Role of credit rating in the banking sector after introduction of basel ii regulation

ROLE OF CREDIT RATING IN THE BANKING SECTOR
AFTER INTRODUCTION OF BASEL II REGULATION- A
REVIEW ON BANGLADESH CONTEXT;
By
Md. Shahinuzzaman
Registration No: 01879, Session: 2008-2009
Department of Finance and Banking
Faculty of Business Administration and Management
PATUAKHALI SCIENCE AND TECHNOLOGY UNIVERSITY
DUMKI, PATUAKHALI- 8602.
April, 2013
INTERNSHIP REPORT

ROLE OF CREDIT RATING IN THE BANKING SECTOR AFTER
INTRODUCTION OF BASEL II REGULATION- A REVIEW ON
BANGLADESH CONTEXT;
April, 2013

Patuakhali Science and Technology University
Dumki, Patuakhali-8602
ROLE OF CREDIT RATING IN THE BANKING SECTOR AFTER
INTRODUCTION OF BASEL II REGULATION- A REVIEW ON
BANGLADESH CONTEXT
By
Md. Shahinuzzaman
Registration Number: 01879
ID: 0803017
An Internship Report Prepared for the Partial Fulfillment
of the Requirements for the Degree
Bachelor of Business Administration

April, 2013
An Internship Report
On
“Role of Credit Rating in the Banking Sector after Introduction of Basel II
Regulation- A Review on Bangladesh Context”
By
Md. Shahinuzzaman
Examination Roll Number: 0803017
Session: 2008-2009
Bachelor of Business Administration (BBA)
Major in Finance and Banking
Submitted to the Department of Finance and Banking
In Partial Fulfillment of the Requirements for the Degree
Bachelor of Business Administration
DUMKI, PATUAKHALI-8602.
April, 2013

Role of Credit Rating in the Banking Sector after Introduction of Basel II
Regulation- A Review on Bangladesh Context;
An Internship Report
Has been approved on
April, 2013
……….…………………………………………
Md. Nur Nabi
Assistant Professor
Internship Supervisor
……………………………………………………
Omar Faruque
External Examiner
Assistant Professor
Department of Finance
Jagannath University, Dhaka
…………………………………………………..
M. Takibur Rahman
Internship Co-supervisor
Assistant Professor

1st
April, 2013
To
Md. Nur Nabi
Assistant Professor and Internship Supervisor
Patuakhali Science and Technology University,
Dumki, Patuakhali-8602.
Subject: Letter of Transmittal
Dear Sir
It is a great pleasure for me to submit here with my dissertation, which has been prepared
under the sound and dynamic leadership of a personality like you.
This internship report is an integral part of my academic program in completion of the degree
named Bachelor of Business Administration, which has assigned me “Role of Credit Rating
in the Banking Sector after Introduction of Basel II Regulation- A Review on
Bangladesh Context” as a part of B.B.A. Program. I have tried my best to collect the relative
information as comprehensive as possible in preparing the report. During preparation of the
report I have experienced practically a lot that will help me a great in my career. It has
enlightened my practical knowledge regarding the present credit rating system. I will be able
to explain anything for more clarification if necessary.
I would like to thank you, for giving me the opportunity to do a report on the above
mentioned topic.
With best regards
…………………………………
Md. Shahinuzzaman
Session: 2008-2009

1st
April, 2013
To
Md. Nur Nabi
Subject: Letter of Authorization
Dear Sir
This is our truthful declaration that the Report on “Role of Credit Rating in the Banking
Sector after Introduction of Basel II Regulation- A Review on Bangladesh Context” is
not an exact copy of any research report or book previously made by others. I also express
my honest confirmation in support of the fact that the report has neither been used before to
fulfill any other course related purposes and not it will be submitted to any other person or
authority in future.
With best regards
…………………………………
Md. Shahinuzzaman
Session: 2008-2009

Tel: 04427-56014, 01813899621Fax: 04427-56009, E-mail:
deanbam_pstu@yahoo.com
ENDORSEMENT OF THE SUPERVISOR
It is our pleasure to certify that, Md. Shahinuzzaman, student of Bachelor of Business
Administration (BBA), Patuakhali Science and Technology University, Dumki, Patuakhali-
8602; has been completed the Internship Program at “Role of Credit Rating in the Banking
Sector after Introduction of Basel II Regulation- A Review on Bangladesh Context”
under my supervision from 1st
January , 2013 to 31st
March, 2013.
I wish him success in his life.
……………………………………….
Md. Nur Nabi

“Role of Credit Rating in the Banking Sector after Introduction of Basel II Regulation” – A Review on Bangladesh Context; I
Foreword……
“…In the name of Allah who can do everything without anything…”
It is with pleasure and affection that I acknowledge my indebtedness to my honorable Course
teacher Md. Nur Nabi, Assistant Professor, Department of Finance and Banking, Faculty of
Business Administration and Management, Patuakhali Science and Technology University,
Dumki, Patuakhali, who has assigned me to prepare this report and help me with his support,
encouragements and expertise. As an intern student of BBA, I am lucky incredibly to have
such a report which is a very rare initiative of working on “Role of Credit Rating in the
Banking Sector after Introduction of Basel II Regulation”- a Review on Bangladesh
Context; So I am very grateful to my honorable course teacher because of his trust on me for
preparing such a report in which I haven’t had enough strong familiarity on this ground.
My total efforts represent broad and throughout discussion of the role of credit rating in the
Banking Sector after introduction of Basel II Regulation in Bangladesh. The purpose of this
report is to fulfill the internship requirement for the Bachelor of Business Administration in
Patuakhali Science and Technology University, Dumki, Patuakhali-8602. While, I was
employed as an intern at WASO Credit Rating (BD) Ltd.: Haque Chamber (Level-5 & 6),
89/2, West Panthapath, Dhaka-1215, Bangladesh.
This report summarizes the role of credit rating in the banking sector in Bangladesh. Though
I face many problems I have tried my best to go into deep and present a report.
………………………….
Md. Shahinuzzaman
Reg. No.: 01879
Session: 2008-2009

“Role of Credit Rating in the Banking Sector after Introduction of Basel II Regulation” – A Review on Bangladesh Context; II
Acronyms
(Alphabetic order)
ACRCL=ARGUS Credit Rating Company Limited
BAM=Business Administration and Management
BB=Bangladesh Bank
BCBS= Basel Committee on Banking Supervision
BDRAL=Bangladesh Rating Agency Limited
BoD=Board of Director
CAR=Capital Adequacy Ratio
CEO=Chief Executive Officer
CR=Credit Rating
CRA=Credit Rating Agency
CRISL= Credit Rating Information and Services Limited
CRAB=Credit Rating Agency of Bangladesh
CRD=Capital Requirements Directive
DSE=Dhaka Stock Exchange
EBIT=Earnings before Interest and Taxes
ECAI’s=External Credit Assessment Institution
ECRL=Emerging Credit Rating Limited
EU= European Union
FASB=Financial Accounting Standard Board
FD=Fair Disclosure
GDP=Gross Domestic Product
IASB=International Accounting Standard Board
ICAAP=Internal capital Adequacy Assessment Process
ICCMS= International Conference on Computational Management Science
ICRA= Internet Content Rating Association
IFS=Issuer Financial Strength
IMF=International Monetary Fund
IOSCO= International Organization of Securities Commissions
IRB=Internal Rating-Based
IT=Information Technology
LC=Letter of Credit
LOSCO= Louisiana Oil Spill Coordinator's Office
MCR=Minimum Capital Requirements
NBFI=Non-Banking Financial Institutions
NCRL=National Credit Rating Limited
PSTU=Patuakhali Science and Technology University
RoA=Return on Asset
RoE=Return on Equity
SEC=Securities and Exchange Commission
SLR/CRR= Statutory liquidity ratio/Cash Reserve Ratio
SME=Small and Medium Enterprise
SRO= Statutory Regulatory Order
SRP=Supervisory Review Process
UK=United Kingdom
WB=World Bank
WCRCL=WASO Credit Rating Company Limited
WTO=World Trade Organization

“Role of Credit Rating in the Banking Sector after Introduction of Basel II Regulation” – A Review on Bangladesh Context; III
Verse of Gratitude……
I would like to acknowledge the following people for their support and assistance with this
internship, especially the person I most wish to thank is my academic internship supervisor
Md. Nur Nabi, Assistant Professor, Department of Finance and Banking, PSTU. My cordial
thanks also to my Co-Supervisor M. Takibur Rahman, Assistant Professor, Department of
Accounting and Information Systems, PSTU and Omar Faruque, Assistant Professor,
Department of Finance, Jagannath University, Dhaka.
I am very much grateful to the authority of WASO Credit Rating Limited to assign me as an
internee and have the opportunity to learn theoretical as well as practical knowledge related
to credit rating system and complete such an ambitious study for my internship program as
well as for preparation of this report.
Next I would like to show my heartiest gratitude towards Juthi Akter, Financial Analyst,
WCRCL. She hse truly been extremely supportive to me in spite of her busy schedule. It
wouldn’t possible to thank all of those marvelous people of WASO Credit Rating Limited.
They have explained everything I asked for in details. Throughout time they were never
impatience. They did not allow me to feel uncomfortable for even a single moment. I am
really grateful to all for their supportive and friendly behavior.
All the people have been kind enough to take the time off their busy schedule and help me in
collecting the necessary information.

