An Overview of Credit Ratings

8/3/2019 An Overview of Credit Ratings

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An Overview of Credit Ratings

Countries are issued sovereign credit ratings. This rating analyzes the general creditworthinessof a country or foreign government. Sovereign credit ratings take into account the overall

economic conditions of a country including the volume of foreign, public and privateinvestment, capital market transparency and foreign currency reserves. Sovereign ratings alsoassess political conditions such as overall political stability and the level of economic stability acountry will maintain during times of political transition. Institutional investors rely onsovereign ratings to qualify and quantify the general investment atmosphere of a particularcountry. The sovereign rating is often the prerequisite information institutional investors use todetermine if they will further consider specific companies, industries and classes of securitiesissued in a specific country.

Credit ratings, debt ratings or bond ratings are issued to individual companies and to specificclasses of individual securities such as preferred stock , corporate bonds and various classes of government bonds. Ratings can be assigned separately to short-term and long-term obligations.Long-term ratings analyze and assess a company's ability to meet it's responsibilities withrespect to all of its securities issued. Short-term ratings focus on the specific securities' abilityto perform given the company's current financial condition and general industry performanceconditions.

Executive Summary

CRAs have been in operation since the late 1890s, signifying an existence of over 100 years.Rating standards by Moody s and S&P were known to be stringent. From 1970 onwards,financial literature has been commenting on the superior information efficiency of the markets,in comparison to information disseminated by the CRAs. With the advent of securitization andits offshoots, a complex web of contracts are stitched together to service structuredobligations. CRAs overestimated the enforceability of the structured obligations and fissures inthe structures resulted in the post-Enron, post-Worldcom debacle. Lack of corporategovernance standards and vigilance by accountants were identified as the root cause, while theCRAs were accused of abetting the intricate structures with high credit ratings.

CRAs (together with accountants) have once again come under sharp criticism after the sub-prime debacle, with the root cause being poor originations standards of banks and excessive,opaque structures designed by aggressive merchant banks. Structured finance, whichcommenced with class markets, moved into mass markets with the impetus from investmentbankers. It is said that CRAs once again overestimated the credibility of the contracting partiesto honour the structured obligations and were led to base their ratings on complex quantitativeblack -box models, with data from benign periods. This has led to investors being saddled withpoor quality, illiquid paper with systemic implications.
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The situation in India is different on account of conservative origination standards and lowercomplexity levels in securitized transactions (mostly Pass-Through-Certificates or PTCs) withvery little systemic implications. There is, however, the possibility of asymmetric informationbetween the issuers and all others due to reasons mentioned in this study.

CRAs have been operating in India since 1988. CRISIL, ICRA and Fitch India have collaborativearrangements with S&P, Moody s and Fitch respectively. CARE is promoted by IDBI & CanaraBank. This demonstrates the pedigree and parentage of Indian CRAs. The quality of their staff isalso observed to be competent. Brickworks, the latest entrant, was established in 2008. Thus, atotal of 5 major CRAs operate in India at present. Most of the ratings by CRAs relate to BankLoans, on account of ascertaining the Credit-related capital adequacy.

The two known incidents of CRAs under public scrutiny were the CRB (the NBFC) collapse in themid 1990s and the default by BPL on its loans from LIC. Barring these two incidents, there hasbeen no widespread criticism of the CRAs. The objective of this study is to gauge the robustnessof the operations of the CRAs with a view to suggest measures for improvements in theirperformance.

PhD level studies in India have shown that (i) Ratings in India are more lenient than theircounterparts in USA (ii) CRAs in India are more subjective in their assessment and (iii) thedeterioration in ratings is not captured in time by CRAs, if compared with financial informationin the public domain. These studies were completed in 2001.

The present study is another attempt to assess the performance of CRAs, particularly in thelight of the significant events in the global financial system and the criticism being faced byCRAs in USA. It covered 5 CRAs, 40 Ratings, 34 Analysts and 10 Institutional Investors.

