liability of the CRA differs. But, the issue to

rate the instrument properly remain unaddressed. The rating done by the agency is been

considered as merely an opinion seemed by the customer and therefore no liability accrues on

them in case of loss incurred by any investor.

The fixing of liability to the rating agency would be a just and a decisive step in checking the

potential malfunctioning in the system. The rating agencies has emerged into a new position after

the post financial crisis held globally. The SEBI regulation controls aspect of the agencies

functioning and could change it when they do not function properly.

The regulatory interventions are invasive in the sense that the measures not only attempt to

increase control over agencies and enhance public scrutiny and disclosure of their conduct and

methodologies, but also attempt to reduce reliance and severely diminish their role in the

financial market. The intended targets of most of these measures are the “big three “rating

agencies. Stringent measures are restricted to the rating of structured financial products. The

smaller CRAs are spared from the onerous obligations with the objective of promoting

competition. Though measures have been adopted to improve internal governance and reducing

conflict of interest, the “user pay” model of revenue generation would remain to be hurdle.

The SEBI should also protect the CRA as when they are being sued frequently by the customer.

There are many instances when the Indian CRAs are being sued by the company for it rates, in a

bid to prevent the rating downgrade. The regulator should view that while framing the laws that

allow them to express their rating opinion without fear of being sued.

CONCLUSION

This comes to conclude that the rating agencies should adopt the changing legal environment,

and the customer purpose towards the security market. The future of an industry would depend

on how it effectively come to the legitimacy of the credit rating. Indeed, one of the most

important drawback in the rating industry is the liability of the credit agency towards the

customer. The state cannot be blamed for the role in not regulating the credit rating agency but


the custom themselves has to be aware about the rating. The way forward is to strengthen the

existing system from an investor's perspective, a system that could heighten predictability and

reduce risk, rather than, finding an alternative which may be cumbersome and costly.

The regulation by the SEBI must also assess the predictive ability of the current rating models

followed by the agencies.

The laws in India which govern the credit rating agencies talk about unsolicited ratings. 10  It is

mandated for rating agencies to accompany the name with “unsolicited” and shall keep a watch

on the rating for the lifetime. 11  They are further required to disclose their policies, methodology

and procedure in detail regarding unsolicited rating. In a welcome move, the rating agencies are

also directed to disclose the extent of participation by the issuer, its management, bankers and

auditors in the credit rating process together with the information with its source for arriving and

reviewing the credit rating. 12  The move shall help in distinguishing genuine cases of information

asymmetry. The agencies also need to keep the record of all the unsolicited ratings carried out in

the last three financial years. The Securities and Exchange Board of India (Credit Rating

Agencies) Regulations, 1999 provide a single provision to deal with this conflict of interest.

Clause 11 of the Third Schedule directs that “A credit rating agency shall maintain an arm's

length relationship between its credit rating activity and any other activity.” 13

Rotation of rating agencies can also explore the possibility of a mandatory rotation of rating

agencies by the debt issuers (like corporations are required to change their auditors periodically

under the Companies Act, 2013).


10 Clause 5, “Guideline for credit rating agency”, Securities and Exchange Board of India, CIR/MIRSD/CRA/6/2010 (2010).

11 Clause 5 (ii) (a), “Guideline for credit rating agency”, Securities and Exchange Board of

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