Unit 4
Consumer finance and credit rating
Introduction
Consumer finance refers to granting of credit by banks and financial institutions to customers for purchase of durable and luxuries items like family car, AC, laptop, mobile phones, washing machine etc. Such type of loans is provided to increase the standard of living of people of our country. It is provided to both households and business man. Such loans are repayable within 3 months to 5 years. Some of the examples providing consumer finance in India are commercial banks, Bajaj Finance Ltd., Muthoot Finance Ltd. Etc.
Sources of consumer finance and types of products of consumer finance
Various sources of consumer credit are mentioned under the following heads-
• single payment loan
• personal instalment loans
• credit cards
• passbook loans
2. credit unions:
• personal instalment loans
• share-draft credit plans
• second mortgages
3. Federal savings banks:
• personal instalment loans
• home improvement loans
• education loans
• savings account loans
4. Consumer finance companies
5. Life insurance companies:
Terms and conditions of consumer credit
There are certain terms and conditions of consumer credits from the view point of consumers and provides, namely-
Pricing of consumer credit
Pricing of consumer credit implies interest paid by consumers for taking consumer credit. The pricing depends on the extent of facility offered by the financer. The elements of pricing of consumer credit are probability of default, administrative expenses etc. The interest rate charged varies depending on the type of credit, duration of credit, amount of credit, nature of institution etc.
Consumer credit scoring
Credit scoring is a statistical analysis performed by lenders to determine the borrower’s creditworthiness which is crucial for lenders before granting any king of credit. It determines the ability of borrower to access loans. Vantage Score, FICO are some of the popular credit scoring models. An individual’s credit score is influenced by his
The credit score of small business is determined by
Advantages and disadvantages of consumer finance
The advantages of consumer finance are mentioned under the following points-
Some of the disadvantages of consumer finance are highlighted under the following points-
Key takeaways
Plastic money includes all types of plastic bank cards makes easier way of paying money. Its birth place is in New York started by Franklin National bank in the year 1951. The Plastic Money in the form of cards has been actively introduced by banks in India in 1990's. It gains popularity among bankers as well as customers and getting accepted in the market place in India with the increase in income, education, awareness level, up gradation in banking services, information technology and recent effort of Government regarding digital India.
Reserve Bank of India (RBI) is taking important steps to enhance Plastic Card's usage and popularity through initiatives like regulating card market to maintain the security levels and to build up confidence of bankers and customers. Despite the strong advances in E - Payments, an estimated 90 per cent of personal consumption expenditure in India is still made with cash which indicates the tremendous growth potential of this business. So, this can be considered as just a beginning which indicates the bright future prospects of Plastic Card market in India. It clearly indicates that the Indian banking sector is accepting the challenge of information technology as all the groups of bankers have now recognized it as essential requirement for survival and growth in future.
Types of plastic cards
Different types of plastic money is divided under the following heads-
1) According to payment service:
2) According to card association/payment system:
Benefits of credit cards
The benefits of credit card are highlighted under the following points-
Dangers of debit cards
Prevention of frauds and misuse of plastic money and Consumer protection
With the advancement of IT, increase in ATM fraud, duplicity etc. are alarming concern. Some of the measures to prevent frauds and misuse of plastic money and consumer protection are mentioned below-
Smart card meaning
Smart card is a physical card enabled with integrated chip that act as security token. It is used for variety of applications like driving license, debit card, credit card, telecommunication etc. it is capable of short range wireless connectivity can also be used for contactless payment systems.
The features of smart card are-
Types of smart card
Financial application of smart cards
Application of smart card in financial and banking sector are highlighted below-
Key takeaways
Meaning
Credit rating simply means rating of the credit worthiness of a company by and assessment of the capacity of an issuer for repayment of principal and interest on debt by an independent agency. According to CRISIL, “Credit rating is an unbiased and independent opinion as to issuer’s capacity to meet its financial obligations. It does not constitute a recommendation to buy/ sell or hold a particular security”. Different credit rating agencies like CRISIL, CARE etc. provide ratings for financial institutions, banks, financial products and instruments, financial services etc. depending on which the investors make investment decision.
Features of credit rating
Some of the essential features of credit rating are mentioned below-
Advantages and disadvantages
Some of the advantages of credit rating are highlighted in the following-
A. Advantages to Investors
1. It provides relevant and reliable information to investors at low cost.
2. It enables investors to take quick investment decision on the basis of ratings.
3. It helps the investors to undertake a detailed risk evaluation. It helps the investors to arrive at a meaningful and consistent conclusion regarding the relative credit quality of the security.