Under study, a simple model, built around Net Worth, Leverage and Interest Cover, was used todetect deteriorations in creditworthiness. When compared with the actual ratings, it was foundthat the actual ratings did not always reflect the falling creditworthiness in a timely manner.The team has also suggested use of Artificial Neural Networks (ANN) which can be deployed byCRAs and Investors, to cross-verify the rating process and do a quality audit.

Over the years, CRAs have been disseminating information on ratings and rationales, free of

cost to the investing public, Many firms are coming into the public domain through the ratingexercise, especially SMEs that approach banks for loans. Hitherto, it was difficult to obtaininformation unlisted firms. The credit rating exercise is likely to instill discipline into SMEs earlyenough at their stage of growth. For the investing community, any additional information at azero-or low-cost, presents an opportunity to bridge the information gap on firms andindustries. As regards structured obligations, CRAs have already introduced complexitygrading to forewarn investors about the intricacy of structures.

While the CRAs have been staffed with very competent personnel, it is also felt that there isroom for improvement in the work systems, to address the problem of asymmetric


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information. Ab initio , there is asymmetric information between the management of ratedcompanies and their auditors. In turn, the CRAs depend on auditors. Further information isobtained from the bankers. The CRAs also rely on projections made by the companymanagements. Due to this over-reliance on information from the company and the auditors,other formal and informal sources of information are not utilized. Many good banks go beyondFinancial Statement Analysis before taking credit decisions. Hence, the asymmetric information

problem will continue to exist. It is strongly suggested that the Due Diligence Review Process(DDR) goes beyond Financial Statement Analysis. More broadly, development of DDR skills isimportant to improve the efficiency of CRAs, Merchant Banks, Lending Banks, Accountants andAuditors. The existing approach of relying on company managements may be insufficient indetecting falling creditworthiness in weaker or not-so-well governed firms.

There is no standard process of analysis across various Analyst teams. There is also a variationbetween the rating judgments of the individual Analysts and the final ratings arrived at byconsensus. Notes of dissent are not recorded, resulting in loss of valuable check-points forfurther monitoring. There seems to be a high level of subjectivity in the final ratings process.

Operational Audits, covering matters of record-keeping, minutes, surveillance, periodicity of reviews etc need to be made mandatory. This will result in the reviews being conducted atshorter levels, as also a proper monitoring trail.

For the benefit of the public, it is necessary to display the various rating symbols of variousCRAs on a common website (say of regulators), on a comparable scale.

While rating structured obligations, CRAs need to constantly update their rating models currentwith realistic cash flow estimates, and communicate the same to investors, so as to mitigate the

effects of model risk and counterparty risk.

Some investment institutions blindly rely on the ratings given by CRAs. Most of the investmentinstitutions, however, use the credit ratings as a filter and perform their own DDR beforemaking the final investment decision. This system of additional cross checks is a healthypractice on the part of users of ratings.

During the year 2008-09, a turbulent period for financial systems all over the world, a numberof Indian companies opted for Corporate Debt Restructuring (CDR). A risk-averse market alsosaw the reluctance of many investors in opting for the conversion of their FCCB into stocks,while opting for the redemption of the instrument itself. This placed additional strain on thefinancial resources of issuers, coupled with the fact that it became extremely difficult to raiseequity from the markets after January 2008. The tumultuous year showed the strain on thefinances of many companies. It also threw up questions on the lax attitude of corporationstowards governance and accounting where form was given precedence over substance. Inlight of the above, Accountants, Auditors, CRAs, Banks, Merchant Banks and Investors need toexercise extra vigil in gauging the creditworthiness of issuer companies.


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A survey of CRAs and their Analysts revealed that there was a very low level of awarenessamong Indian accountants of International Financial Reporting Standards (IFRS) which Indiancorporations need to comply with effective from financial year 2011. Awareness levels andcompetence needs to be raised on a war footing across the entire financial community, with anemphasis on substance, not merely formats. This would be a major step in strengthening theIndian financial system.