“Role of Credit Rating in the Banking Sector after Introduction of Basel II Regulation” – A Review on Bangladesh Context; IV
Table of Contents . . . . . .
SL
No.
Particulars Page
No.
Foreword I
Acronyms II
Word of Gratitude III
Table of Contents IV-V
List of Tables VI
List of Graphs VI
List of Appendixes VI
Chapter-01(Introduction)
Abstract 1
Keywords 1
1.1 Introduction 2
1.2 Definition of the Study 2
1.3 Origin of the Study 3
1.4 Purpose of the Study 3
1.5 Rationale of the Study 3
1.6 Objectives of the Study 4
1.7 Scope of the Study 4
1.8 Methodology 4
1.8.1 Sources of Data 4
1.8.2 No. of Companies 4
1.8.3 Data collection methods 5
1.8.4 Data processing 5
1.9 Limitations of the study 5
1.10 Literature Review 5-6
Chapter-02(Credit Rating and Basel II)
2.1 Overview of Credit Rating 7
2.1.1 Meaning and Definition of Credit Rating 7
2.1.2 Origin of Credit Rating (CR) and Credit Rating Agencies (CRA’s) 7
2.1.3 Credit Rating and Bangladesh 8-9
2.1.4 Overview of Credit Rating Agencies in Bangladesh 9-11
2.1.5 Functions of a Credit Rating Agency 11
2.1.6 Advantages and Disadvantages of Credit Ratings 12-14
2.2 Overview of Basel II 14
2.2.1 Meaning and Definition of Basel II 14
2.2.2 Background of Basel II 14-15
2.2.3 The main objective of the Basel II Accord is to: 15
2.2.4 The Basel II Framework consists of three pillars: 15-17
2.2.5 The significant features of Basel II 18
2.2.6 Basel II Implementation Scenario in Bangladesh 18

“Role of Credit Rating in the Banking Sector after Introduction of Basel II Regulation” – A Review on Bangladesh Context; V
2.2.7 Positive and Negative Impact of Basel II 19-20
2.2.8 Role of Rating Agencies under Basel II 21
2.2.9 Problems in Developing Countries: 21
2.3 Matrix of Participants in the Basel Process 21-22
Chapter-03 (Credit Rating System and Mapping)
3.1 Credit Rating Systems or Modus Operandi of WCRCL 23
3.2 Mapping comparison 24
Chapter-04 (Credit Rating Methodology)
4. Rating Methodology 25
4.1 List of Rating Methodologies in BD ECAI’s 26-27
4.2 Corporate Rating Methodology 28-33
4.2.1 Diagram of Corporate Rating Methodology 34
4.2.2 Comparison among the Methodologies of Different ECAI’s 35-36
4.3 Banks and Non-Banking Financial Institution Rating Methodology 37-40
4.3.1 Diagram of Banks and NBFI’s Rating Methodology 40
4.3.2 Comparison among the Methodologies of Different ECAI’s 41
4.4 Small Medium Enterprises (SMEs) Rating Methodology 42-43
4.4.2 Comparison among the Methodologies of Different ECAI’s 44
4.5 General Insurance Rating Methodologies 45-48
4.5.1 Diagram of GI’s Rating Methodology 48
4.5.2 Comparison among the Methodologies of Different ECAI’s 49-50
4.6 WCRCL Rating Scales & Definitions 51-52
Chapter-05 (Growth and Impact of Rating after Basel II)
5.1 Total Credit Rating Scenario in Bangladesh from 2008-2012 53
5.2 The Growth Rate of credit rating in 2009-2012 53
5.3 Total number of Rating in 2012 by Credit Rating Agencies 54
5.4 Rating by CRISL & CRAB in 2008-2012 54
5.5 Total number of Rating in 2012 by Credit Rating Agencies (Grading Wise) 55
Chapter 06(Bank Performance (pre and post of Basel II)
6.1 Bank Performance (pre and post of Basel II) 56-57
6.2 Importance of Credit Rating in the Banking Sector 58
6.3 Impact of Basel II on banking industry 58-59
Chapter-07 (Conclusion)
7.1 Prospects 60
7.2 Findings of the Study 60-61
7.3 Recommendations 61-62
7.4 Conclusion 62-63
7.5 References 63-64
7.6 Appendices 65-68

“Role of Credit Rating in the Banking Sector after Introduction of Basel II Regulation” – A Review on Bangladesh Context; VI
 List of Tables:
No: Name Page
Table-1 : The list of Credit Rating Agencies in Bangladesh 9
Table-2 : Evolution of the Regulatory Environment 14
Table-3 : Matrix of Participants in the Basel Process 21
Table 4 : Mapping Comparison 24
Table-5 : Sequential steps in the total rating assessment process 34
Table-6 : Comparison among the Corporate Rating Methodology of Different ECAI’s 35-36
Table-7 : Comparison among the Banks and FI’s Methodology of Different ECAI’s 41
Table-8 : Comparison among the SME’s Methodology of Different ECAI’s 44
Table-9 : Comparison among the General Insurance Methodology of Different ECAI’s 49-50
Table-10 : WCRCL Rating Scales & Definitions 51-52
Table-11 : Aggregate profitability ob banking Industry in Bangladesh 56
 List of Figures:
No: : Name Page
Figure-1 : Summary of Basel II 15
Figure-2 : Credit Rating Systems 23
Figure-3 : Rating Methodology 25
Figure-4 : Corporate Rating Methodology 34
Figure-5 : Banks and Financial Institution Rating Methodology 40
Figure-6 : General Insurance Rating Methodology 48
 List of Charts or Graphs:
No: Name Page
Graph-1 : Total Credit Rating Scenario in Bangladesh from 2008-2012 53
Graph-2 : Growth Rate of credit rating in 2009-2012 53
Graph-3 : Rating in 2012 by Credit Rating Agencies 54
Graph-4 : Rating by CRISL & CRAB in 2008-2012 54
Graph-5 : Rating in 2012 by Credit Rating Agencies (Grading Wise) 55
Graph-6 : Aggregate Return on Asset of Banking Industry in Bangladesh 56
Graph-7 : Aggregate Return on Equity of Banking Industry in Bangladesh 57
Graph-8 : Aggregate Return on NIM of Banking Industry in Bangladesh 57
 List of Appendixes:
No: Name Page
Appendix-1 : Rating Methodology Published BB 65
Appendix-2 : Rating Map Published BB 66
Appendix-3 : Rating in 2012 by Credit Rating Agencies 67
Appendix-4 : Rating Matrix in 2012 67
Appendix-5 Aggregate profitability ob banking Industry in Bangladesh 68

“Role of Credit Rating in the Banking Sector after Introduction of Basel II Regulation” – A Review on Bangladesh Context; A
Chapter # 01
INTRODUCTION
Abstract
1.1 Introduction
1.2 Definition of the Study
1.3 Origin of the Study
1.4 Purpose of the Study
1.5 Rational of the report
1.6 Objectives of the Study
1.7 Scope of the Study
1.8 Methodology
1.9 Limitations of the Study
1.10 Literature Review

“Role of Credit Rating in the Banking Sector after Introduction of Basel II Regulation” – A Review on Bangladesh Context; 1
“Role of Credit Rating in the Banking Sector after Introduction of
Basel II Regulation”- A Review on Bangladesh Context;
Md. Shahinuzzaman (April, 2013)
shahinpstu@gmail.com
Keywords: Credit Rating (CR), Credit Rating Agency (CRA), Basel II, WASO credit Rating
Co. (BD) Ltd., Credit Risk, Standard Approach.
1.1Introduction:
Credit Rating Agencies (subsequently denoted CRAs) specialize in analyzing and evaluating
the creditworthiness of corporate and sovereign issuers of debt securities. In the new
financial architecture, CRAs are expected to become more important in the management of
both corporate and sovereign credit risk. Their role has recently received a boost from the
revision by the Basel Committee on Banking Supervision (BCBS) of capital standards for
banks culminating in Basel II. The logic underlying the existence of CRAs is to solve the
problem of the informative asymmetry between lenders and borrowers regarding the
creditworthiness of the latter. Issuers with lower credit ratings pay higher interest rates
Abstract: Credit Rating Agencies (CRAs) play a key role in financial
markets by helping to reduce the informative asymmetry between lenders
and investors, on one side, and issuers on the other side, about the
creditworthiness of companies or countries. CRAs' role has expanded with
financial globalization and has received an additional boost from Basel II
which incorporates the ratings of CRAs into the rules for setting weights
for credit risk. Ratings tend to be sticky, lagging markets, and overreact
when they do change. This overreaction may have aggravated financial
crises in the recent past, contributing to financial instability and cross-
country contagion.
The recent bankruptcies of Enron, WorldCom, and Parmalat have
prompted legislative scrutiny of the agencies. Criticism has been especially
directed towards the high degree of concentration of the industry.
Promotion of competition may require policy action at national and
international level to encourage the establishment of new agencies and to
channel business generated by new regulatory requirements in their
direction.
Financial regulators recognize certain credit rating agencies for regulatory
purposes. However, it is often argued that credit rating agencies have an
incentive to assign inflated ratings. This paper studies the Role of Credit
Rating in the Banking Sector after Introduction of Basel II Regulation- A
Review on Bangladesh. Credit rating agencies may collude to assign
inflated ratings. Yet it is showing that there exists vast role which induces
credit rating agencies to assign correct ratings.

embodying larger risk premiums than higher rated issuers. Moreover, ratings determine the
eligibility of debt and other financial instruments for the portfolios of certain institutional
investors due to national regulations that restrict investment in speculative-grade bonds.
The importance of credit rating is to protect the investor who cannot get inside
information about the instruments for investment due lack of time and lack of expertise.
credit rating has assumed an important place in the modern and developed financial markets.
It is a boon to the companies as well as investors. It facilities the company in raising funds in
the capital market and helps the investors to select their risk return trade off. As investors are
concerned with the timely payment of interest and principal, credit rating indicates the credit
worthiness of borrowers. Credit rating essentially indicates the risk involved in a debt
instruments as well as its quality. Higher the credit rating greater is the probability that the
borrower will make timely payment of principal and interest and vice versa.
Thus credit rating is not a general evaluation off the issuing organization. it essentially
reflex the probability of timely repayment of principal and interest buy a borrower a
company . The credit rating is not a onetime evaluation of credit risk of a security. The rating
agency may change the rating considering the changes periodically. Despite their ubiquity in
the financial markets, credit ratings are often misunderstood. Confusion about what credit
ratings are, and the role they play in the financial system, has sometimes led to their misuse
and prevented them from fulfilling their true role: that is, to help close the information gap
between lenders and borrowers by providing independent opinions of creditworthiness.
The credit rating has created an environment for a mushroom growth of such agencies in
Bangladesh as many industry or people have started considering it as a solid business
proposition without going into greater details. However, rating is a research on fundamentals.
The fate of the rating agencies is absolutely uncertain and the current scenario is bound to
destroy the rating market and ultimately most of the rating agencies are bound to face closure,
with the moving of the banks towards Internal Rating Based (IRB)-approach as per road map
of Bangladesh Bank.
In this paper, there have seven chapters. 1st
chapters include introduction, objectives,
methodology and etc. 2nd
chapter about credit rating and Basel II, 3rd
chapter about credit
rating system and mapping, 4th
chapter about credit rating methodology, 5th
chapter include
growth and impact of rating after Basel II, 6th
chapter include pre and post scenario of
banking industry after Basel II introduction and finally chapter 7th
include prospect, findings,
recommendation, conclusion and references.
1.2 Definition of Study:
Study is a presentation of acts best on intensive review, observation, data analysis and
interpretation etc. It highlights the role of credit rating in the Banking Sector after
introduction of Basel II Regulation in Bangladesh.

