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How to Set Up a Credit Rating Agency and How It Operates?

How to Set Up a Credit Rating Agency and How It Operates?

Monday October 01, 2018,

6 min Read

Credit Rating Agency in India
Credit Rating Agency in India, Image Credit: Unsplash

How to Set Up a Credit Rating Agency in India?

SEBI is the final authority and regulator for granting the approval for the business of Credit Rating Agency in India. Thus the applicant has to submit its application to SEBI for approval purpose.

SEBI (Credit Rating Agencies) Regulations, 1999 has stipulated (under regulation 3) certain criteria/parameters for the grant of a certificate to undertake the business of credit rating agency. They can be described as under:

A.  The applicant is a setup and incorporated as a company under the Companies Act, 1956;

B.  The main object clause of the applicant in its Memorandum of Association shall be rating activity;

C. The applicant has a minimum net worth of rupees five crore. However, for the credit rating agency already existing at the commencement of these regulations by SEBI, with a net worth of less than rupees five crore, shall be considered to have satisfied this net worth requirement/condition, if it raises its net worth to the required minimum net worth within a period of three years of such commencement.

D.  The applicant shall have adequate infrastructure facility enabling it to provide rating services in accordance with the provisions/ regulations of the Act;

E.  The applicant and the promoters, as mentioned in regulation 4 should have professional competence, financial soundness and general reputation of fairness and integrity in business transactions, to the satisfaction of the Board (SEBI);

F.  No legal proceeding connected with the securities market should have been initiated against either the applicant, or its promoter, or any director of the applicant or its promoter, which may have an adverse impact on the interests of the investors;

G.  Either applicant, or promoter, or director, or its promoter should not have at any time in the past been convicted of any offense involving moral turpitude or any economic offense;

H.  The applicant shall have, in its employment, the persons/ staff having adequate professional and other relevant experience to the satisfaction of the Board;

I.    Either the applicant or any person directly or indirectly connected with the applicant has not in the past been –

        i.     refused by the Board a certificate under these regulations or

       ii.     Either applicant or any person directly or indirectly connected with the applicant shall not be subjected to any proceedings for a contravention of the Act or of any rules or regulations made under the Act.

Explanation - For the purpose of this clause, the expression "directly or indirectly connected person" means any person who is an associate, subsidiary, inter-connected or group company of the applicant or a company under the same management as the applicant.

J.   The applicant, in all other respects, shall be a fit and proper person for the grant of a certificate taking into account the criteria specified in Schedule II of the SEBI (Intermediaries) Regulations, 2008.

K.  To confirm if the grant of a certificate to the applicant is in the interest of investors and the securities market as a whole.

If all the above-mentioned criteria/parameters are satisfied, the Board (SEBI) grants the applicant the approval to undertake credit rating agency business.

How Does A Credit Rating Agency Operate?

A credit rating agency can be best defined as a private company whose main objective is to assess the ability of borrowers, either governments or private enterprises, to repay their debt. For this, the credit rating agency assesses the borrower and issues some credit ratings which are based on the borrower’s solvency status.

Currently, the three biggest global rating agencies like Fitch Rating Ltd. Moody’s and standard and poor’s control 95% business of the world market.

In India, credit rating agencies came into existence in the second half of the 1980s. And as of now, we have crisis, ICRA, CARE, SMERA, Fitch India, Equifax and Brickwork Ratings etc. credit rating agencies registered under SEBI.

To evaluate the status of solvency of the borrower, it is the work of the credit rating agency to issue credit ratings corresponding to the borrower’s credit risk. This will indicate the chance of default on the part of the borrower in repayment of the loans.

Although there is no standard scale or measure, such credit ratings are generally denoted by letters referring to the potential risk, with the highest rating represented by AAA and the lowest rating by C or D, according to the agency. Further, a credit rating agency may also forecast how a particular rating of the company may change in future time.   

Each rating agency has its own method to calculate its ratings for the credit risk considering quantitative (financial data), qualitative (business strategy for a company or political stability for a country) and contextual criteria (changes in the industry for a company or public finances for a country) of the company. However, the final rating indicates the evaluation of a borrower’s credit risk at a point of given time under consideration. This evaluation is not an advice to the investors or lenders but it is just an evaluation only. In fact, these ratings are invaluable tools for investors who are looking to get a better sense of worthiness of their investment in say bonds, debentures or any other debt instrument offered by the company (lender).

Thus, credit rating agency, as seen above, essentially assigns ratings to any debt instruments to be issued/offered either by private corporations or any government body. Since the investors (lenders) want to know that their investment is secured and it would get adequate compensation for the risk they are taking, thus the role of the credit rating agency is very crucial. An investor can come to know the level of risk in the investment of a debt instrument offered for subscription by just reading the credit ratings of the company.

Now a day, many of them also have special sections to carry on research and development work of the industries and providing the training to the staff and executives of the companies for better management.

Thus, credit rating agencies offer very valuable services and their role is very vital in the investment field.

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