It is often said that Balance Sheets seldom repay loans but people do. This brings back theissues of good governance and accounting to the fore. The ex isting form -over- substance styleof governance goes against the grain of true corporate governance. To address this deeperissue, the subject of corporate governance or lack of it, merits further research for a timelydetection of falling corporate governance standards. Some suggested parameters to detectform -over- substance governance styles are: aggre ssive expansion, diversification, mergers &acquisitions, frequent fund-raising sprees, leverage and related party transactions, to name afew. The outcome of such research could result in inputs to strengthen the financial marketsand CRAs in particular.

Raters and Ratings: Evolution and the Current State of the Art

The Raters

A credit rating agency (CRA) is a commercial concern engaged in the business of credit rating of any debt obligation or of any project or program requiring finance in the form of debt orotherwise. CRA is different from a mercantile credit agency, which usually supplies generalinformation on corporate. It is also different from a credit bureau, which collates informationon credit record of corporate or even individuals. Nor is it a credit-assessing agency like thecredit department of a commercial bank. The most significant aspect of credit rating is that it isan opinion made available for public, influencing decisions by participants in financial markets.The following information on the origin and growth of credit rating has been collected fromtwo sources, viz., Cantor and Packer, 1995 and ICRA, 1994. The precursors of bond ratingagencies were the mercantile credit agencies, which rated merchants ability to pay theirfinancial obligations. After the financial crisis of 1837 in the US, Louis Tappan established thefirst mercantile credit agency in New York in 1841. Robert Dun subsequently acquired theagency, which first published its first ratings guide in 1859. In 1849, John Bradstreet formedanother mercantile rating agency, which published a ratings book in 1857. In 1933, the twoagencies were merged into Dun and Bradstreet, which became the owner of Moodys InvestorsService (Moodys) in 1962. Credit goes to John Moody for introducing formally the credit ratingsymbols in 1909 using Aaa through C notations when Moodys started rating US railroadbonds.

Meanwhile, Henry Varnum Poor published, The History of Railroads and Canals of the UnitedStates in 1860. The railroads were the principal engine propelling the Industrial Revolution. In1906, Standard Statistics began publishing financial information on US industrial companies.Rating for various other corporate bonds followed in 1923. In 1941, Poors Publishing Companyand Standard Statistics Company merged to form Standard & Poors Corporation (S&P). S&Pwas a publicly owned corporation till 1966 when its controlling interest was acquired byMcGraw Hill Incorporated which acts as the holding company.


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While the rating of corporate bonds started in the early twentieth century, sovereign ratingsrepresent a relatively new line of business for the agencies. The first industrial country to berated was France, by S&P in 1959. Both Moody s and S&P rated Venezuela, a non -industrialcountry, in October 1977. Fitch IBCA entered the business of sovereign rating only in 1975. Incases where a sovereign does not seek a rating, but a corporate entity of such a country seeks arating, CRAs do assign an implicit sovereign rating. The scope of rating in international arena

broadened in 1960s to include sovereign states and public agencies raising funds ininternational financial markets.

With the increasing number of companies and sovereigns entering into the international capitalmarket for raising funds, the credit rating operations of both Moody s and S& P have expandedand, hence, they maintain offices in major countries of the world. Besides these two worldfamous credit rating agencies in USA, there are a few more famous agencies that offersovereign ratings. These are Canadian Bond Rating Service, Dominion Bond Rating Service Ltd.,Duff & Phelps Credit Rating Co., The Fitch IBCA Group, Japan Credit Rating Agency Ltd. andThomson Bank Watch Incorporated. While normally CRAs assign a rating on the request of anissuer, there are occasions when unsolicited ratings are assigned, and in many such cases, thefact that they are unsolicited is made explicit with an asterisk.

There is also the criticism against the structure of CRAs in USA, with an oligopolistic marketlargely carved out between Moody s. S&P and Fitch. This quest for market shares is viewed as areason for a lack of commonality in the rating symbols. Also, the argument put forward formaintaining the oligopoly is that size begets experience and expertise, hence a larger number of smaller firms is undesirable in the interests of quality standards.

