- What is a bank loan rating? Why has it become relevant?
CRISIL assigns Bank Loan Ratings to various types of facilities provided by banks, such as working capital demand loans, cash credit, project loans, loans for general corporate purposes, and non-fund-based facilities. Bank loan ratings indicate the degree of risk with regard to timely payment of interest and principal on the facility being rated.
On April 27, 2007, The Reserve Bank of India (RBI) issued new guidelines on capital adequacy for banks. These guidelines require banks to link the minimum size of their capital to the credit risk in their portfolios. This is a departure from the present framework, under which banks calculate the minimum size of their capital as a proportion of the entire loan portfolio, regardless of the degree of credit risk. To determine credit risk in their loan portfolios, banks will need to use credit ratings assigned by approved External Credit Assessment Institutions (ECAIs) such as CRISIL.
A bank loan rating will help corporates in the following ways:
- Improve bargaining power with lenders to get lower interest rates and better credit terms
- Showcase the rating to various counterparties and investors
- What is Basel II?
Basel II is recommendatory framework for banking supervision, issued by the Basel Committee on Banking Supervision in June 2004. The objective of Basel II is to bring about international convergence of capital measurement and standards in the banking system. The Basel Committee members who finalised the provisions are primarily representatives from the G10 countries, but several countries that are not represented on the committee have also stated their intent to adopt this framework.
RBI, in April 2007, has issued guidelines on the New Capital Adequacy Framework to banks operating in India, based on the Basel II framework. These guidelines replaced the ones issued in April 1992, when RBI had implemented the first set of recommendations of the Basel Committee, known as Basel I.
- When do Basel II norms come into effect?
The revised framework for capital adequacy is effective from March 31, 2008, for all Indian banks having an operational presence outside India (12 public sector banks and five private sector banks) and for all foreign banks operating in India. It was applicable to all other commercial banks (except local area banks and regional rural banks) from March 31, 2009.
- What is the impact of Basel II on banks in India?
Under the new framework, banks will need to provide capital for credit risk based on the risk associated with their loan portfolios. If a bank has high-quality credit exposures (for example, if the majority of its credit exposures are in the 'AAA' and 'AA' categories) it will save capital on account of credit risk; the difference is apparent in the illustration below. Conversely, a bank with relatively lower rated credit exposures will need to provide more capital.
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Illustration of capital-saving potential by banks on a loan of Rs.1000 Million |
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Rating |
Basel I |
Basel II |
| |
Risk
weight |
Capital
required1
(rs. mn) |
Risk
weight |
Capital
required
(rs. mn) |
Capital
saved
(Rs. Mn) |
| AAA |
100% |
90 |
20% |
18 |
72 |
| AA |
100% |
90 |
30% |
27 |
63 |
| A |
100% |
90 |
50% |
45 |
45 |
| BBB |
100% |
90 |
100% |
90 |
0 |
| BB and below |
100% |
90 |
150% |
135 |
(45) |
| Unrated |
100% |
90 |
150%2 |
135 |
(45) |
1 Capital required is computed as Loan Amount x Risk Weight x 9%
2In November 2008, RBI as a countercyclical measure changed the risk weights for unrated exposure to 100%
Additionally, banks will have to provide incremental capital for market risk and operational risk. Capital for operational risk was not part of the previous regulatory framework.
- Is credit rating mandatory under Basel II for all loans given by banks?
Credit rating is not mandatory under Basel II. However, banks are likely to be able to save capital if they get their loan portfolios rated. If a bank chooses to keep some of its loans unrated, it may have to provide a risk weight of 100 per cent for credit risk on such loans. From April 1, 2009, this minimum size was reduced to Rs.100 million.
On the other hand, by getting loans rated, a bank can save capital on loans in the higher rating categories, as shown in the illustration above. CRISIL expects pricing of fresh loans to be strongly correlated with the credit ratings that such loans carry. Higher-rated corporates in particular will benefit from this development.
- Which type of facilities will be rated by CRISIL?
CRISIL will rate all types of loans and working capital facilities of banks. These include project loans, corporate loans, general purpose loans, working capital demand loans, cash credit facilities, and non-fund-based facilities like letters of credit and bank guarantees.
- Why will corporates now want to get themselves rated?
