Credit Rating:

Credit rating is the rate of the rating company on the ability and finance position as well as history finance position to pay off the debts. Credit rating estimates all the finance position such as assets and liabilities, balance sheets, long terms assets and liabilities, debt-equity ratio and past of the company to pay the debts. With all these financial instruments, credit rating company gives the rating to the company of which it is rating and tell the investors as well as lenders about the financial position with its rating. Like normally credit rating gives company point 1 to 5 and 5 indicates that company has sound financially position whereas 1 indicates that company has poor financial position.

Credit Rating Agencies:

Credit Rating Agencies are essentially the corporations with specialized functions namely, assessment of the likelihood of the timely payments by an issuer on a financial obligation. In India the rating activities started with the incorporation of the Credit Rating Information Services of India Ltd. (CRISIL) in 1987 which commenced its operations of rating of companies in 1987-1988 and was promoted by Industrial Credit and Investment Corporation of India Ltd. (ICICI) and Unit Trust of India (UTI). The second rating agency Investment Information and Credit rating Agency of India Ltd. (ICRA) was incorporated in 1991 and was jointly sponsored by Industrial Finance Corporation of India (IFCI) and other financial institutions and banks.

The other rating agency, Credit Analysis and Research Ltd. (CARE), incorporated in April 1993, is a credit rating information and advisory services company promoted by Industrial Development Bank of India (IDBI) jointly with Canara Bank, Unit Trust of India (UTI), private sector banks and financial services companies. Another rating agency Onicra Credit Rating Agency of India Ltd., which was incorporated in 1993, is recognized as the pioneer of the concept of individual credit rating in India.

Issues of Credit Ratings in India:

Casual and anecdotal evidence suggests that there are concerns among investors and regulators about the performance of rating agencies in India. Notable financial failures such as those of CRB capital markets have led to writings in the press which have raised questions about the role of rating agencies in providing sufficiently early warnings to investors. The impact of the institutional features of the business of ratings on the independence and performance of rating agencies in India has also been the subject of considerable debate. CRISIL, ICRA, and CARE are all promoted by large financial institutions. Firms, which borrow from such financial institutions, it can be validly argued, would also be under some compulsion to hire the rating agency promoted by the lending institution. Secondly, rating in India is compulsory for any firm that chooses to raise money through a public issue of debt.

This results in an assured market for the rating agencies. The choice is not between rating and not-rating but one of which agency to hire. This could well lead to a situation of having to choose the best among the worst. Thirdly, rating agencies engage in a variety of other businesses such as corporate advisory services. Such services are often on offer to the same firms which also hire the agencies for rating services. This situation can justifiably raise questions about potential for a conflict of interest. Fourthly, firms which are not satisfied with the rating assigned by an agency are under no obligation to publish such a rating. They can instead go to a competing rating agency and try to obtain a better rating. This can and perhaps led to a "shopping for rating" and some expeditious business strategy being adopted by rating agencies. Venkatesh and Gupta (1997), examine the universe of ratings assigned to fixed deposits issued by investment firms and find that there is a significant concentration of ratings on the border between the speculative and investment grades. A possible explanation for this concentration could be obliging agencies which assign "on-the- border" investment grades to firms which would otherwise find it difficult to raise money in the markets. Such expeditious strategy can result in a significant number of such ratings being downgraded subsequent to the issue of debt. Gupta and Venkatesh (1997), on an analysis of 124 rating changes assigned to debt instruments issued by manufacturing companies find that the number of ratings downgraded are significantly larger than those upgraded. Finally, in the absence of a bond market in India, the debt issuing firms do not experience the negative effects on their wealth of downgrades and the investors are often left with no recourse but to hold these downgraded (and sometimes upgraded) instruments at the coupon rates at which they were issued.

IPO Grading:

It is a rating assigned by the Securities and Exchange Board of India-registered credit rating agencies to initial public offerings (IPOs) of various firms. The grade indicates an assessment of business fundamentals and market conditions in comparison to other listed equities at the time of the issuance. These ratings are generally assigned on a five-point scale, with a higher score indicating stronger companies. IPO grading can be done either before filing the draft offer documents or thereafter. However, the red herring prospectus must have the grades given by all the rating agencies.