All of these agencies are represented in India through their collaborations:

S&P : CRISILMoody s : ICRA Fitch : CARE (for 1 year only)Fitch : Fitch India (formerly Duff & Phelps India)

These collaborations bring in financial capital, and more importantly, know-how, experience,depth of expertise, research capabilities and manpower synergies. The global orientationreceived by CRAs in India is further enhanced by two factorsAffiliation to the Association of Credit Rating Agencies in Asia (ACRAA), an ADB sponsored body.Indian CRAs are founder members.

Alignment with the IOSCO Code of Conduct, to the extent they coincide with the SEBI Code of Conduct for CRAs.

These collaborations, affiliations and alignments enable the Indian CRAs to benefit from anexposure to an international environment.

It is also a notable feature that Indian CRAs, in turn, provide technical expertise and knowhowto CRAs in Mexico and other countries in the SAARC and ASEAN regions. This provides anemerging markets perspective. Indian CRAs have a leadership position in Asia, behind only

Japan, whose CRAs show a greater affinity in interacting with CRAs from the developed (G7)countries.

As on date, there are 5 CRAs in India:

CRISIL (est. 1988), ICRA (est. 1991), CARE (est.1993), Fitch India (formerly Duff & Phelps India,


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est. 1996, taken over by Fitch in 1999), Brickworks (est. 2008).

Notably, India has 5 CRAs in comparison to 3 of USA. Thus, competition is stiffer since there aremore CRAs for a financial market that is smaller than USA in value, and hence dilutesoligopolistic power. However, in terms of number of firms and issues, India could be a marketof considerable size. During the current downturn from 2008, the number of rating assignmentshas increased, and to some extent, issuers have got away with discounts in rating fees (whichrange from Rs.1 lakh to 2 lakhs per rating assignment). This is evidence of a dilution of theoligopolistic power.

At a smaller level, there is SMERA (Small & Medium Rating Agency) which rates loans availed bySmall & Medium Enterprises. The rating fees are around Rs.40,000 per assignment, which thelarge CRAs find to be unviable; hence such assignments are either rejected or outsourced tosmaller Chartered Accountant firms, supplemented by a cursory telephonic verification. Thequality of personnel at SMERA or smaller agencies may not be the same as those at the SEBIregistered CRAs. Outsourcing is a matter of policy and should generally be discouraged forreasons of quality as well as privacy.

Another phenomenon is the presence of Credit Information Companies (CIC) which arerecognized by the RBI through the Credit Information Companies Regulation Act. Their servicesare availed by credit granting institutions for the sanctioning and monitoring of facilities toindividuals who borrow loans, housing loans and avail of credit card facilities. The CreditInformation Bureau of India Limited (CIBIL) is one such example.

The Rating Process

In 1934, Benjamin Graham, David Dodd and Sydney Cottle wrote their book Securities Analysisa classic work that marked the beginning of the field. Until then, financial analysis was sketchyand bereft or analytical principles or rigour. They also pioneered the first steps in theQuantitative School of financial information for decisions on Securities investment. SecuritiesAnalysis is the classic textbook used in Columbia University till this day. This 1934 classic hascome to the forefront once again in recent times, indicating how the tenets of conservativevalue investing protect the investor from overpaying when investing in securities, tenets whichare overlooked as unfashionable during the periods of economic boom. The Graham approachinvolves an analysis over the past 10 years to ascertain the track record of an issuer.

Also in parallel, during the 1930s, a notable development was the emergence of Philip Fisher ,who wrote his book Conservative Investors Sleep Well. This is a rec ommended textbook atStanford Business School. He stressed on the Qualitative aspects such as Management Visionand Integrity, Marketing & Sales Capabilities, Employee Morale Levels, Product Developmentetc. The hallmark of this approach is the use of informal information in addition to formalsources so as to obtain a more complete evaluation of a company s prospects. This technique,currently known as the process of Due Diligence Review (DDR) is critical in any financialappraisal. With the onset of outsourcing, financial appraisal skill seems to be a dying art,viewed as a poor cousin to investment banking and financial engineering. Thus, Philip FishersQualitative School neatly complemented the Quantitative School of Graham et al.