1.3 Origin of the Study:
Practical acquaintance is fundamental part for applying academic intelligence. Bearing this
motto in mind the internship program was being included in Bachelor of Business
Administration program. After completing one hundred and twenty six credit hours at
Patuakhali Science and Technology University (P.S.T.U.) under the Bachelor of Business
Administration program, the student (I) was placed at WASO Credit Rating Co. (BD) Ltd.
as an intern for three months by the Faculty of Business Administration and Management
(BAM). This report is the result of internship program and requirement of the mentioned
company on the selected topic “Role of Credit Rating in the Banking Sector after
Introduction of Basel II Regulation” – A Review on Bangladesh Context;
1.4 Purpose of the Study:
Knowledge and learning become perfect when it is associated with theory and practice.
Theoretical knowledge gets its perfection with practical application. The primary purpose of
this study is to provide the intern with the practical experience by orienting engaging with
an organization. As our educational system predominantly text based, inclusion practical
orientation program , as an academic component is as exception to the norm as the parties
educational institution and the organization substantially benefit from such a program, it
seems a “win-win situation”. It establishes contracts and networking contracts. Contracts may
help to get a job. That is, students can train and prepare themselves for the job market. In
such state of affairs the present aiming at analyzing the experience of practical orientation
related to an appraisal of WASO Credit Rating Co. Ltd.
1.5 Rationale of the report:
As a student of a faculty of business studies, it is helpful to gain the practical knowledge
about an organization and its overall activities. By doing this kind of activities, we can enrich
our practical knowledge .With the application of acquired knowledge we will be able to
develop ourselves and compete globally. So, I can say that the rationale of this is
comprehensive.
The concept of credit rating by the rating agencies to support capital adequacy of the banks
came up in view of the need for implementation of Base-II capital adequacy framework by
Bangladesh Bank. Under Basel-II framework, Bangladesh Bank adopted a standardized
approach for credit risk under which the services of rating agencies were required under
certain strict terms and conditions. Bank client rating is a very sensitive issue in view of the
fact that most of the private sector companies, enjoying banking facilities, are not
maintaining standard financials for appropriate evaluation. In addition, the businesses of the
clients are directly affected by the economy, government policy and many other
considerations, in addition to the factors dependent on the sponsors. Unless and until all the
above factors are properly evaluated through sectoral studies, the ratings are bound to give
wrong signals.
In this study I have tried my level best to show the role of credit rating regarding the banking
sector. This study will be helpful to evaluate the role of credit rating after introduction of
Basel II.

1.6 Objectives of the Study:
The first objective of preparing this report is to fulfill the partial requirements of the B.B.A
program. Generally every study is conducted to get one or more findings; if the findings are
predetermined they called the objectives of the study. The main objective of this study is to
evaluate the role of credit rating in the Banking Sector after introduction of Basel II
Regulation in Bangladesh. To invent something new perfect investigation and by through
above discussion of a known or unknown matter, and to make a right decision on that matter
by achieving real knowledge about that mater, is the main objective of internship.
Some motives of internship are given below:
1. To make theoretical knowledge clear and exact about credit rating and Basel II.
2. Assessment of Credit Rating services by a banking sector before and after
implementation of Basel II.
3. Assessment of awareness for Credit Ratings in the corporate sector.
4. Finding the contribution of Credit Rating Companies in the Banking Sector
1.7 Scope of the Study:
This report is a descriptive study which tries to focus on the theories and practices of Credit
Rating Agencies in the context of Bangladesh. In connection with this effort, a study has been
conducted on ECAI’s approved by the central bank in Bangladesh.
1.8 Methodology:
1.8.1 Sources of Data:
The study is related with both primary and secondary data. Primary data has been collected
from practical work exposure and the direct interview of the senior employees of WASO
Credit Rating Co. Ltd., Credit Rating Information and Services Ltd (CRISL), Credit Rating
Agency of Bangladesh Ltd (CRAB), National Credit Ratings Ltd, Emerging Credit Rating
Ltd and ARGUS Credit Rating Services Ltd. It should be noted that CRISL, CRAB, NCRL,
ECRL and ARGUS are covering the momentous credit rating market in Bangladesh.
Secondary data has been collected form:
 Related information is collected through internet.
 Daily newspaper, journals.
 Web site of the concerned companies (www.crislbd.com, www.crab.com.bd,
www.ncrbd.com, www.emergingrating.com, www.acrslbd.com,
www.wasocrditrating.com, www.apharating.com, www.bdral.com)
1.8.2 No. of Companies (CRAs): The data has been collected from the 8 credit rating
companies operating their business in Bangladesh. The sample size is 8. Their listing are
shown below-

01. Credit Rating Information and Services Ltd (CRISL)
02. Credit Rating Agency of Bangladesh Ltd (CRAB)
03 National Credit Ratings Ltd
04 Emerging Credit Rating Ltd
05. ARGUS Credit Rating Services Ltd.
06. WASO Credit Rating Company (BD) Limited
07. Alpha Credit Rating Limited
08. The Bangladesh Rating Agency Limited
1.8.3 Data collection methods: Considering the nature of the study-
 The study requires the published rating report of the respective companies.
 Data has been taken from the officials of the companies.
1.8.4 Data Analysis:
All the related data in this study are already produced by the ECAI’s. Just I have made
analysis to arrive at a decision.
1.9 Limitations of the Study:
The study is entitled to the following limitations-
 I have taken only three year period (2010- 2012) which is not enough to depict the
actual picture.
 Reluctance of the companies to disclose the rating report.
 All works have been done through computer so there is chance of printing mistake.
 As a growing and newly launched sector it’s not well established.
 It would be better if is it possible to highlights some additional banking scenario
(investment status, risk taking standard, etc.) pre and post of Basel II but for some
constraints (lack of information, time, confidentiality, complex and slow process, etc.)
it was not possible.
1.10 Literature Review:
The role of credit rating has increased considerably during recent years. However, there is an
unsettled debate about credit ratings’ impact and importance in the literature. On the positive
side, Graham and Harvey (2001) show that credit ratings are more important in affecting a
firm’s funding policy than factors suggested by capital structure theories. Along this front,
Faulkender and Petersen (2006) reveal that firms which issue rated bonds are more leveraged.
Kisgen (2006, 2009) finds that firms close to a rating upgrade or downgrade issue less debt
than equity, relativeto firms without a rating change. Tang (2009) also documents that credit
ratings significantly affect firms’ access to credit markets. Others, however, question the
importance of credit ratings as providers of information. For example, Brealey and Myers
(2003) argue that credit rating agencies reflect as much about market participants’ opinion
about a firm’s financial condition as providing new information. The consequences of rating
changes on the valuation of stock and bonds have been extensively examined. For example,
Hand et al. (1992) show that only rating downgrades have a negative impact on stock and
bond prices, while upgrades’ information is incorporated into prices prior to announcement.
Ederington and Goh (1998) reveal that downgrades cause negative equity returns and

analysts’ earnings forecast revisions. Brooks et al. (2004) confirm that rating changes have
the same impact on countries’ market returns as in the case of firms. Jorion et al. (2005)
explore the effect of the Fair Disclosure (FD) Regulation in the US, which prohibited the
selective, non-public disclosure of information by firms to favored investment analysts
excluding credit rating agencies, to find that the informational effect on stock prices of
downgrades and upgrades is much larger in the post-FD period.
In an effort to tie together the empirical findings, as well as to provide a comprehensive
explanation for the increased role of credit ratings, Boot et al. (2006) develop a theoretical
model to show that credit ratings coordinate investors’ beliefs. As they argue, credit ratings
have a real value and impact through their monitoring role, especially in the credit watch
procedure, and the significance of the ratings for institutional investors’ decisions. However,
Boot et al. (2006) point out that market participants’ increased reliance on credit rating
agencies might discourage other monitoring mechanisms and fuel an excessive dependence
on them.
More recently, Kuang and Qin (2009) document the role and significance of credit ratings on
firms’ managerial actions to find that credit ratings act as delegated monitors and deter
managers’ risk taking incentives. In accordance with this finding, Kang and Liu (2009)
provide evidence on the positive impact of rating changes on managers’ incentives. They
show that credit ratings play a disciplinary role on managers’ actions and help reduce agency
conflicts, in combination with other corporate governance mechanisms.
At present there are eight domestic credit rating agencies and no international or regional
credit rating agencies exist in Bangladesh. The first, Credit Rating Information and Services
Limited (CRISL), was set up in 1995 and got license from the Securities and Exchange
Commission to operate as a rating agency in 2002. It is a joint venture of Malaysia Berhad,
JCR-VIS Credit Rating Company of Pakistan, and a few financial institutions and
professionals of Bangladesh. The second, the Credit Rating Agency of Bangladesh (CRAB),
was established in 2003. CRAB received license in 2004 from SEC under ‘Credit Rating
Companies Rules 1996’. CRAB formally launched its operation in April 2004. The sponsors
are some leading personalities and professional in the private sector and institutions of the
country. CRAB has technical collaboration with ICRA Limited of India, which is a
subsidiary of Moody’s Investors Service. ICRA is one of the largest rating agencies in Asia.
National Credit Ratings Ltd. and Emerging Credit Rating Ltd. were established in 22nd
June
2010. Remaining four ARGUS Credit Rating Services Ltd., WASO Credit Rating Company
(BD) Limited, Alpha Credit Rating Limited and The Bangladesh Rating Agency Limited
were established in respectively 21st
July 2011, 15th
February 2012, 20th
February 2012 and
7th
March 2012.
Anytime that you apply for credit, whether it be for a credit card, auto loan or home loan, a
lender will review your credit report and determine your credit rating. The higher you’re
rating, the more likely you are to qualify, as well as to nab higher loan amounts and lower
interest rates. A high credit rating can offer you a degree of financial freedom that those with
a low rating may never see.