4. It suggests the creditworthiness of the instrument and indicates the degree of risk involved in the instrument. Hence the investors can make direct investment decisions.
B. Advantages to Issuers (Rated Companies)
1. It acts as an ideal index of faith placed by the market in the issuers.
2. It increases the investor base. This enables the rated companies to raise any amount required at lower cost without difficulty.
3. It acts as a guide to companies scoring lower rating. This enables the management to take steps on their operating and marketing risks. This will change the perception against the companies in the market.
4. It encourages discipline among corporate borrowers to improve their financial structure and performance to get better rating.
The disadvantages of credit rating are highlighted below-
2. In most of the cases, the rating is done on the basis of the information supplied by the issuer themselves which may not reliable and valid.
3. Rating is a static study of present and past data of a company ignoring some dynamic factors. This may lead to changes in the rating.
4. Different agencies provide different rating for the same instrument. In this way the investors may got confused.
5. If the staffs of credit rating agency are inexperienced or less skilled, then the rating may not be perfect.
Regulatory framework
SEBI Regulations, 2003 require every credit rating agency to follow the code of conduct as given below:
1. A credit rating agency shall make all efforts to protect the interests of investors.
2. A credit rating agency, in the conduct of its business, shall observe high
standards of integrity, dignity and fairness in the conduct of its business.
3. A credit rating agency shall fulfil its obligations in a prompt, ethical and
professional manner.
4. A credit rating agency shall at all times exercise due diligence, ensure proper care and exercise independent professional judgement in order to achieve and maintain objectivity and independence in the rating process.
5. A credit rating agency shall have a reasonable and adequate basis for performing rating evaluations, with the support of appropriate and in depth rating researches. It shall also maintain records to support its decisions.
6. A credit rating agency shall have in place a rating process that reflects consistent and international rating standards.
7. A credit rating agency shall not indulge in any unfair competition nor shall it wean away the clients of any other rating agency on assurance of higher rating.
8. A credit rating agency shall keep track of all important changes relating to the client companies and shall develop efficient and responsive systems to yield timely and accurate ratings. Further a credit rating agency shall also monitor closely all relevant factors that might affect the creditworthiness of the issuers.
9. A credit rating agency shall disclose its rating methodology to clients, users and the public.
10. A credit rating agency shall not make any exaggerated statement, whether oral or written to the client either about its qualification or its capability to render certain services or its achievements with regard to the services rendered to other clients.
11. A credit rating agency shall not make any untrue statements, suppress any material fact or make any misrepresentation in any documents, reports, papers or information furnished to the Board, stock exchange or public at large.
12. A credit rating agency shall maintain an appropriate level of knowledge and competence and abide by the provisions of the Act, regulations and circulars, which may be applicable and relevant to the activities carried on by the credit rating agency. The credit rating agency shall also comply with award of the Ombudsman passed under Securities and Exchange Board of India (Ombudsman) Regulations, 2003.
13. A credit rating agency shall ensure that there is no misuse of any privileged information including prior knowledge of rating decisions or changes.
14. A credit rating agency or any of his employees shall not render, directly or indirectly any investment advice about any security in the publicity accessible media.
15. A credit rating agency shall maintain an arm’s length relationship between its credit rating activity and any other activity.
Credit rating agencies in India
The credit rating agencies operating in India are discussed below
CRISIL is the first credit rating agency in India. It is a public limited company established in 1987 in the private sector. It is promoted jointly by ICICI and UTI. It started its operations on 1st January 1988. Its objectives is to accord credit rating to public limited companies which desire to float share capital, debentures, public deposits or commercial paper to raise finance from the public.
Objectives of CRISIL
1. To assist the investors in making investment decisions in fixed interest securities.
2. To guide the investors in understanding the risk associated with a particular debt instrument.
3. To help the companies raise large funds at a lower cost.
4. To create awareness of the concept of credit rating amongst corporations, merchant bankers, brokers, regulatory bodies.
5. To provide regulators with a market driven system in order to ensure discipline and a healthy growth of capital markets.
The services rendered by CRISIL may be summarised as below:
b. Information services: CRISIL offers information services also. Its main product ‘CRISIL CARD’ provides corporate and balance sheet data for the sake of analysis. It assesses the outlook and solvency of the concerned companies on the basis of published data. CRISIL 500 Equity Index is an index newly launched on the basis of 500 companies representing 74% of market capitalization of the Mumbai Stock Exchange.
c. Advisory services: It also offers services to the Governments, banks, financial institutions etc. It provides advisory services in the areas of energy, transport, urban infrastructure, tourism, economy, corporate, capital markets, and financial services. It also undertakes credit and counter party ratings for corporates.