The 1930s are known for the disillusionment of the investing public with the quality of information disseminated by the financial community. It was also a period in which thedissatisfaction with the accounting community was made public. Thus, the 1930s are a periodwhich witnessed the formation of the SEC, the imposition of the Glass-Steagall Act thatseparated Commercial Banking from Investment Banking. The repeal of the Glass-Steagall Actrecently has exposed the systemic risks, seen from the downfall of Citigroup and other banksin the USA. European banks are further weakened by a total absence of an act similar to the


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Glass-Steagall Act.

Academic interest in financial analysis reemerged with studies by Edward Alt-man who used thestatistical technique of Multiple Discriminant Analysis (MDA), which has the ability to filter datainto two baskets: Safe and Default categories. It is a scoring model (revolving around a Z-score),with different weights to different ratios and variables. Based on the relevance of the variousweights and variables, subsequent researchers have been able to tweak the Altman Z-ScoreModel to devise their own scoring models.Supplementary to such studies, the Linear Probability Models (LPM) became popular inpredicting bond defaults. These models were further improved upon by the LOGIT and PROBITmodels, which are comparable.

In later developments, Credit Risk Measuring approaches such as Credit-metrics, Loss-Given-Default (LGD) and the KMV Models have extensively been used to measure credit defaultprobabilities and assign ratings and rating transitions. In particular, Moody s, and Standard andPoor (S&P) have equipped themselves with these techniques.

A study of the sub-prime crisis in USA is illustrative of the functioning, through a paper byVikrant Vig et al, presented at the Conference on Securities Markets organized by NISM inDecember 2008. The US CIC compiles a score and discriminates loan applicants into twobaskets credit-worthy or otherwise. The cut-off score was 620 for obtaining a mortgage loan.It was found that most of the defaults that occurred were by applicants who had obtained ascore marginally above 620 (say, 621 to 630). This led to the massive sub-prime crisis and itsglobal consequences. The lesson here is that the CIC and the applicants got around the systemand weakened the mortgage loan systemically. Abetted by lax standards of loan origination ina quest to boost balance sheet size and adventurous investment bankers, elaborate structuredobligations were created. Whereas the CICs failed in the loan-filtering process, the CRAs failedin detecting risks in the design of the pretty securitization structures.

By analogous reasoning, it is assumed that the maximum potential for default is by borrowerswho artificially manage to get a rating barely above the acceptable credit rating or credit score.For example, the highest defaults would be in the BBB category and need a stronger level of sanctioning procedures and scrutiny of collateral security.

At the 2003 Conference by ISMA held in Madrid, one of the Hedge Fund managers mentionedthat the International Rating Agencies lagged behind the market information. This was stated inthe light of the collapse of WorldCom and Xerox, in the aftermath of the Enron fallout.

The RBI has rightly been very critical of the role of Direct Selling Agents (DSAs) which are ill-equipped to filter bad loan proposals due to the commission structures that are based oncommissions. This perverse incentive structure results directly into a moral hazard and couldpose a systemic risk. Likewise, in Mutual Funds (regulated by SEBI) and Insurance (regulated byIRDA), cases of mis-selling are more widespread than on evidence, due to the possibility of un-reported complaints. This could be the genesis of premature redemptions and adverse claims.Along the same lines, tough norms need to be placed for recognition and renewal of registration of CRAs, SMERA and CICs. Although they operate in different segments, the basicDue Diligence Process (DDR) remains the same. This argument is extendable to auditors also,who are the first level in the filtering process. While there will always be asymmetricinformation between the issuer/borrower vis--vis the CRA and lender, steps need to be taken tominimize the asymmetry. Here, the DDR skills of the personnel will be the most important riskmitigating device.

CRAs and regulators need to be doubly careful in the blind spots or grey regulatory zones. AIGfor instance, was an insurance company whose unregulated affiliate strayed into Credit DefaultSwaps (CDS) that were traded in the unregulated OTC markets. Investment losses directly hitthe capital and the vulnerability showed up after it was too late. In this regard, complexitygrading is a good step and must be factored in to expose the heightened risks (counterparty


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risk) that is in addition to the basic credit risk, since one of the counterparties in the structuredobligation who may be unregulated and hence possess inadequate risk capital.

