A credit rating is primarily done to derive the credit worthiness of an enterprise or an individual or even a country.

Credit rating means an overall evaluation of the strengths and weaknesses of a potential borrower. It also means a borrower's ability to repay his debt. The ratings take into account the financial history, the assets and liabilities. In India, the SMEs being a productive sector, more and more small and medium enterprises are feeling the need to go in for credit ratings for an easy credit assess. For the sustainable growth of the sector, more and more SMEs have to take advantage of credit ratings.

Credit Analysis & Research Ltd. (CARE Ratings) is a full service rating company that offers a wide range of rating and grading services across sectors. CARE has an unparallel depth of expertise. CARE Ratings methodologies are in line with the best international practices. CARE Ratings has completed over 8488 rating assignments having aggregate value of about Rs.26609 bn (as at Sep 30, 2010), since its inception in April 1993. CARE is recognised by Securities and Exchange Board of India (Sebi), Government of India (GoI) and Reserve Bank of India (RBI) etc.

Dr. D R Dogra, Managing Director and Chief Executive Officer, CARE, who has varied experience spanning over three decades in commercial banking with an extensive knowledge about the functioning of the corporate and the small sector talks to SME WORLD in Mumbai recently. How Credit Rating is an ingredient for a better credit flow in an SME-dominated economy like ours? SMEs have been the growth engine for many developing economies and India is no exception. The contribution of SMEs to India's GDP is expected to increase steadily over next 10-15 years. However, restricted access to funding, especially access to risk capital, has been a major impediment to the growth of this sector. A large proportion of the businesses in the SME sector are essentially 'Micro' businesses comprising proprietorship or partnership concerns and are largely family owned. Given this profile, lenders and investors are weary of taking exposure to this segment due to issues like unstructured information flow, lack of collateral and improper accounting and managerial information systems. Moreover, the high risk perception of the SMEs also

stems from the fact that these businesses are more prone to failure and have difficulty in attracting and retaining quality manpower. Further, the transaction cost for catering to the SME segment is high for banks, financial institutions and other investors, which further discourages them to lend to this sector.

Credit Rating can go a long way in addressing this information asymmetry that exists between the SMEs and the capital providers. Over and above being an unbiased, objective and independent opinion from a professional agency, credit rating process involves extensive analysis of an entity's business and financial profile and the state of the industry in which it operates. Besides, interaction with management of the entity being rated, visits to its operational facilities and due diligence with bankers and statutory auditors provide an all round risk assessment of an entity. The entire exercise culminates into a rating outcome as per the scale on which the entity is rated.

Credit rating of debt instruments and bank facilities assesses the ability of the rated entity to service its debt obligations in a timely manner and hence are indicative of the probability of default. A large number of SMEs have been assigned Bank Loan Ratings (BLR) after the full-fledged implementation of the Basel-II Capital Adequacy norms by the Reserve Bank of India (RBI) from April 2009. Besides BLR, CARE also provides SME Ratings and NSIC-CARE SSI Performance & Credit Ratings. CARE's SME Ratings provide an opinion on the overall creditworthiness of an SME vis--vis other SMEs. The NSIC-CARE SSI Performance and Credit Rating, applicable for registered SSIs, assesses SSI units on dual parameters of Performance Capability and Financial Strength. While BLRs are already being used by the banks for their capital adequacy provisions, SME & SSI ratings can also aid the lenders in their lending & pricing decisions pertaining to the SMEs. The utility of SME/SSI ratings is enhanced from the fact that the overall risk assessment framework used to arrive at these ratings is similar to the one used for assigning instrument and bank loan ratings in which CARE has significant experience and has wide acceptability. What is the reason that the concept of credit ratings is not gaining momentum? Credit rating has been around in India for over a decade now, however, its utility in the initial years was limited due to a relatively underdeveloped bond market in the country coupled with a weak institutional framework. While the bond markets still continue to evolve in our country, the institutional and capital market framework has come a long way and has now become much more established. Also, with the advent of the Basel-II guidelines, the whole banking system is using the ratings assigned by independent Credit Rating Agencies (CRAs) for arriving at their capital adequacy. One reason why the proliferation of credit ratings appears low could be that the full implementation of the Basel-II guidelines took place very recently in April 2009 and the SME segment particularly never had the need for a credit rating as they could not access the bond markets and bank funding was a primary source of funding which didn't require an entity to go for ratings. Subsequent to the Basel-II guidelines, a large number of SMEs have been rated under the BLR scale and the awareness about ratings has gone up significantly. Hence, it would be improper to say that credit rating is not gaining momentum. As the capital markets evolve in India, credit ratings will have a much greater role to play in the economy. Do you think credit ratings become redundant when banks and financial institutions are indulging in their own rating? Why the banks are hesitant to rely on credit ratings by professional agencies? The Basel-II guidelines implemented by the Reserve Bank of India (RBI) are based on the international best practices in the banking industry. These guidelines recommend the Standardized Approach for measurement of credit risk by banks which entails use of credit ratings assigned by external CRAs, like CARE, for arriving at the risk weights for various loan exposures of the bank. While banks do have their own internal credit assessment methods, the use of external credit ratings done by a professional and independent agency has been mandated to strengthen the overall banking system. Also, because the bank loan ratings have come into being very recently, banks are in the process of aligning their internal assessment models in line with independent credit ratings. Moreover, some of the assessment parameters considered by the banks in their lending decision and the information provided by the bank ratings also vary. Credit ratings provided by CARE comment on the ability of the entity to service its debt in a timely manner and do not indicate the recovery aspect of the loan once a default has happened. Credit ratings are assigned from a long term perspective and factor in the ability of an entity to withstand industry and business cycles in the medium term. CARE frequently publishes its rating methodologies for various sectors and banks & FIs need to look at ratings in that perspective.