2. Investment Information of Credit Rating Agency of India Ltd. (ICRA)
It is promoted by IFCI Ltd. It started operations in 1991. It offers credit rating services for rating debentures or bonds, preference shares, medium term debts, including certificates of deposits as well as short term instruments including commercial paper. It has entered into an area called Earning Prospects and Risk Analysis. ICRA also provides credit assessment and general assessment. The primary objective of ICRA is to provide information and guidance to investors/creditors for determining the credit risk associated with a debt instrument/credit obligation. ICRA Limited is a Public Limited Company, with its shares listed on the Bombay Stock Exchange and the national Stock Exchange. Today, ICRA and its subsidiaries together form the ICRA Group of Companies (Group ICRA).
Objectives of ICRA are-
1. To provide information and guidance to investors and creditors.
2. To enhance the ability of the borrower/issuer to enter into financial markets for raising resources from a wide range of investing public.
3. To help the regulators in promoting the transparency in the financial markets.
4. To enable the banks, investment bankers and brokers in placing debt with investors by providing them with a marketing tool.
Services/Functions of ICRA are discussed below-
1. Rating Services
ICRA rates rupee-denominated debt instruments, such as bonds and debentures (long-term), fixed deposit programmes (medium term), commercial paper and certificates of deposit (short-term), and structured obligations and sector-specific debt obligations (issued by Power, Telecom, and Infrastructure companies).
2. Grading Services
ICRA has developed highly specialised evaluation methodologies for grading of construction entities; real estate developers and projects; healthcare entities; maritime training institutes; and initial public offers (IPOs). These grading methodologies have been developed in association with reputable and specialised bodies, associated with the domain.
3. Advisory Services:
ICRA offers a wide range of management advisory services. These include: (a) strategic counselling, (b) risk management, (c) restructuring solutions, (d) inputs for policy formulation, (e) client specific need based studies in the banking and financial services, manufacturing and services sector etc.
4. Outsourcing:
ICRA Online Ltd, a subsidiary of ICRA, provides technology solution, targeted at distributors of third party financial products, insurance brokers, and stock broking houses. The BPO Division of ICRA Online serves financial service companies, financial institutions, investment banks, private equity and venture capital funds, market researchers and the like. The focus is on high and knowledge processing like financial modelling, data analysis valuation etc.
5. Software development:
ICRA Techno Analysis Ltd., a subsidiary of ICRA offers complete portfolio information technology solutions to meet the dynamic needs of present day businesses. The services range from the traditional development of client server, web centric and mobile applications to the generation of cutting edge business analysis.
3. Credit Analysis and Research Ltd. (CARE)
It is promoted by the IDBI. It began its operations from October 1993. It offers a wide range of services. Credit rating is conducted for debentures, fixed deposits, commercial papers etc. CARE ratings are recognised by the Government of India and regulatory agencies in India. It is registered with the Securities and Exchange Board of India (SEBI). The ratings are also recognised by RBI, NABARD, NHB and NSIC. The three largest shareholders of CARE are IDBI Bank, Canara Bank and State Bank of India. CARE is a full service rating company offering a wide range of rating and grading services. These includes rating debt instruments/enterprise ratings of corporates, banks, Financial Institutions (FIs), Public Sector Undertakings (PSUs), state government bodies, municipal corporations, NBFCs, SMEs, microfinance institutions, Structured finance and Securitisation transactions.
Services or Functioning of CARE are-
a) Credit rating: It undertakes the credit rating of all types of debt instruments. The rating provides a relative ranking of the credit quality of debt instruments. It also rates quasi-debt obligations such as the ability of insurance companies to meet policy holders’ obligations.
b) Information services: It makes available information on any company, industry, or sector required by a business enterprise. This information will enable the users to make informed decisions regarding investments.
c) Advisory services: It conducts sector studies and provides advisory services in the areas of financial restructuring, valuation and credit appraisal systems.
d) Equity research: It conducts the detailed study of the shares listed in the major stock exchanges. On the basis of this study, it can identify the potential winners and losers on the basis of the fundamentals affecting the industry, economy, market share, management capabilities and other relevant factors.
e) Other services: It undertakes performance rating of parallel marketers of LPG and Superior Kerosene Oil (SKO) as notified by Central Government. It also provides a valuable input in assisting decision making process in banks and Development Financial Institutions. It has a strong structured finance team and has been instrumental in developing rating methodologies for innovative asset backed securities in the Indian capital market.
Credit rating symbols
AAA: highest safety
AA: high safety
A: adequate safety
BBB: inadequate safety
B: high risk
C: substantial risk
D: default.
Key takeaways
References