Rating symbols and their definations

AAA - 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 - 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 - 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 - 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 - Instruments with this rating are considered to have moderate risk of default

regarding timely servicing of financial obligations.

B - Instruments with this rating are considered to have high risk of default


C - Instruments with this rating are considered to have very high risk of default



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D - Instruments with this rating are in default or are expected to be in default

soon.

Modifiers {"+" (plus) / "-"(minus)} can be used with the rating symbols forthe categories AA to C. The modifiers reflect the comparative standing within thecategory.

Uses of ratings

Credit ratings are used by investors, issuers, investment banks, broker-dealers, andgovernments. For investors, credit rating agencies increase the range of investment alternativesand provide independent, easy-to-use measurements of relative credit risk; this generallyincreases the efficiency of the market, lowering costs for both borrowers and lenders. This inturn increases the total supply of risk capital in the economy, leading to stronger growth. It alsoopens the capital markets to categories of borrower who might otherwise be shut outaltogether: small governments, startup companies, hospitals, and universities.

Ratings use by bond issuers

Issuers rely on credit ratings as an independent verification of their own credit-worthiness andthe resultant value of the instruments they issue. In most cases, a significant bond issuancemust have at least one rating from a respected CRA for the issuance to be successful (withoutsuch a rating, the issuance may be undersubscribed or the price offered by investors too low forthe issuer's purposes). Studies by the Bond Market Association note that many institutionalinvestors now prefer that a debt issuance have at least three ratings.

Issuers also use credit ratings in certain structured finance transactions. For example, acompany with a very high credit rating wishing to undertake a particularly risky research project

could create a legally separate entity with certain assets that would own and conduct theresearch work. This " special purpose entity " would then assume all of the research risk andissue its own debt securities to finance the research. The SPE's credit rating likely would be verylow, and the issuer would have to pay a high rate of return on the bonds issued.

However, this risk would not lower the parent company' s overall credit rating because the SPEwould be a legally separate entity. Conversely, a company with a low credit rating might be ableto borrow on better terms if it were to form an SPE and transfer significant assets to
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tha tsubsidiary and issue secured debt securities. That way, if the venture were to fail, thelenders would have recourse to the assets owned by the SPE. This would lower the interest ratethe SPE would need to pay as part of the debt offering.

The same issuer also may have different credit ratings for different bonds. This differenceresults from the bond's structure, how it is secured, and the degree to which the bondis subordinated to other debt. Many larger CRAs offer "credit rating advisory services" thatessentially advise an issuer on how to structure its bond offerings and SPEs so as to achieve agiven credit rating for a certain debt tranche. This creates a potential conflict of interest, of course, as the CRA may feel obligated to provide the issuer with that given rating if the issuerfollowed its advice on structuring the offering. Some CRAs avoid this conflict by refusing to ratedebt offerings for which its advisory services were sought.

Ratings use by government regulators

Regulators use credit ratings as well, or permit ratings to be used for regulatory purposes. Forexample, under the Basel II agreement of the Basel Committee on Banking Supervision, bankingregulators can allow banks to use credit ratings from certain approved CRAs (called "ECAIs", or"External Credit Assessment Institutions") when calculating their net capital reserverequirements. In the United States, the Securities and Exchange Commission (SEC) permitsinvestment banks and broker-dealers to use credit ratings from "Nationally RecognizedStatistical Rating Organizations " (NRSRO) for similar purposes. The idea is that banks and otherfinancial institutions should not need keep in reserve the same amount of capital to protect theinstitution against (for example) a run on the bank, if the financial institution is heavily invested

in highly liquid and very "safe" securities (such as U.S. government bonds or short-term commercial paper from very stable companies).