“Role of Credit Rating in the Banking Sector after Introduction of Basel II Regulation” – A Review on Bangladesh Context; B
Chapter # 02
OVERVIEW OF CREDIT
RATING AND BASE II
2.1 Overview of Credit Rating
2.1.1 Meaning and Definition of Credit Rating
2.1.2 Origin of Credit Rating (CR) and Credit Rating
Agencies (CRA’s)
2.1.3 Credit Rating and Bangladesh
2.1.4 Overview of Credit Rating Agencies in
Bangladesh
2.1.5 Functions of a Credit Rating Agency
2.1.6 Advantages and Disadvantages of Credit
Ratings
2.2 Overview of Basel II
2.2.1 Meaning and Definition of Basel II
2.2.2 Background of Basel II
2.2.3 The main objective of the Basel II Accord is to:
2.2.4 The Basel II Framework consists of three
pillars:
2.2.5 The significant features of Basel II
2.2.6 Basel II Implementation Scenario in Bangladesh
2.2.7 Positive and Negative Impact of Basel II
2.2.8 Role of Rating Agencies under Basel II
2.2.9 Problems in Developing Countries:
2.3 Matrix of Participants in the Basel Process

2.1 Overview of Credit Rating
2.1.1 Meaning and Definition of Credit Rating
Credit rating is the opinion of the rating agency on the relative ability and willingness of tile
issuer of a debt instrument to meet the debt service obligations as and when they arise. Rating
is usually expressed in alphabetical or alphanumeric symbols. Symbols are simple and easily
understood tool which help the investor to differentiate between debt instruments on the basis
of their underlying credit quality. Rating companies also publish explanations for their
symbols used as well as the rationale for the ratings assigned by them, to facilitate deeper
understanding.
In other words, the rating is an opinion on the future ability and legal obligation of the issuer
to make timely payments of principal and interest on a specific fixed income security. The
rating measures the probability that the issuer will default on the security over its life, which
depending on the instrument may be a matter of days to thirty years or more.
In fact, the credit rating is a symbolic indicator of the current opinion of the relative
capability of the issuer to service its debt obligation in a timely fashion, with specific
reference to the instrument being rated. It can also be defined as an expression, through use of
symbols, of the opinion about credit quality of the issuer of security/instrument.
2.1.2Origin of Credit Rating (CR) and Credit Rating Agencies (CRA’s)
The credit rating system started in 1958 to keep track of which borrowers were not repaying
on their deals. Over time, more lenders adopted the practice created by the Fair Isaac
Corporation (FICO) to ensure better profits on their loans. As of 2009, the credit rating
system serves over 80 countries across the globe.
The concept of using rating agencies to assess the level of risk associated with a debt arose
around the beginning of the 20th century when three major credit rating agencies were
formed. Although additional rating agencies were formed in subsequent years, the original
rating agencies – Fitch, Moody’s, and Standard and Poor’s – are the most prominent.
1. Fitch
The Fitch Publishing Company was founded in 1913 by John Knowles
Fitch, a 33-year-old entrepreneur who had just taken over his father’s
printing business. Fitch had a unique goal for his company: to publish
financial statistics on stocks and bonds.
In 1924, Fitch expanded the services of his business by creating a system for rating debt
instruments based on the company’s ability to repay their obligations. Although Fitch’s rating
system of grading debt instruments became the standard for other credit rating agencies, Fitch
is now the smallest of the “big three” firms.

2. S&P
Henry Varnum Poor was a financial analyst with a similar vision to John
Knowles Fitch. Like Fitch, Poor was interested in publishing financial
statistics, which inspired him to create H.V. and H.W. Poor Company.
Luther Lee Blake was another financial analyst interested in becoming a financial
publisher. In order to achieve this dream, Blake founded Standard Statistics in 1906, just a
year after Poor’s death. Standard Statistics and H.V. and H.W. Poor published very similar
information. Hence, it made sense for the two companies to consolidate their assets, and they
merged in 1941 to form the Standard and Poor’s Corporation. Today, Standard and Poor’s not
only provides ratings but also offers other financial services, such as investment research, to
investors. They are now the largest of the “big three” rating agencies.
3. Moody’s
John Moody founded the financial holding company, Moody’s Corporation,
in 1909. Although Moody’s provides a number of services, one of their
largest divisions is Moody’s Investor Services. While Moody’s has
conducted credit ratings since 1914, they only conducted ratings of
government bonds until 1970.
Moody’s has grown significantly over the years. Presently, Moody’s is the second largest of
the “big three” firms.
2.1.3Credit Rating and Bangladesh
The rating industry in Bangladesh is now considered to be a parentless industry. The behavior
of the regulators towards nourishing this industry does not appear to be rational. As the
researcher and initiator of this highly prestigious global profession, this scribe feels frustrated
not because of the reason that there is a mushroom growth of licensing. The frustration is
rather about the management of the regulatory framework. The authorities concerned have
remained careless, while being responsible for creating such a bad environment. The rating
agencies are still defined by the SEC rules as an investment advisory company. This has not
changed over a long time. The paid-up capital still remains at Tk. 5.0 million (50 lakh), to
start a rating agency by any group of sponsors. The regulators will realize the adverse
consequences of such a situation at certain point of time when the total industry will lose its
credibility in the national and international market.
Credit Rating Information and Services Limited, now popularly known as CRISL, carries the
history of credit rating in Bangladesh. Although the Bangladesh capital market does not have
enough work for one credit rating agency to survive on commercial consideration as a full-
fledged rating agency, the regulators have licensed in total eight rating agencies till 2012.

At present, there are a number of rules and regulations that are directed towards credit rating.
The Credit Rating Companies Rules 1996 (subsequently amended in 2009) of the Securities
and Exchange Commission (SEC) is the mother regulation which provides for the credit
rating of all debt instruments and right offers of equity securities at a premium. The direct
listing rules of Dhaka Stock Exchange (DSE) provides for having, at least, BBB rating to be
eligible for the purpose. The Bangladesh Bank (BB) made credit rating mandatory for all
banks with annual surveillance in 2006. The insurance regulator of the country also through a
SRO made the credit rating compulsory for all the general insurance companies and
biannually for all life insurance companies.
2.1.4Overview of Credit Rating Agencies in Bangladesh
SL
No.
Name of the Company Date of Issuance
of Registration
Certificate
Address
01. Credit Rating Information
and Services Ltd (CRISL)
21/08/02 Nakshi Homes (4th
and 5th
floor),
6/1A, Segunbagicha, Dhaka-1000
02. Credit Rating Agency of
Bangladesh Ltd (CRAB)
24/02/04 Chamber Building (6th
Floor), 122-
124 Motijheel C/A, Dhaka-1000
03 National Credit Ratings
Ltd
22/06/2010 3 BijoyNagor, 3rd
floor, Dhaka-1000
04 Emerging Credit Rating
Ltd
22/06/2010 SHAMS Rangs, House #104, Park
Road, Flat# A1, A2, Baridhara,
Dhaka-1212
05. ARGUS Credit Rating
Services Ltd.
21/07/2011 13 level, BDBL Building, Motijheel,
Dhaka.
06. WASO Credit Rating
Company (BD) Limited
15/02/2012 Haque Chamber (Level-5), 89/2
West Panthopath, Dhaka-1205
07. Alpha Credit Rating
Limited
20/02/2012 Navana Rahim Ardent (1st
floor), 39
Kakrail, Dhaka-1000
08. The Bangladesh Rating
Agency Limited
07/03/2012 47 Karwan Bazar, Latif Tower (12th
floor), Dhaka-1215
Table 1: The list of Credit Rating Agencies in Bangladesh
CRISL
Credit Rating Information and Services Limited is a company that started its journey to
implement a Concept in Bangladesh – “Credit Rating”. Before CRISL, “Credit Rating” was
text paper words for the teachers and students of Bangladesh. The voyage of how CRISL
conceptualized this idea in 1995 and implemented it in Bangladesh and finally achieved its
operating license in 2002 – after almost eight years of struggle – has a long, interesting,
exciting and also painful history. CRISL is now the national flagship company representing
the profession at home and abroad.
CRAB
Credit Rating Agency of Bangladesh Ltd. (CRAB) was incorporated as a public limited
company under the Registrar of Joint Stock Companies in August 2003 and received its

certificate for commencement of business in November 2003. It has been granted licence by
the Securities & Exchange Commission (SEC) of Bangladesh for operating as a credit rating
company in February 2004. The formal launching of the company was held on 5 April 2004.
NCRL
National Credit Ratings Limited (NCR) is a full service rating company that offers a wide
range of services. Incorporated as a public company, NCR started its business with a paid up
capital of TK 10.00 million. The Securities and Exchange Commission granted the license to
NCR in June 2010 under the Credit Rating Companies Rules 1996.The Company is
recognized by the Bangladesh Bank as an External Credit Assessment Institution (ECAI).
ECRL
The ISLQ International Star for Leadership in Quality Award acknowledges the strong
commitment to quality and excellence. Mr. Ahsan Parvez (Managing Director& CEO) & Mr.
Noor-e-Khoda Abdul Mobin (Deputy Managing Director& COO) received the award in the
Concorde La Fayette Hotel in Paris on June 25, 2012, from the president of B.I.D., Mr. Jose
E. Prieto. Emerging Credit Rating Ltd. is made up of a team oriented towards the continuous
improvement of processes, striving for an important role in the leadership of the business
world.
ACRSL
ARGUS Credit Rating Services Ltd. (ACRSL) is the next-generation Credit Rating Agency
of Bangladesh. Founded as a joint-venture between global experts in credit & equity research
and local sponsors with strong capital markets track record, ACRSL received its license from
the SEC in 2011. ACRSL is partnered with DP Information Group (“DP”), the premier credit
rating agency of Singapore for over 30 years. Having pioneered credit rating in Singapore,
DP has played an influential role in the development of the credit rating sector in China,
Indonesia, and Philippines. Further, DP’s parent company, the UK based Experian Group is
one of the world’s top credit reference agencies.
WCRCL
WASO Credit Rating Company (BD) Ltd. (“WCRCL”) was incorporated as a public limited
company under the Office of the Registrar of Joint Stock Companies and Firms in July of
2009. With the license from the Securities & Exchange Commission (SEC) of Bangladesh to
operate as a credit rating company, WCRCL has officially started its journey on 15th
February, 2012. It has also been recognized as an External Credit Assessment Institution
(ECAI) by Central Bank of Bangladesh in October of 2012.