A company which has filed the draft offer document for an IPO on or after May 1, 2007, must be rated by at least one agency. Companies cannot reject the grade. If dissatisfied, they can opt for another agency. But, all grades obtained for the IPO must be disclosed to the regulator and the investors.

Grading of Initial Public Offerings in India:

The decision to introduce the requirement recognized the needs of the Indian capital market and was the result of pressure from certain investor groups. However, the path to mandatory grading IPOs has been unsteady, with opposition from companies, investment bankers, fund managers, market experts and even the SEBI board members. The parties that are in opposition want the grading to be an optional exercise. They argue that the mandatory grading has increased the cost of raising funds and also has led to delay in the IPO process, which SEBI was attempting to make faster and shorter with the help of grading. Given that the grading expenses have been as high as one percent of the total issue size in some cases, some of the concerns by the opposition deserve consideration. (SEBI Regulations)

In the year 2006 SEBI introduced optional grading of IPOs unlisted companies and framed guidelines relating to disclosure of the IPO by issuer companies who may want to opt for grading of their IPOs by the rating agencies. If the issuer companies opt for grading, then they are required to disclose the grades, including the unaccepted ones, in the prospectus. The correction in the market in April 2007, resulting in many new scraps dipping below their offer price, triggered the SEBI move to make IPO grading mandatory.

IPO Grading – Reliable Mechanism or a Hit-or-Miss?

Data collected in 2012, concerning all the companies whose IPOs were graded shows that some of the companies even though graded 4 and 3 by the credit rating agencies, their pricing performances are much below their offer price. A few companies like were trading much above their offer price, others like were trading much below their offer price. At the same period a few companies with a low grade of 1 and 2 were trading at much above their offer prices.

The reason is that IPO grading can be considered as, ab initio, a bad idea. It stems from the mistaken notion that the regulator's job is to protect small investors. It is not. The regulator's job is to ensure full and proper disclosure to investors and fair play between market players. Nothing more.

The argument that small investors cannot go through the detailed information contained in company prospectus and hence need the crutch provided by ratings is absurd. Investors who cannot go through the prospectus have no business to enter the stock market; they can go through mutual funds. Indeed, assigning grades to new issues can lull investors into a false sense of security about the risks and rewards of equity investing and can make equity look safer than it is.

CONCLUSION:

The credit rating system in India is, on the face of it and mostly otherwise too, sound and works beautifully. A system that was introduced was the first time in 1988 has been working satisfactorily in the past two and a half decades.

However there lies a very fundamental problem that plagues the whole of India, everywhere and in all systems. Nepotism. Imagine a bank or a financial institution that already has a stake in a corporate entity. Now add to that a credit rating agency that is sponsored by such bank or institution. It leaves a huge question mark on the integrity of the credit ratings.

IPO Grading as a system has had mixed reviews in India, both by the market and by the investors. When it was made mandatory, there were many voices that spoke against it, including the then chairman of SEBI who said that if it wasn’t introduced in other countries, and by other authorities, then there must be a good reason for it.

Data also shows that the IPO Gradings of the credit rating agencies are not on the mark more times than they should be.

Academically both Credit Rating and IPO Grading seem sterling systems that can only help the investors, however for them to realize their full potential, a number of changes need to be made.

REFERENCE:

1 K.S Venkateshwara Kumar, S. Hunamantha Rao, Credit Rating Role in Modern Financial System,

2 Ranadev Goswami and S. Venkatesh, Understanding and Use of Credit Ratingin India: A Survey of Individual and Institutional Investors,

3 Kuljeet Kaur, Dr. Rajinder Kaur, Credit Rating in India: A Study of Rating Methodology of Rating Agencies

4 What is IPO Grading, http://www.business-standard.com/article/pf/what-is-ipo-grading-111051700025_1.html

5 V.Ravichandran , Dr. Rajarajan Vanjeko, Grading of IPO System in India,

6 www.crisil.com

7 www.indiaratings.co.in

Received on 05.03.2015 Modified on 15.03.2015

Int. J. Rev. & Res. Social Sci. 3(1): Jan. – Mar. 2015; Page 04-06