Why is there no awareness worth its ilk in attracting more and more entrepreneurs to go for credit ratings? For most start-ups in India, the primary funding source is from personal resources like own savings & from family and friends. While venture capital (VC) can be sought by entrepreneurs in some sectors, majority of them don't have access to it. The first outside source of funding for most SMEs is the bank. Till they have access to this source, entrepreneurs will not be aware about credit rating and its benefits in the long term. Moreover, for those who are aware, the apprehension of getting a low rating can also discourage entrepreneurs to go for it. CARE frequently participates in seminars & workshops along with various industry associations and the banking community to spread awareness about credit rating and its benefits. How will an SME suffering from low credit ratings enhance its ratings to acceptable levels? CARE provides a rating rationale to the rated entities which highlights the strengths and weaknesses considered by it while arriving at those ratings. Addressing these constraints can help SMEs to improve their ratings going ahead. Such constraints can be internal to an entity (related to its operations) and/or external constraints (like industry & economic scenario). An SME can more specifically focus on the internal constraints related to its operations in the short to medium term and chalk out a strategy for dealing with the industry level constraints in the long run in order to improve its rating gradually.

What are the principal parameters that are adopted by a credit rating agency for assessment? The risk assessment framework adopted by CARE involves assessment of management strength, analysis of entity's business and industry and financial analysis. For evaluation of the management, CARE looks at the qualifications and experience of the promoters in running its business, strategic initiatives adopted, resourcefulness of the promoter, organizational structure, control systems in place and capabilities demonstrated at times of stress. For business risk analysis, CARE looks at parameters like product/service profile, revenue concentration in terms of products/services and customers, cost structure, geographical presence, utilization levels of production unit, position in the industry value chain & level of integration, marketing & distribution setup and market share. Industry analysis involves assessment of the level and nature of competition in the sector, degree of fragmentation, regulatory risk, seasonality & cyclicality, bargaining power of the suppliers and customers and linkage with overall economic cycles. The entity being rated is also compared with its peers on operational and financial parameters. Financial analysis is based on financial ratios and looks at an entity's growth, profitability, solvency position & liquidity. Scenario analysis is done to project an entity's future capacity to meet its debt obligations in a timely manner. Besides, CARE also takes into account project risk in case of companies having on-going or planned capital expenditure

Money
SME World >> Money

Credit Rating Can Help Develop Information Symmetry Between SMEs and Lenders : Dr. Dogra
SME WORLD Bureau Apr 2011

Page 5 of 6 Do you have the same parameters for every enterprise? How do you rate the strengths and weaknesses of an SME? Are capabilities or the hidden potentialof an enterprise also taken into consideration while rating it for

credit worthiness? The overall risk assessment framework for all entities going for BLR remains the same. However, for SME Ratings, a slightly different approach is taken looking at the specific characteristics of this sector vis--vis large corporates. Under SME Ratings, the assessment of the overall creditworthiness of an SME is done in relation to other SMEs. This relative assessment within the SME universe gives a better idea about the creditworthiness of SMEs and can be used by lenders and investors to distinguish between good and poor credits within the sector. The SME Rating framework also includes a cluster approach for SMEs operating as a part of a recognized cluster. A robust risk assessment framework coupled with relative assessment within the SME universe is beneficial to the borrowers as well as lenders and investors. Besides SME Ratings, the NSIC-CARE SSI Performance and Credit Rating are applicable for units registered as SSIs. This rating assesses a SSI unit on dual parameters of Performance Capability and Financial Strength. Again the assessment is done relative to the SSI universe and comparison is made with similar units. A cluster approach, similar to the one used for SME Ratings, is also used in SSI ratings. Is there any motivation from the government side towards credit ratings? The government, through the National Small Industries Corporation (NSIC), provides subsidy of up to 75% of the cost of getting a Performance & Credit Rating for SSI from CARE. Besides, the government, through the Basel-II guidelines of the RBI, has ingrained credit rating in the Indian financial system. What are the broad advantages that could motivate an enterprise to go for credit rating? Credit rating not only meets a regulatory requirement of getting finance from banks but also helps in enhancing an entity's standing with its existing and prospective customers and suppliers. It also works as a feedback mechanism for the management and helps in self-assessment vis--vis peers. Besides, these ratings are published and this creates good visibility for SMEs. Kindly outline the finer points of CARE? CARE is a full service CRA promoted with major shareholders being IDBI Bank, Canara Bank and SBI. It offers a wide range of rating and grading services across sectors and has a track record of over 17 years in the rating business. CARE's rating methodologies are in line with the best international practices. CARE is recognised by Securities and Exchange Board of India (Sebi) and RBI. CARE is headquartered in Mumbai with regional offices in Ahmedabad, Bangalore, Chennai, Delhi, Hyderabad and Kolkata. CARE is setup as two divisions: CARE Ratings and CARE Research. The various rating and grading services come under the Ratings division. CARE Research provides contemporary research and information covering various industries and financial markets. Publications include Industry Research Reports with Updates, Debt Market Review, Budget Analysis, other policy impact analysis, and special commentaries on topical issues. CARE Research offers both subscription based reports and also customized reports on request. The division has an established network of primary and secondary sources, which enable the analyst to form unbiased opinion on the industry segments. It has also developed different methodologies for forecasting the future demand-supply situation in a particular industry.