ALPHA
Alpha Rating was incorporated on the 24th of February 2011. a result of the initiative of a
few distinguished and renowned professionals of Bangladesh and the with support and
organizational assistance from SATCOM IT Ltd., Axis Resources Ltd., Equity Care
Bangladesh Ltd., and TAN Equity and Investment Ltd.Date of Issuance of Registration
Certificate is 20th
February 2012.
BDRAL
The Bangladesh Rating Agency Ltd (BDRAL), a subsidiary of Dun & Bradstreet South Asia
Middle East Ltd., is the pioneer in rating the SME sectors in Bangladesh.BDRAL has
launched its SME ratings in Bangladesh following a successful pilot phase carried out in the
year 2009.Date of Issuance of Registration Certificate is 7th
March 2012.
2.1.5 Functions of a Credit Rating Agency
A credit rating agency serves following functions:
1. Provides unbiased opinion:An independent credit rating agency is likely to provide an
unbiased opinion as to relative capability of the company to service debt obligations because
of the following reasons:
i. It has no vested interest in an issue unlike brokers, financial intermediaries.
ii. Its own reputation is at stake.
2. Provides quality and dependable information:.A credit rating agency is in a position to
provide quality information on credit risk which is more authenticated and reliable because:
i. It has highly trained and professional staff that has better ability to assess risk.
ii. It has access to a lot of information which may not be publicly available.
3. Provides information at low cost: Most of the investors rely on the ratings
assigned by the ratings agencies while taking investment decisions. These ratings are
published in the form of reports and are available easily on the payment of negligible price. It
is not possible for the investors to assess the creditworthiness of the companies on their own.
4. Provide easy to understand information: Rating agencies first of all gather information,
and thenanalyze the same. At last these interpret and summarize complex information in a
simple and readily understood formal manner. Thus in other words, information supplied by
rating agencies can be easily understood by the investors. They need not go into details of the
financial statements.
5. Provide basis for investment: An investment rated by a credit rating enjoys higher
confidence from investors. Investors can make an estimate of the risk and return associated
with a particular rated issue while investing money in them.
6. Healthy discipline on corporate borrowers: Higher credit rating to any credit investment
enhances corporate image and builds up goodwill and hence it induces a healthy/ discipline
on corporate.

7. Formation of public policy: Once the debt securities are rated professionally, it would be
easier to formulate public policy guidelines as to the eligibility of securities to be included in
different kinds of institutional port-folio.
2.1.6Advantages and Disadvantages of Credit Ratings
2.1.6.1 Advantages of Credit Rating
The advantages, importance or benefits of credit rating to the investors are:-
1. Helps in Investment Decision: Credit rating gives an idea to the investors about the
credibility of the issuer company, and the risk factor attached to a particular instrument. So
the investors can decide whether to invest in such companies or not. Higher the rating, the
more will be the willingness to invest in these instruments and vice-versa.
2. Benefits of Rating Reviews: The rating agency regularly reviews the rating given to
a particular instrument. So, the present investors can decide whether to keep the instrument or
to sell it. For e.g. if the instrument is downgraded, then the investor may decide to sell it and
if the rating is maintained or upgraded, he may decide to keep the instrument until the next
rating or maturity.
3. Assurance of Safety: High credit rating gives assurance to the investors about the
safety of the instrument and minimum risk of bankruptcy. The companies which get a high
rating for their instruments will try to maintain healthy financial discipline. This will protect
them from bankruptcy. So the investors will be safe.
4. Easy Understandability of Investment Proposal: The rating agencies give rating
symbols to the instrument, which can be easily understood by investors. This helps them to
understand the investment proposal of an issuer company. For e.g. AAA (Triple A), given by
CRISL for debentures ensures highest safety, whereas debentures rated D are in default or
expect to default on maturity.
5. Choice of Instruments: Credit rating enables an investor to select a particular
instrument from many alternatives available. This choice depends upon the safety or risk of
the instrument.
6. Saves Investor's Time and Effort: Credit ratings enable an investor to his save time
and effort in analyzing the financial strength of an issuer company. This is because the
investor can depend on the rating done by professional rating agency, in order to take an
investment decision. He need not waste his time and effort to collect and analyze the financial
information about the credit standing of the issuer company.
The merits, advantages, benefits of credit rating to the issuing company are:-
1. Improves Corporate Image: Credit rating helps to improve the corporate image of a
company. High credit rating creates confidence and trust in the minds of the investors about
the company. Therefore, the company enjoys a good corporate image in the market.
2. Lowers Cost of Borrowing: Companies that have high credit rating for their debt
instruments will get funds at lower costs from the market. High rating will enable the
company to offer low interest rates on fixed deposits, debentures and other debt securities.
The investors will accept low interest rates because they prefer low risk instruments. A

company with high rating for its instruments can reduce the cost of public issue to raise
funds, because it need not spend heavily on advertising for attracting investors.
3. Wider Audience for Borrowing: A company with high rating for its instruments can
get a wider audience for borrowing. It can approach financial institutions, banks, investing
companies. This is because the credit ratings are easily understood not only by the financial
institutions and banks, but also by the general public.
4. Good for Non-Popular Companies: Credit rating is beneficial to the non-popular
companies, such as closely-held companies. If the credit rating is good, the public will invest
in these companies, even if they do not know these companies.
5. Act as a Marketing Tool: Credit rating not only helps to develop a good image of the
company among the investors, but also among the customers, dealers, suppliers, etc. High
credit rating can act as a marketing tool to develop confidence in the minds of customers,
dealer, suppliers, etc.
6. Helps in Growth and Expansion: Credit rating enables a company to grow and
expand. This is because better credit rating will enable a company to get finance easily for
growth and expansion.
2.1.6.2 Disadvantages of Credit Rating
Disadvantages of Credit Rating are as follows:
1. Biased rating and misrepresentations: In the absence of quality rating, credit rating
is a curse for the capital market industry, carrying out detailed analysis of the company,
should have no links with the company or the persons interested in the company so that the
reports impartial and judicious recommendations for rating committee. The companies
having lower grade rating do not advertise or use the rating while raising funds from the
public. In such cases the investor cannot get information about the riskiness of instrument and
hence is at loss.
2. Static study: Rating is done on the present and the past historic data of the company
and this is only a static study. Prediction of the company’s health through rating is
momentary and anything can happen after assignment of rating symbols to the company.
Dependence for future results on the rating, therefore defeats the very purpose of risk
inductiveness of rating. Many changes take place in economic environment, political
situation, government policy framework which directly affects the working of a company.
3. Concealment of material information: Rating Company might conceal material
information from the investigating team of the credit rating company. In such cases quality of
rating suffers and renders the rating unreliable.
4. Rating is no guarantee for soundness of company: Rating is done for a particular
instrument to assess the credit risk but it should not be construed as a certificate for the
matching quality of the company or its management. Independent views should be formed by
the user public in general of the rating symbol.
5. Human bias: Finding off the investigation team, at times, may suffer with human
bias for unavoidable personal weakness of the staff and might affect the rating.
6. Reflection of temporary adverse conditions: Time factor affects’ rating, sometimes,
misleading conclusions are derived. For example, company in a particular industry might be

temporarily in adverse condition but it is given a low rating. This adversely affects the
company’s interest.
7. Down grade: Once a company has been rated and if it is not able to maintain its
working results and performance, credit rating agencies would review the grade and down
grade the rating resulting into impair ring the image of the company.
8. Difference in rating of two agencies: Rating done by the two different credit rating
agencies for the same instrument of the same issuer company in many cases would not be
identical. Such differences are likely to occur because of value judgment differences on
qualitative aspects of the analysis in tow different agencies.
2.2 Overview of Basel II
2.2.1 Meaning and Definition of Basel II
Basel II is an international business Standard that requires financial institution to maintain
enough cash reserves to cover risk incurred by operations.The Basel accords are a series of
recommendations on banking laws and regulations issued by the Basel Committee on
banking supervision (BCBS). The name for the accords is derived from Basel, Switzerland,
where the committee that maintains the accords meets.
2.2.2Background of Basel II
In June 2004, BCBS issued a revised framework of ICCMS, introduced the famous “Three
Pillar Concept” of Capital Adequacy for strengthening the risk management practices of the
banking industry. Later, in June 2006, a comprehensive revision of ICCMCS was in public
by incorporating Basel II Framework, June 2004, the elements of the 1988 Accord that were
not revised during the Basel II process, the 1996 Amendment to the Capital Accord to
Incorporate Market Risks, and the paper on the Application of Basel II to Trading Activities
and the Treatment of Double Default Effects, 2005. The paper has been invariably termed as
Basel-II framework. This was also supposed to be applied on a fully consolidated basis to
any holding company that is the parent entity within a banking group to ensure that it
captures the risk of the whole banking group. Basel-II incorporated the treatment for the
activities of banking entities, securities entities, financial entities, insurance entities and
commercial entities when they are subsidiaries or minority owner of any bank holding
company. Another groundbreaking addition in this version of this capital accord was the
incorporation of the treatment of securitization exposure for credit risk. Both traditional and
synthetic securitization exposures have been accounted for consideration.
Evolution of the Regulatory Environment
1988 Basel Capital Accord
1996 Market Risk Capital Amendment
1996 – 1998 Ad hoc rules for credit derivatives
Jun. 1999 Consultative Document from Basel Committee
Jan. 2001 Basel Committee proposes New Capital Accord
June 2004 The purpose of Basel II, which was initially published. BCBS issued a revised
framework of ICCMS, introduced the famous “Three Pillar Concept” of Capital

Table 2: Evolution of the Regulatory Environment
2.2.3The main objective of the Basel II Accord is to:
 Strengthen the soundness and stability of international banking systems
 Create and maintain a level playing field for internationally active banks
 Promote the adoption of more stringent practices in the field of risk management
2.2.4The Basel II Framework consists of three pillars:
1. Calculation of minimum capital requirements
2. Supervisory review
3. Market discipline (public disclosure)
Figure 1: Summary of Basel II
Pillar 1- Minimum Regulatory Capital Requirements
For the first pillar of the Basel II Capital Accord the Basel Committee proposed capital
requirements associated with three categories of risk:
Adequacy for strengthening the risk management practices of the banking industry.
Nov. 2005 Basel II: International Convergence of Capital Measurement and Capital Standards: A
Revised Framework
June 2006 a comprehensive revision of ICCMCS was in public by incorporating Basel II
Framework
Basel II
Pillar-1 Pillar-2 Pillar-3
Minimum Capital
Requirement (MCR)
o Credit Risk-
 Standardized Approach
 Foundation of IRB
Approach
 Advanced IRB
Approach
o Market Risk-
 Standardized Method,
 Internal Model
Approach
o Operational risk-
 Basic Indicator
Approach
 Standardized Approach
Supervisory Review
Process (SRP)
o Bank End-
 Internal Capital
Adequacy Assessment
Process (ICAAP)
 Risk Management
o Supervisory End-
 Evaluation of Banks’
internal systems
(ICAAP)
 Assessment of Risk
Profile
 Review of compliance
with all regulations
 Supervisory measures.
Market Discipline
o Transparency-
 For market participants
concerning bank’ risk
position (scope of
application, risk
management, detailed
information on own
funds etc.)
o Comparability
 Between and among
the banks within the
jurisdiction.