CRA ratings are also used for other regulatory purposes as well. The US SEC, for example,permits certain bond issuers to use a shortened prospectus form when issuing bonds if theissuer is older, has issued bonds before, and has a credit rating above a certain level. SECregulations also require that money market funds (mutual funds that mimic the safety andliquidity of a bank savings deposit, but withou tFederal Deposit InsuranceCorporation insurance) comprise only securities with a very high NRSRO rating. Likewise,insurance regulators use credit ratings to ascertain the strength of the reserves held byinsurance companies.

In 2008, the US SEC voted unanimously to propose amendments to its rules that would removecredit ratings as one of the conditions for companies seeking to use short-form registrationwhen registering securities for public sale.

This marks the first in a series of upcoming SEC proposals in accordance with Dodd-Frank toremove references to credit ratings contained within existing Commission rules and replacethem with alternative criteria.
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Under both Basel II and SEC regulations, not just any CRA's ratings can be used for regulatorypurposes. (If this were the case, it would present a moral hazard) .[citation needed ] Rather, there is avetting process of varying sorts. The Basel II guidelines (paragraph 91, et al. ), for example,describe certain criteria that bank regulators should look to when permitting the ratings from aparticular CRA to be used. These include "objectivity," "independence," "transparency," and

others. Banking regulators from a number of jurisdictions have since issued their owndiscussion papers on this subject, to further define how these terms will be used in practice.(See The Committee of European Banking Supervisors Discussion Paper, or the State Bank of Pakistan ECAI Criteria).

In the United States, since 1975, NRSRO recognition has been granted through a "No ActionLetter" sent by the SEC staff. Following this approach, if a CRA (or investment bank or broker-dealer) were interested in using the ratings from a particular CRA for regulatory purposes, theSEC staff would research the market to determine whether ratings from that particular CRA arewidely used and considered "reliable and credible." If the SEC staff determines that this is thecase, it sends a letter to the CRA indicating that if a regulated entity were to rely on the CRA's

ratings, the SEC staff will not recommend enforcement action against that entity. These "NoAction" letters are made public and can be relied upon by other regulated entities, not just theentity making the original request. The SEC has since sought to further define the criteria it useswhen making this assessment, and in March 2005 published a proposed regulation to thiseffect.

On September 29, 2006, US President George W. Bush signed into law the "Credit RatingReform Act of 2006". This law requires the US Securities and Exchange Commission to clarifyhow NRSRO recognition is granted, eliminates the "No Action Letter" approach and makesNRSRO recognition a Commission (rather than SEC staff) decision, and requires NRSROs toregister with, and be regulated by, the SEC .S & P protested the Act on the grounds that it is

an unconstitutional violation of freedom of speech. In the Summer of 2007 the SEC issuedregulations implementing the act, requiring rating agencies to have policies to prevent misuseof nonpublic information, disclosure of conflicts of interest and prohibitions against "unfairpractices".

Recognizing CRAs' role in capital formation, some governments have attempted to jump-starttheir domestic rating-agency businesses with various kinds of regulatory relief orencouragement. This may, however, be counterproductive, if it dulls the market mechanism bywhich agencies compete, subsidizing less-capable agencies and penalizing agencies that devoteresources to higher-quality opinions.

Ratings use in structured finance

Credit rating agencies may also play a key role in structured financial transactions. Unlike a"typical" loan or bond issuance, where a borrower offers to pay a certain return on a loan,structured financial transactions may be viewed as either a series of loans with different
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characteristics, or else a number of small loans of a similar type packaged together into a seriesof "buckets" (with the "buckets" or different loans called "tranches" ). Credit ratings oftendetermine the interest rate or price ascribed to a particular tranche, based on the quality of loans or quality of assets contained within that grouping.

Companies involved in structured financing arrangements often consult with credit ratingagencies to help them determine how to structure the individual tranches so that each receivesa desired credit rating. For example, a firm may wish to borrow a large sum of money byissuin gdebt securities. However, the amount is so large that the return investors may demandon a single issuance would be prohibitive. Instead, it decides to issue three separate bonds,with three separate credit ratings A (medium low risk), BBB (medium risk), and BB(speculative) (using Standard & Poor's rating system).

