INTRODUCTION
In providing independent opinions to investors as to the credit quality of debt issuer, credit ratings have become important parameters in market acceptance and pricing of debt[1]. Ratings are now viewed as easily usable tools for differentiating credit quality by both individual investors ill-equipped to assess credit risk, and institutional investors often required to hold instruments of given credit categories in their portfolio[2]. This introductory note reviews the key definitions and features of credit ratings and the bases on which ratings are assigned. It briefly addresses the correlation between credit quality and default rates, and outlines some of the criteria underpinning sub-sovereign credit assessments in emerging and developing economies[3].
With the increasing market orientation of the Indian economy, investors value a systematic assessment of two types of risks, namely “business risk” arising out of the “open economy” and linkages between money, capital and foreign exchange markets and “payments risk”[4]. With a view to protect small investors, who are the main target for unlisted corporate debt in the form of fixed deposits with companies, credit rating has been made mandatory. India was perhaps the first amongst developing countries to set up a credit rating agency in 1988[5].
The function of credit rating was institutionalized when RBI made it mandatory for the issue of Commercial Paper (CP) and subsequently by SEBI. When it made credit rating compulsory for certain categories of debentures and debt instruments. In June 1994, RBI made it mandatory for Non-Banking Financial Companies (NBFCs) to be rated. Credit rating is optional for Public Sector Undertakings (PSUs) bonds and privately placed non-conve11ible debentures upto Rs. 50 million. Fixed deposits of manufacturing companies also come under the purview of optional credit rating[6].
The Ratings industry in India has been built up to its present position over a period of 15 years. Over the years, credit ratings have evolved into a 90-crore market, with four agencies providing rating services, and significant pull from investors for the product[7]. The ratings business in India has seen three phases:
· First phase, as described above, there was no experience of credit ratings, and virtually no awareness, on the part of investors and issuers.
· Second phase saw the advent of regulatory support for credit ratings, with the introduction and increasing rigor of regulations covering primarily the markets for public issue of debt and for fixed deposits. Aimed at protecting smaller investors, these measures also amounted to regulatory recognition of the role of credit ratings and the quality of the effort put in till then, in estimating credit quality. With these measures, credit ratings rapidly passed out of the arcane realm of high finance, and into the lexicon of the individual market participant.
· Third phase recent years have seen a third phase of the market’s development with public issues of debt reducing in volume; the focus has shifted to the market for private placements. Almost all the privately placed debt issued in the Indian market is rated, even though this is not a regulatory requirement. This shift is entirely driven by investors in these securities, who typically tend to be highly sophisticated financial sector entities.
Credit rating is also known as Security Rating in India. It is mandatory for the issuance of debt instruments, debentures; commercial paper issued by corporate and public deposits of all NBFCs (Non Banking Financial Companies).
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