1. Credit Risk
Credit risk is the possibility of a loss as a result of a situation that those who owe money to
the bank may not fulfill their obligation. The following methods can be used to determine
credit risk: The Standardized Approach, The Foundation Internal Rating Based Approach and
the Advanced Rating Based Approach. The Standardized Approach provides improved risk
sensitivity compared to Basel I. The two IRB approaches, which rely on banks’ own internal
risk ratings, are considerably more risk sensitive.
 Standardized approach (credit risk)
The term standardized approach refers to a set of credit risk measurement techniques
proposed under Basel II capital adequacy rules for banking institutions.In this approach,
securitized claims will also be assigned their own risk weights depending on their external
ratings. Under this approach the banks are required to use ratings from External Credit Rating
Agencies to quantify required capital for credit risk. In many countries this is the only
approach the regulators are planning to approve in the initial phase of Basel II
Implementation.
The Basel Accord proposes to permit banks a choice between two broad methodologies for
calculating their capital requirements for credit risk. The other alternative is based on internal
ratings.
 Internal Ratings-Based (IRB) Approach
Under the Basel II guidelines, banks are allowed to use their own estimated risk
parameters for the purpose of calculating regulatory capital. This is known as the Internal
Ratings-Based (IRB) Approach to capital requirements for credit risk. Only banks meeting
certain minimum conditions, disclosure requirements and approval from their national
supervisor are allowed to use this approach in estimating capital for various exposures.
Such an approach has two primary objectives -
 Risk sensitivity - Capital requirements based on internal estimates are more sensitive
to the credit risk in the bank's portfolio of assets
 Incentive compatibility - Banks must adopt better risk management techniques to
control the credit risk in their portfolio to minimize regulatory capital
2. Market risk
Market risk is the risk that the value of a portfolio, either an investment portfolio or a
trading portfolio, will decrease due to the change in value of the market risk factors.
The associated market risks are.
 Equity risk, the risk that stock prices and/or the implied volatility will change.
 Interest rate risk, the risk that interest rates and/or the implied volatility will change.
 Currency risk, the risk that foreign exchange rates and/or the implied volatility will
change.

 Commodity risk, the risk that commodity prices (e.g. corn, copper, crude oil) and/or
implied volatility will change.
3. Operational Risk
An operational risk is a risk arising from execution of a company's business functions.
Operational risk is defined in the Basel II as the risk of loss resulting from inadequate or
failed internal processes, people and systems, or from external events. Three different
methods can be used to measure operational risk: The Basic Indicator Approach, the
Standardized Approach and the Advanced Measurement Approach.
Pillar 2- Supervisory review of capital adequacy
The second pillar of Basel II is a supervisory review of capital adequacy. The second pillar
notes that national supervisors must ensure that banks develop an internal capital assessment
process and set capital targets consistent with their risk profiles. Furthermore it encourages
the bank’s management to develop risk management techniques and their use within capital
management. The supervisors are responsible for evaluating how well banks are assessing
their capital adequacy needs relative to their risks. Internal processes of the bank are subject
to supervisory review and intervention. In the Bangladesh the role of supervisor is fulfilled by
the Bangladesh Bank (BB).
Pillar 3 – Market discipline and disclosure
The third pillar of the Basel II Capital Accord is about market discipline and disclosure. The
main goal of this pillar is to promote the development of financial reporting about risks. In
this way market participants can get a better understanding of banks risks profiles and the
adequacy of their capital position by disclosure. Pillar 3 in the Basel II Capital Accord sets
out disclosure requirements and recommendations in several areas. These requirements apply
to all banks and when a bank cannot meet these requirements it can be constrained in the way
it manages capital. For example the bank may not use any of the advanced techniques under
Pillar 1.

2.2.5The significant features of Basel II
 Significantly more risk sensitive capital requirements and takes into account
operational risk of banks apart from credit and market risks. It also provides for risk
treatment based on securitization.
 Great use of assessment of risk provided by banks’ internal systems as inputs to
capital calculations.
 Provides a range of options for determining the capital requirements for credit risk
and operational risk to allow banks and national regulators to select the approaches
that are most suitable for them.
 Capital requirement under the new accord is the minimum. It has a provision for
supplementary capital that can be adopted by national regulators.
 The Accord promotes strong risk management practices by providing capital
incentives for banks having better risk management practices.
One most note that the capital requirements under Basel II do not include liquidity risk,
interest rate risk of banking book, strategic risk, and business risk. These risks would fall
under “Supervisory Review Process”. If supervisors feel that the capital held by a bank is not
sufficient, they could require the bank to reduce its risk or increase its capital or both.
2.2.6 Basel II Implementation Scenario in Bangladesh
 In2006, BB issued an action plan / roadmap.
 Inconsequence 2 major tasks were done
 Guidelines for recognition of eligible ECAI’s- September 2008,
 Guidelines on RBCA– a Revised Regulatory Capital Framework in line with Basel II-
December 2008.
 Banks entered in Basel-II regime fully in January 2010.
 Capital broadly categorized in 3 parts.
 Tier-1:Core Capital
 Tier-2:Supplementary Capital
 Tier-3:Additional Supplementary Capital
 MCR is now 10% of RWA with 5% core capital or Tk.400 million whichever is higher
(from July 2011).
 BB structured its RBCA guidelines considering all propositions of Basel-II. Calculating
RWA following propositions of Basel-II. Calculating RWA following approaches used
 Credit Risk-Standardized Approach,
 Market Risk-Standardized (Rule Based)Method
 Operational Risk- Basic Indicator Approach.
 Foundation IRBA both at Bangladesh Bank and other banks level and Parallel run along
with Standardized Approach in 2012.

2.2.7 Positive and Negative Impact of Basel II
2.2.7.1Positive Impact of Basel II on banks:
The new Basel Accord i.e. Basel II will have an impact on the banking system in various
ways. The implementation of Basel II provides the Indian banks an opportunity to reduce
their credit risk weights as well as reduce their required regulatory capital. They can do so by
suitably adjusting their portfolios. The Internal Ratings Based approach would give freedom
to the individual banks by giving them the right to assess their own economic capital by
taking risk into consideration resulting in a degree of regulatory restraint1
. The Standardized
or IRB approach will help the banks for most of its exposures, including its securitization
exposures. As incentives for adopting the more advanced approaches for credit and
operational risks, banks are anticipated to experience lower capital requirements and
therefore lower costs under these approaches (Francis, 2006). Basel II aligns economic risk
more closely with regulatory risk. This will make it easier for the banks to lend to corporate,
increase their retail lending and provide mortgage under loans with higher margins (crockett,
2005). It will change the treatment of credit risk ensuring that banks have sufficient capital to
cover operational risk. It will lead to an improvement in the risk measurement assessment
thereby giving banks an opportunity to gain competitive advantage by allocating capital to
those processes segments and markets that demonstrate a strong risk return ratio. Another
benefit that banks would get from Basel II is a better understanding of risk return trade off for
capital supporting specific business, customer products and processes. Some of the other
advantages that the banks would enjoy by implementing Basel II would be that the strong risk
management process will help them to serve the customers better and also the small and
medium sized business will get liquidity into the portfolio, helps in collateralizing and
hedging2
. The Pillar 2 of Basel introduces the concept of economic capital which will help
the banks to determine capital adequacy based on the level of risk and required capital
thereby reducing arbitrage opportunity. It also provides incentives for banks to transfer credit
risks through instruments such as asset-backed securities or credit derivatives, while retaining
the customer relationship3
. Basel II will also provide banks with businesses benefits by
improving corporate governance, improving allocation of capital, the risk based pricing will
help to improve the competitiveness, capital saving, better decision making will allow
counter parties to deal and enhancing the value of stakeholders (Oosthuizen, 2005). Basel II
will give the banks different options from which they can choose like large banks are
expected by the market and supervisors to apply advanced risk management methods. A bank
with non-complex operations may use a simple and less expensive system. Basel II is drafted
flexibly in order to incorporate future changes such as new financial instruments, new
activities and so on, can be incorporated without having to change the basic structure.
1.(www.ibase.br/userimages/FLGG%20-20Chalapurath%20Chandrasekhar.pdf)
2.(www.us.kpmg.com/microsite/FSLibraryDotCom/docs/Basel_AWorldwide%20Challenge_web%20(2))
3.(www.us.kpmg.com/microsite/FSLibraryDotCom/docs/Basel_AWorldwide%20Challenge_web%20 (2)).