The firm expects that the effective interest rate it pays on the A-rated bonds will be much lessthan the rate it must pay on the BB-rated bonds, but that, overall, the amount it must pay forthe total capital it raises will be less than it would pay if the entire amount were raised from asingle bond offering. As this transaction is devised, the firm may consult with a credit ratingagency to see how it must structure each tranche in other words, what types of assets mustbe used to secure the debt in each tranche in order for that tranche to receive the desiredrating when it is issued.

There has been criticism in the wake of large losses in the collateralized debt obligation (CDO)market that occurred despite being assigned top ratings by the CRAs. For instance, losses on$340.7 million worth of CDOs issued by Credit Suisse Group added up to about $125 million,despite being rated AAA or Aaa by Standard & Poor's, Moody's Investors Serviceand Fitch Group.

The rating agencies respond that their advice constitutes only a "point in time" analysis, that

they make clear that they never promise or guarantee a certain rating to a tranche, and thatthey also make clear that any change in circumstance regarding the risk factors of a particulartranche will invalidate their analysis and result in a different credit rating. In addition, someCRAs do not rate bond issuances upon which they have offered such advice.

Complicating matters, particularly where structured finance transactions are concerned, therating agencies state that their ratings are opinions (and as such, are protected free speech,granted to them by the "personhood" of corporations) regarding the likelihood that a givendebt security will fail to be serviced over a given period of time, and not an opinion on thevolatility of that security and certainly not the wisdom of investing in that security. In the past,most highly rated (AAA or Aaa) debt securities were characterized by low volatility and high

liquidity in other words, the price of a highly rated bond did not fluctuate greatly day-to-day,and sellers of such securities could easily find buyers.

However, structured transactions that involve the bundling of hundreds or thousands of similar(and similarly rated) securities tend to concentrate similar risk in such a way that even a slightchange on a chance of default can have an enormous effect on the price of the bundledsecurity. This means that even though a rating agency could be correct in its opinion that thechance of default of a structured product is very low, even a slight change in the market's
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perception of the risk of that product can have a disproportionate effect on the product'smarket price, with the result that an ostensibly AAA or Aaa-rated security can collapse in priceeven without there being any default (or significant chance of default). This possibility raisessignificant regulatory issues because the use of ratings in securities and banking regulation (asnoted above) assumes that high ratings correspond with low volatility and high liquidity.

List of credit rating agencies

Agencies that assign credit ratings for corporations include:

A. M. Best (U.S.)

Baycorp Advantage (Australia) Bulgarian Credit Rating Agency (Bulgaria, European Union) Capital Intelligence (Cyprus) Capital Standards Rating (Kuwait) Credo line (Ukraine) Dagong Global (People's Republic of China) Dominion Bond Rating Service (Canada) Egan-Jones Rating Company (U.S.) Fitch Ratings (Dual-headquartered U.S. /UK), 80% of which is owned by FIMALAC,a French

firm.

CRISIL(India) Japan Credit Rating Agency, Ltd. (Japan )[34] Moody's Investors Service (U.S.) Muros Ratings (Russia alternative rating agency) Rapid Ratings International (U.S.) Standard & Poor's (U.S.) Weiss Ratings (U.S.)

Big Three (credit rating agencies)

The Big Three credit rating agencies are Standard & Poor's, Moody's Investor Service, and FitchRatings. Moody's and S&P each control about 40 percent of the market. Third-ranked FitchRatings, which has about a 14 percent market share, sometimes is used as an alternative to oneof the other majors.
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Credit rating agencies in india

ONICRA CREDIT RATING AGENCY OF INDIA

CREDIT RATING INFORMATION SERVICES OF INDIA LTD. (CRISL)

INVESTMENT INFORMATION AND CREDIT RATING AGENCY OF INDIA (ICRA)

CREDIT ANALYSIS AND RESEARCH LTD. (CARE)

DUFF & PHELPS CREDIT RATING INDIA PVT. LTD. (DCR INDIA)

An Overview of Credit Ratings

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