Criteria for Assessing CRISIL's Performance

This paper makes an attempt to assess the quality of credit rating function being performed by CRISIL (Credit Rating and Information Services of India...
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This paper makes an attempt to assess the quality of credit rating function being performed by CRISIL (Credit Rating and Information Services of India Ltd.). With this objective, the paper addresses two important questions: a) Are CRISIL's standards of rating comparable to international standards? (b) Are CRISIL's ratings internally consistent? Based on the assessment of companies rated AAA by CRISIL on the S&P standards, the authors conclude that CRISIL's credit rating standards are not only much below international standards, they are also internally inconsistent. V Raghunathan and Jayanth R Varma are both faculty members in the Finance and Accounting Area at the Indian Institute of Management, Ahmedabad.

In the context of the freeing of interest rates and the greater reliance on market forces in the financial sector, credit rating assumes increased significance. Until recently, CRISIL (Credit Rating and Information Services of India Limited) was the only credit rating agency in India. All ostensible indications are that the country's first credit rating agency has done well and is continuing to do so. This is borne out by the increasing acceptance of CRISIL's ratings by the financial community and the investing public. In a country with no history of credit rating institutions, this success of CRISIL in a relatively short time span is no mean achievement. However, in the ultimate analysis, a credit rating agency's track record may be considered good or bad only on the strength of how good or bad its ratings are. Having been in operation for four years, perhaps it is time to take stock of CRISIL's credit rating performance. But then, how docs one set about the task?

Criteria for Assessing CRISIL's Performance One could reasonably assess the quality of CRISIL's ratings by asking two questions: •

Are CRISIL's standards of rating comparable to international standards?



Are CRISIL's ratings internally consistent?

Methodology With the above twin questions in mind, we decided to investigate all the debentures (being the long term debt instrument) rated AAA by CRISIL. Unfortunately, there were only four of them, namely, the debentures of Ashok Leyland, Bajaj Auto, Indian Petro Chemicals Ltd (IPCL) and Tata Chemicals. We chose the reputed US rating agency Standard & Poor (S&P) as the benchmark against which to compare CRISIL. For ten key ratios used by S&P, we obtained the median value of each ratio for companies rated in each category from A A A to CCC. This data are given in Table 1. For example, for companies rated AAA, the median pretax interest coverage was 10.46 while for CCC rated companies this ratio was only 0.09. Table 1, therefore, gives us an idea of the standards that S&P applies for credit rating. For example, the typical pattern of ratios

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Source: Klapper, 13(1990). "Rating Corporate Fixed Income Securities," in Kuhn, R L(Ed.) Corporate and Municipal Securities, Vol III of the Library of Investment Banking, Homewood, Illinois: Dow Jones-Irwin. Note: Ratios 7,8 and 10 are in fact reciprocals of the original S&P ratios. This has been done so that for all the ratios, higher values indicate higher credit-worthiness. The ratio involves information concerning lease income, etc., which is not available from public sources. **The denominator of the ratio involves information concerning the capitalixed value of lease rentals, which again is not available from public sources.

for a company which S&P rates AAA can be read off the first column of Table 1. S&P rating symbols differ only slightly from CRISIL's and the definitions of these symbols (AAA, AA, etc.) are by and large comparable.

four AAA rated debentures. The ratios have been arrived at using the CMIE data (Centre for Monitoring Indian Economy, Key Financial Data on Larger Business Units, January/July 1991).

We then examined the exact definition of each of these ten S&P ratios and tried to identify the nearest Indian ratios corresponding to them. It turned out that we were unable to identify corresponding Indian equivalents for ratios 2 and 9 (of Table 1). This was because the fixed charge in ratio 2 included rents on leases — a piece of information not available in the Indian context. Again, no equivalent for ratio 9 could be found since the permanent capital in the denominator of the ratio included a component representing investments in leases—once again not available in the Indian context. Hence ratios 2 and 9 were dropped and corresponding Indian equivalents were identified for the remaining eight ratios (See Table 2). Table 2 provides the values of the Indian equivalent of S&P ratios for the

CRISIL's Rating versus S&P Rating

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Given the ratios in Table 2 for the four Indian AAA debentures, how do these compare with the S&P standards? In other words, what will be the rating for the four debentures if we were to apply S&P's standards? In However, since the CMIE data do not provide a break-up between short-term and long-term debt, this break-up is obtained from the Bombay Stock Exchange (BSE) Directory. The CMIE data have been preferred over the BSE data since its data are normalixed for various accounting as well as other differences, such as excise, advance taxes paid, customer's advance deposits and so on. In the case of Ashok Leyland, the accounting period comprises 15 months. This has been taken into account in computing the relevant ratios.

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Table 2: Indian Equivalent of S&P's Ratios for 1990 for Firms Whose Debentures are Rated AAA by CRISIL S&P Ratio

Ratio

Ashok Leyland

llajaj

IPCL

EBIT/INT

2.17

4.25

1.74

2.45

lr~dian

1

Pretax Interest Coverage

2

Pretax Fixed Charge Covcrag