Banks will get a higher degree of freedom in the way they operate or may operate in the
future, but has some built-in restraints to ensure at least a basic level of capital, such as
minimum floors on the capital requirements (Lind, 2005). Some of the other benefits of Basel
II would include a more active portfolio management and forward looking risk assessment in
which there would be more activeness in portfolio risk management by access to timelier and
higher quality risk information and by differential capital requirement. The pricing of risk
will be more proactive and there would also be an improvement in performance
management.4
2.2.7.2Negative of Impact Basel II on banks:
The banks in Bangladesh that would be applying Basel II will have to face certain drawbacks
as well. The Basic Indicator approach specifies that banks should hold capital charge for
operational risk equal to the average of the 15 per cent of annual positive gross income over
the past three years, excluding any year when the gross income was negative. Also the capital
required by the bank would depend on the level of bad debt it has or the non performing asset
lying with it. The preference of banks for government securities and the increased risk-
aversion of banks following the adoption of Basel II would adversely affect credit to
agriculture and small scale industries1
. Banks which will not be adopting Basel II will not
face its compliance challenges but may nonetheless is pushed to use it as a competitive
benchmark. Regulators have to face a challenge as they have to provide a level playing field
in their jurisdiction and internationally as the Basel Committee's recommendations are
implemented by legislatures in various countries. In addition, they have to ensure that their
examiners are adequately trained to assess bank's compliance with the new capital rules.2
Medium-sized national banks which have limited international presence will have to think
hard about their credit ratings systems, given that credit risk remains the main part of their
total risk. Most will initially adopt the simpler Standardized approach to measuring credit
risk. Others will adopt the IRB Foundation approach indicating that banks with major retail
business might well expect significant capital reductions when applying the IRB Foundation
approach. Small banks might face the problem that the implementation of Basel II
requirements and the development of internal credit rating systems will turn out to be costly
for them. But without a credit ratings system of some kind it will be difficult for them to price
their loans competitively. Therefore, it may be out of reach for many smaller banks. It is very
unlikely that these banks will have the financial resources, intellectual capital, skills and large
scale commitment that larger competitors have to build sophisticated systems to allocate
regulatory capital optimally for both credit and operational risks.
4.(www.kpmg.com.mx/gobiernocorporativo//libreria_gc/rrr/Basilea%20II/basel_ii.pdf)
1.(www.ibase.br/userimages/FLGG%20-20Chalapurath%20Chandrasekhar.pdf)
2.(www.us.kpmg.com/microsite/FSLibraryDotCom/docs/Basel_AWorldwide%20Challenge_web%20
3.(http://www.globalriskregulator.com/archive/May2003-06.html)

2.2.8 Role of Rating Agencies under Basel II
As required by the Capital Requirements Directive (CRD), European authorities have
considered whether the methodologies of the three external credit assessment institutions
(ECAIs) meet the requirements of objectivity, independence, ongoing review and
transparency and that their ratings meet the requirements of credibility and transparency.
Furthermore they have considered which of the 'risk weights' should be attached to their
ratings (the 'mapping').
2.2.9 Problems in Developing Countries:
As Bangladesh is a developing country it can come across various problems in implementing
Basel II. The capital regulation that Basel II requires is a matter of concern that whether it
will ensure systematic banking stability or not. Even the currency mismatch which is a major
threat to banking is appropriately mentioned in Basel II or not. Then Basel II might reduce
the bank credit levels to developing economies both internationally and nationally. It could be
worse for poorer countries and those with low perceived creditworthiness. This could reduce
their investment, demand and future growth. Developing countries have a greater percentage
of lower rated borrowers. The IRB approach has a lesser incentives to lend to such borrowers.
This, along with withdrawal of uniform risk weight of 0% on sovereign claims may result in
overall reduction in lending by internationally active banks in developing countries and may
increase their cost of borrowing. Moreover, the concern is whether Basel II would increase
pro-cyclicality of bank lending, both domestically and from international banks. This would
increase volatility of growth and investment, as well as increase systemic risk in the banking
system. Moreover, the introduction of Basel II could discourage particularly lending to Small
Medium Enterprises (SME’s) and to other sectors or modalities crucial for growth,
employment and investment (Jones, 2007).
2.3 Matrix of Participants in the Basel Process
Public Private Mixed
Supranational G10, G20, G77,
European Union,
BIS,
BCBS, Basel Senior
Supervisors Group,
Financial Stability
Board, IMF, World
Bank, IOSCO, IASB,
FASB
“Core banks”, the
financial markets,
hedge funds,
“financial
engineers”, financial
risk analysts, credit
rating agencies, mass
media
Banks and
investment firms;
risk management
and credit rating
agencies and
professional
Economists. The
G30 and IIF
National Executive branch,
finance ministries,
central banks,
financial regulators,
legislatures and
subcommittees,
Large national banks
and corporations,
pension funds,
insurance industry,
industry associations
and lobbyists
Federal Reserve
Bank of New York,
“Government-
Sponsored
Enterprises”
Sub-national State banking
Supervisors
Community banks,
private citizens
Table 3: Matrix of Participants in the Basel Process

Basel is an example of multilevel governance. It involves supranational institutions (Bank for
International Settlements, the Basel Committee), central banks, finance ministries, multiple
overlapping financial regulators, industry lobbyists, legislative bodies with oversight powers,
transnational governance structures (regulators working across state boundaries to develop
new regulations), and transnational interest groups. The Bank of International Settlements
(BIS) was established by central banks in 1930 in Basel, Switzerland as “the central bankers’
central bank”. It was initially intended to serve as a clearinghouse of information shared
between central banks overseeing the repayment of Germany’s reparations from World War
I. Since then, the BIS has grown into the institutional setting in which central bankers can
address issues of concern to their individual economies and the global economy. The Basel
Committee on Banking Supervision (“Basel Committee” or BCBS), comprised of twenty-
seven countries, conducts its work under the review of its oversight body, the Group of
Central Bank Governors and Heads of Supervision of its member jurisdictions. The Financial
Stability Board also works closely with the Committee.
The dominant function of modern independent central banks is to control the national money
supply. Whether central banks should simultaneously act as regulators of their local banking
systems is not a universally agreed function. Felsenfeld surveyed thirty countries and
concluded that twenty do not give their central banks regulatory responsibilities. The central
bank of the United States does regulate a major share of the American financial system
including national banks and all bank holding companies.
England has gone the other way with the Central Bank of England performing regulatory
functions until they were taken away in 1997 and given to the newly formed Securities and
Investment Board (now Financial Services Authority). Debate over the independence of
central banks has not been settled, although independent central banks have spread around the
globe. When economic conditions become dire, the power of the central bank increases as the
need to “rescue” the economy increases and the central bank steps into the role envisioned as
the “lender of last resort.” Indeed the Global Financial Crisis has shown the extent to which
the Fed has the authority to act as “lender of last resort” not only to commercial banks but to
investment banks, insurance companies, and other businesses under a provision of a 1932
federal law concerning “unusual and exigent circumstances”. [Basel II implementation
guideline]

“Role of Credit Rating in the Banking Sector after Introduction of Basel II Regulation” – A Review on Bangladesh Context; C
Chapter # 03
CREDIT RATING
SYSTEMS
3.1 Credit Rating Systems or Modus
Operandi of WCRCL
3.2 Mapping Comparison

3.1 Credit Rating Systems or Modus Operandi of WCRCL (Figure 2)
Client WCRCL Ratings
Operational
Independence
Rating Request to
WCRCL
Initiation of
Confidentiality Clause
Mandate of Authorized
Persons
Interaction with
Rating Team,
Responds to Queries,
Provide Information &
Support to Analysis
Ensuring the Facts &
Figures in the Draft
Report and also for
Rating Analysis
Yes
Accepts
Rating?
No
Acceptance of Mandate
MOU with Client Including
Confidentiality Agreement
Analyst Team Formation
Interaction with Client, Collect &
Collate Information, Undertake Site
Visit and Others
Analysis of the Information,
Preparation of Draft and Submission to
Internal Review Committee (IRC)
Review of IRC and Collection of
Additional Information, If Necessary
Issue of Draft Report without Rating to
Client & Finalization of the Draft
Report
Placing To Rating Committee the
Accepted Draft, Detail Analysis and
Also the Comments from Clients
Rating Committee Awards Rating And
Rating Release To Client with Rating
Rationale
Issue of Rating Report with Rating
Rationale
Press Release, Publish on the WCRCL
Website
Business
Team
Operations
Team
Compliance
Team

3.2 Mapping Comparison
The mapping of rating scales of CRISL, CRAB, NCRL, ECRL and ARGUS with BB rating grades has already been specified in the Guidelines.
Now, the rating scales of CRISL, CRAB, NCRL, ECRL, ARGUS and WCRCL have been mapped with BB rating grades as given below:
Long Term Rating Category Mapping
BB’s
Rating
Grade
Equivalent
Notch/Notation of
CRISL
Equivalent
Notch/Notation of
CRAB
Equivalent
Notch/Notation of
NCRL
Equivalent
Notch/Notation
of ECRL
Equivalent
Notch/Notation of
ARGUS
Equivalent
Notch/Notation of
WCRCL
1 AAA AAA AAA AAA AAA AAA
AA+, AA, AA AA1, AA2, AA3 AA+, AA, AA AA+, AA, AA AA+, AA, AA AA+, AA, AA
2 A+, A, A A1, A2, A3 A+, A, A A+, A, A A+, A, A A+, A, A
3 BBB+, BBB, BBB BBB1, BBB2,
BBB3
BBB+, BBB,
BBB
BBB+, BBB,
BBB
BBB+, BBB, BBB BBB+, BBB, BBB
4 BB+,BB, BB BB1, BB2, BB3, BB+,BB, BB BB+,BB, BB BB+,BB, BB BB+,BB, BB
5 B+, B, B-
CCC+, CCC, CCC-
CC+, CC, CC-
B1, B2, B3
CCC1, CCC2,
CCC3
CC
B+, B, B- B+, B, B- B+, B, B- B+, B, B-
6 C+, C, C-, D C, D C+, C, C-, D C, D C+, C, C-, D C+, C, C-, D
Short Term Rating Category Mapping
S1 ST-1 ST-1 N1 ECRL-41 ST-1 P1
S5, S6 ST-5, ST-6 ST-5, ST-6 N5 D ST-5, ST-6 P5&P6
Table 4: Mapping Comparison
Basel II Implementation Cell, Banking Regulation and Policy Department, Bangladesh Bank.www.bb.org.bd

“Role of Credit Rating in the Banking Sector after Introduction of Basel II Regulation” – A Review on Bangladesh Context; D
Chapter # 04
Credit Rating
Methodology
4. Rating Methodology
4.1 List of Rating Methodologies in BD ECRA’s
4.2 Corporate Rating Methodology
4.2.1 Diagram of Corporate Rating Methodology
4.2.2 Comparison among the Methodologies of
Different ECAI’s
4.3 Banks and Non-Banking Financial Institution
Rating Methodology
4.3.1 Diagram of Banks and NBFI’s Rating
Methodology
Different ECAI’s
4.4 Small Medium Enterprises (SMEs) Rating
Methodology
4.4.1Diagram of SMEs Rating Methodology
Different ECAI’s
4.5General Insurance Rating Methodologies
4.5.1Diagram of GI’s Rating Methodology
Different ECAI’s
4.6 WCRCL Rating Scales & Definitions