Under the earlier framework, there was no need for a borrower to have its loans or bank facilities rated. This will change with the implementation of the new framework: RBI has asked banks to use ratings assigned by rating agencies like CRISIL to arrive at risk weights and thereby compute capital requirements. Based on this RBI requirement, banks will require their prospective borrowers (and customers for non-fund-based facilities) to get their facilities rated. Some banks may also provide incentives (such as lower interest rates for loans) to higher rated facilities, sharing the capital savings on such exposures.
- Is a rating required before a company can get a loan sanctioned, or to renew its working capital facilities?
Rating is not a pre-requisite for a loan sanction or for renewal of working capital facilities. However, a bank could insist on a rating for the loan/facility before sanction/renewal, as it would help the bank in saving capital and also provide an additional input for the bank in deciding on the terms of the loan.
- What is CRISIL's rating scale for bank loan ratings?
CRISIL will rate long-term loans or facilities (with original contracted maturities of one year or more) and cash credit facilities (as required by RBI in its guidelines) on its long-term rating scale. Short-term facilities (with original contracted maturities of one year or less) will be rated on CRISIL's short-term rating scale. Please refer to the annexure for details of CRISIL's long-term and short-term rating scales.
- How long will CRISIL take to rate a bank loan?
From the day it receives a written request for a bank loan rating, along with all information required for the analysis, CRISIL will take three to four weeks to complete the exercise. If CRISIL has already rated other instruments - such as non-convertible debentures or commercial paper - issued by the rated entity, the incremental effort involved in the analysis would be minimal and hence the assessment could be carried out much faster.
- Will CRISIL rate every bank facility separately?
CRISIL will assign individual ratings to each facility. The validity of each rating will be linked to the tenure of the rated facility.
- In case of consortium lending, does the borrower need to take a separate rating for each banker?
A company that has borrowed from a consortium of lenders can get the entire loan amount or facility rated by CRISIL at one go; a rating letter issued for the entire facility can be submitted to all the banks in the consortium.
- Should a company also get its non-fund-based limits rated by CRISIL?
Under the new framework, banks will have to provide capital on both fund-based and non-fund-based exposures. However, the capital requirements on non-fund-based exposures are lower than the capital requirements on fund-based exposures of a similar magnitude. Hence, banks may initially focus on ensuring that their fund-based exposures are rated, to maximise their capital savings.
- What about foreign currency loans and external commercial borrowings (ECBs)? Will CRISIL also rate these?
According to the new framework, risk weights on banks' exposure to resident corporates, irrespective of the currency of exposure, will be calculated based on ratings assigned by domestic rating agencies such as CRISIL. Accordingly, CRISIL will assign ratings for foreign currency loans taken by resident corporates from Indian banks or foreign banks based in India.
Under the new framework, risk weights on banks' exposures to non-resident corporates will be calculated based on ratings from global rating agencies such as Standard & Poor's.
- If a company's non-convertible debentures are rated, can the same rating be used by banks for all exposures to the company?
Under the new framework, in circumstances where the borrower has a specific assessment for an issued debt, the rating applicable to that debt may be applied to the bank's unrated claims for capital relief only if:
• The bank's claim ranks pari-passu with, or is senior to, the specific rated debt in all respects, and
• The bank's claim has a maturity that is not later than the maturity of the rated claim.
In case of short-term exposures, the risk weight to be used for the unrated claim will be one category higher than the risk weight for the rated claim. For example, consider a company that has two short term facilities - Rs.200 million Commercial paper (CP) and Rs.100 million short term bridge loan; the CP is rated 'P1' by CRISIL, a rating that would attract a risk weight of 30 percent. If a bank intends to use the 'P1' rating of the CP as a proxy for the short term bridge loan, however, it will need to provide the risk weight applicable to a P2 rating at 50 percent.
- Does a corporate have the option to accept the rating?
The company has the option to accept or not accept the rating assigned. Once the rating is accepted, CRISIL will issue a rating letter to the borrower, issue a press release for the rating, post it on its website, and carry it in its monthly ratings publication. Only ratings that are available in the public domain can be used by banks for calculating risk weights.
- If the corporate does not accept the rating, will CRISIL share the rating with the bank?
Only after the company accepts the rating, it will be publicly released and shared with the bank.
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