4. Rating Methodology
The specific insights of each sector (qualitative and quantitative factors, such as appraisal of
the historic and projected financials, level of profitability, capacity utilization, capital
expenditure need, and cash flow adequacy, debt servicing capacity, free cash flow, and time
series analysis) are converted to specific traits with appropriate weightage for highest
performance, lowest performance, industrial average etc. to arrive at a meaningful rating of
an organization.
Figure 3: Rating Methodology (Source: CRAB)
LOCAL
CURRENCY
DEPOSIT
CEILING (AAA-C)
LOCAL
CURRENCY
DEPOSIT
CEILING (AAA-C)
FINANCIAL
STRENGTH
RATING
(A-E)
BASELINE
RISK
ASSESSMEN
T
(Aaa-C)
LOCAL
CURRENCY
DEPOSIT/
DEBT
RATINGS
(Aaa-C)
FOREIGN
CURRENCY
DEPOSIT/DEBT
RATINGS
(Aaa-C)
Probability of
National
Government
Support
Other External
Support Factors
INTRINSIC FACTORS EXTERNAL FACTORS

4.1 List of Rating Methodologies in Bangladesh Credit Rating Agencies
CRISL methodologies cover followings sectors:
 Bank and Financial Institutions
 Merchant Banks
 Microfinance Institutions
 Manufacturing Corporate
 General Insurance
 Securities Firm
 Airlines
 Life Insurance
 Asset Backed Securities
 Bank Loan / Facility Rating
 Government Support Entities
 Investment Company
 Trading Concerns
 Telecommunication
 SME (Small Medium and
Enterprise)
CRAB rating methodologies are as follows:
1. Bank Rating Methodology
2. Financial Institution Rating Methodology
3. Corporate Rating Methodology
4. General Insurance Rating Methodology
5. Life Insurance Rating Methodology
6. Government Owned Enterprise Rating Methodology
7. Securitization Rating Methodology
NCRL Rating Methodology
 Corporate Rating Methodology
 Financial Institutions Rating Methodology (Bank & NBFI)
 Bank Loan Rating Methodology
 Brokerage Rating Methodology
 Insurance Company Rating Methodology (General)
Emerging Credit Rating Methodology
A. Corporate Debt Rating
1. Rating Process for Construction Companies
2. Rating Process for the Telecommunication Industry
3. Rating Process for the Oil & Gas Industry
4. Rating Process for Plantation Companies
5. Rating Process of Automotive Industry
6. Rating Process for Homebuilders
B. Financial Institution Rating
1. Rating Process for Financial Institutions
2. Rating Process for Financial Holding Companies
3. Rating Process for Islamic Financial Institutions
C. General Insurance

D. Life Insurance
E. Project Finance
F. Issuer Debt Rating
G. Rating Process Govt. Agencies
H. Bond Rating
In this chapter I have tried to discuss the corporate rating methodology, Banking and Non-
Banking financial institution rating methodology, small and medium enterprise (SME) rating
methodology and general insurance rating methodology performed by different ECAI’s in
Bangladesh with highlighting their diagram and comparison among theme.

4.2 Rating Methodology (Corporate/Manufacturing Corporate)
A. Industrial Risk
1. Regulatory framework: Regulatory framework has direct impact on the industry
and to the firms operating under the industry. The regulatory framework of the industry in
most cases are dictated by the government industrial policy, annual budgetary frame work
and measures including tax holidays, cash incentives, labour laws, environmental compliance
issues and even by the import policy of the government and sometimes also been influenced
by external factors such as buyers requirements from abroad, WTO Commitment of the
government etc.
2. Industrial Risks: Risk is inherent in all industrial firms. Risk assessment in manufacturing
units begins with an understanding of their operating environment. The operating
environment dictates the factors to be taken into account while evaluating its long term
performance and its possible impact on the cash flow, profitability and ultimately
repayment capacity. The operating performance of industrial units is affected by trend of
various economic variables including GDP, interest and exchange rates and nature of the
industry. In addition, pattern of demand growth, elasticity of demand, inherent risk in
manufacturing, unstable power supply, small and unstable market, entry of advance
technologies plays an important role in evaluation.
3. Growth potentials: Growth potential of a firm vis-à-vis its industrial growth plays an
important role in CRISL analytical rating framework. The industry life cycle such as
introductory stage, growth stage, maturity stage and sunset stage, all deserves a weightage in
analysis. However, the above potential is always reviewed in the context of future risks
potentials. Again the matured industries are not over risk weighted in view of maturity
rather the factors such as business stability gets due priority vis-à-vis its other peripheral
factors.
4. Vulnerability: The vulnerability of the industry through controllable and uncontrollable
factors are considered in the analytical framework of CRISL the degree of sensitivity of
demand to economic cycle, change in government policies such as import policy, industrial
policy, tariff policy etc are the key elements to be considered in rating an industrial unit. The
volatility of prices of raw material may also create a vulnerable situation for the
industries. The political influence on the trade unions effecting labour intensive industries
such as garments, are susceptible to vulnerability.
5. Industrial Cyclicality: Cyclical companies are those manufacturing units such as
sugar, cotton spinning, automobiles paper and pulp etc whose sales in volume moves with the
macroeconomic fundamentals and the operation of which needs different volume of resources
as it moves with cycle. CRISL analytical framework considers the high and low picks of the
cycle and gives due weights to the factors at each stage of cycle and tries rates through the
cycle. Under the above circumstances CRISL ratings are forward looking. Normally
the companies in cyclical industries accumulates cash and creates buffer during the
boom period in order to keeping the company in smooth operation during the down turn

6. Entry Barrier: Strong restriction on the new entrant in the industry protects the interest of
the existing companies and viewed as plus point while keeping the industry open for anybody
may at any point of time take away the share of the existing companies and ultimately poses a
threat for survival or profitable operation. However, CRISL considers that the strong
prohibition factors such as huge capital outlay, creation of franchise value and brand image of
the products needing time, Government restriction, distribution net work etc.
7. Size of the industry: Size of the industry on the economy and the size of the companies
operating under the industry play an important role in analyzing long term and long term
viability. Large companies have greater tenacity and staying power due to their extensive
resource base and stronger shields. Those companies also enjoys broader market access,
larger market share, strong marketing network, franchise value which ultimately assist the
company’s long term viability.
8. Threats of product substitution: -Availability of substitute at cheaper price or
availability of substitute products at the door step may intensify the competition. CRISL
analysis inter alia considers existing and potential substitutes that may stand as threat to the
existing products of the company. In addition alternative uses of the products are also
explored to have an understanding under distress situation.
B. Business Risk Analysis
Under the business risk analysis CRISL evaluates the issuer’s business model, business
strategies and competitive strength in the industry. Again business risk can be classified in
two sub sector Market Risk and Operational Risk.
i)Market Risk
1. Competition: The nature of competition varies from industry to industry. However the
product lines and its market share determines the nature of competition an organization may
face. In order to survive in the competition, the cost efficiency in production and quality of
product at competitive price is essential. Presently competitive advantages are being created
through strong infrastructure build up and supply chain which are given due weight in the
analytical process.
2. Market position, size and Age of the Business: Market share, size and age of the
organization play an important role in deciding on the competitiveness of a company. Size of
an organization assist in achieving economy of scale, determining economic order size, cost
efficiency and thereby lowering the unit cost of production. The size of an organization also
justifies the research expenditure and capital intensive equipment, effective distribution
channel and branch network.
3. Product demand: Product demand in the market is a very important factor in the process
of ascertaining the market stability and future growth. In this connection CRISL reviews the
plant capacity utilization and quantity of production compared to the market demand,
seasonality of the product demand etc are critically reviewed.

4. Product and Service diversity: In a highly competitive environment more particularly in
the industries having frequent change in technology, product diversity and scope of
switchover to other alternative products with small or no cost is considered to be a favorable
point in the overall rating process. In the rating process, the diversity is considered to be
mitigating factor against concentration risk. Companies having more product lines are
always preferred to the companies dependent on single product or product line.
5. Customer Analysis: The number of customers occupying large portion of receivables,
customer concentration, company reliability on few customers, capacity of the company to
absorb the shock of switching over to new customer, impact of customer shifting to other
competitors are reviewed by CRISL in its analytical exercise. Dependence on the customers
in various market segments such as Domestic vs. export market, whole sale vs. retail
market, distribution channels, long term sales contract, impact on market due to change in
price all are given due weightage while carrying out customer analysis.
6. Customer satisfaction: CRISL reviews customer satisfaction of an organization in order
to ascertain the market continuation and market growth. Customer satisfaction can be
reviewed by average continuation of a customer with the company, repeat orders, product
rejection rate etc.
ii) Operational Risk
1. Plant location and production facilities: Plant facilities, technology and plant location
counts significantly in reviewing a manufacturing company. Location of an export oriented
company in the export processing zone or near to that or access to easy communication is
considered to be advantageous while the location of a company requiring heavy raw
material or selling heavy products in the port side or river side involving cost effective
transportation is considered to be a positive factor. Excess to low cost utilities facilities such
as gas and water and electricity is given due weightage.
2. Availability of Raw material: Availability of raw material either from local market or
export market plays an important role in the rating process. In case of local supply, the supply
chain, sufficiency in terms of quality, no of suppliers, seasonality, price fluctuation, lead time
and case of import, additional factors such as import policy, the government duty structure,
import restrictions, cash incentive considerations all plays important role in the CRISL
analytical process
3. Technology vs. Asset efficiency: Modern technology provides competitive edge over old
technology. Asset composition, balanced equipment for maximum production efficiency
all plays positive role while old and outdated technology reduces competitiveness having a
negative impact on rating
4. Cost Structure: Cost structure plays an important role in the industrial
production. CRISL classifies the cost into direct material, direct labour and overhead. Again
cost accumulation and it allocation to various products through job order costing system, or
process cost system is reviewed in order to arrive at a meaningful cost efficiency analysis.

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