Report On Credit Rating | The Lawyers & Jurists

Chapter: 01
Introduction

1.1 Background of the
Report:

In the present world most of the economic activities are largely depended
on credit. Investment in productive sectors and other business activities needs
to be financed from a variety of sources. Of course, before granting the credit
facility the lender will try to be ensured that the borrower is capable to
repay the loan. For this the rating service is designed to provide both the
parties with reliable information. In modern economy the government has to
raise fund from both domestic and international institutions to finance its
operations. For this reason the need for sovereign credit rating is increasing
day by day.

As a developing country Bangladesh government took the initiative to rate
itself in 2006. The Bangladesh Bank requested two credit rating agencies, Standard &poor’s and Moody’s
which assigned ratings BB- and Ba3 as on 06 April And 12 April of this
year respectively. Both of the ratings reflects the better creditworthiness as
same as some emerging economic countries such as Vietnam and Indonesia. These
rating also unveil the opportunities of foreign direct investment and access to
international finance for Bangladesh.

In this circumstances, as part of
my academic program to obtain the degree of BBA, my Faculty Supervisor, Ranjan
Kumar Mitra, asked me to prepare a report on Credit Rating focusing Sovereign
Rating to Bangladesh. This report helped me to acquire knowledge on the very
new topic as a business student from Bangladesh. So,
I want to give my heartiest thanks to my supervisor to give such opportunity to
show my capability and aptitude in this relevant area.

1.2 Scope of the
Report:

This report gives an overview of
the credit rating system, its scenario in Bangladesh and describes its
classification. It explains the sovereign rating and its methodologies mainly
focusing the Standard &poor’s and Moody’s Investors Services. This report
finally shows the sovereign Rating to Bangladesh and its impact on the economy.

1.3 Objectives of the
Report:

The broad objective of the report is to explicate the Sovereign Credit Rating Methodology
and rating of Bangladesh by Standard &poor’s and Moody’s.

The specific objectives of this
study are as follows:

To
give an overview of credit rating and its classification.

To illustrate the present
scenario of credit rating industry in Bangladesh.

To
illustrate the sovereign credit rating methodologies used by S&P’s and
Moody’s.

To
describe the impacts of sovereign rating to Bangladesh economy.

To find out the variables that are considered
to rate Bangladesh.

Corporates

Financial
Institutions

Infrastructure
& Project Finance

Managed
Investments

Sovereign
& Supranational

Structured
Finance

Sub-Sovereign

U.S.
Public Finance

ability to
pay a loan

interest

amount of
credit used

saving
patterns

spending
patterns

debt

Credit
Ratings – based on analysis performed by experienced professionals who
evaluate and interpret information from a multitude of sources, credit
ratings provide a detailed opinion about a corporation’s credit risk.

Counterparty
Credit Ratings –these types of ratings are useful for clients who are
seeking asset or custodial management services or joint ventures. They are
also useful for comparing a company’s creditworthiness to that of its
peers.

Rating
Evaluation Services – an analytical tool for corporations that are
considering strategic or financial initiatives that could impact its
creditworthiness. More specifically, this service allows corporations to
assess the potential ratings impact of different types of debt.

Private
Client Services – an independent and objective tool developed for senior
credit, financial, risk and investment managers to evaluate and manage
risk with the help and insight of a Standard & Poor’s credit specialist.

Bank
Loan and Recovery Ratings – developed for senior lenders, these types of
ratings go beyond the overall corporate creditworthiness of the borrower
to capture the impact of covenants, collateral and other repayment
protection.

3.1.3 Financial
Institutions Rating:

3.1.4 Insurance:

Insurance
Financial Strength Ratings – useful for buyers of insurance, risk managers
and employee benefit administrators, this type of rating provides details
on an insurance organization’s ability to pay its policies and contracts.
Insurance brokers and agents may also use these ratings to meet due
diligence and disclosure requirements.
Insurance
Financial Enhancement Ratings – provides investors with an assessment of
an insurer’s willingness to pay financial guarantees on a timely basis.
Insurance
Security Circle Icon – assigned only to rated insurers who have completed
Standard & Poor’s interactive rating process and have obtained a BBB
rating or above, this tool can help insurers easily promote their good
financial standing to existing and prospective policyholders.
Bond
Insurance – Standard & Poor’s offers the most comprehensive coverage
of bond insurance in the marketplace. Our bond insurance ratings are
supported by a diverse and global network of sector professionals in
structured finance, project finance, public finance, and corporate and
financial institutions. Learn more about Bond Insurance below.

3.1.5
International Public Finance:

CRAB

CRISL

·
Entity Ratings

·
Financial Institution Ratings

·
Corporate Debt Ratings

·
Equity Ratings (Initial public Offerings and Right
Offerings)

·
Structured Finance Ratings

·
Insurance Companies Rating/Claims Paying Ability
Rating

·
Mutual Funds Schemes Rating

·
Corporate Governance & Stakeholder Value
Addition Rating

·
Clientele Rating for Banks/Financial Institutions

·
Other Rating Services

Corporate/
entity rating for direct listing or for IPO at premium
Bank/
financial institution rating
Insurance
claim paying ability rating
Bank
counter party rating
Bank
loan exposure/ Facility rating
Rating
of the structured products such as Zero Coupon Bonds. Mortgage backed or
asset backed securities, debentures, preference share financings,
subordinated debt products
Securitized
transactions
Project
financing ratings
Micro
Finance rating
MFI-
social impact rating
Educational
Institution Rating
Corporate
Governance Rating

The Growth of the Sovereign Ratings Business
Year Rating Was First Assigned by S&P or Moody’s	Number of Newly Rated Sovereigns	Median Rating Assigned (S&P/ Moody’s)
Pre-1975	3	AAA/Aaa
1975-79	9	AAA/Aaa
1980-84	3	AAA/Aaa
1985-89	19	A/A2
1990-94	15	BBB-/Baa3

Per
Capita Income,

GDP
Growth,

Fiscal
Balance,

External
Balance,

External
Debt,

Economic
Development,

Inflation,
and

Default
History

Per
capita income: The greater the potential
tax bases of the borrowing country, the greater the ability of a
government to repay debt. This variable can also serve as a proxy for the
level of political stability and other important factors.

GDP
growth: A relatively high rate of economic
growth suggests that a country’s existing debt burden will become easier
to service over time.

Fiscal
balance: A large federal deficit
absorbs private domestic savings and suggests that a government lacks the
ability or will to tax its citizenry to cover current expenses or to
service its debt.

External
balance: A large current account
deficit indicates that the public and private sectors together rely
heavily on funds from abroad. Current account deficits persists result in
growth in foreign indebtedness which may become unsustainable over time.

External
debt: A higher debt burden should
correspond to a higher risk of default. The weight of the burden increases
as a country’s foreign currency debt rises relative to its foreign
currency earnings (exports).

Economic
development:
Although level of development is already measured by our per capita income
variable, the rating agencies appear to factor a threshold effect into the
relationship between economic development and risk. That is, once
countries reach a certain income or level of development, they may be less
likely to default. We proxy for this minimum income or development level
with a simple indicator variable noting whether or not a country is
classified as industrialized by the International Monetary Fund.

Inflation: A high rate of inflation
points to structural problems in the government’s finances. When a
government appears unable or unwilling to pay for current budgetary
expenses through taxes or debt issuance, it must resort to inflationary
money finance. Public dissatisfaction with inflation may in turn lead to
political instability.

Default
history:
Other things being equal, a country that has defaulted on debt in the
recent past is widely perceived as a high credit risk. Both theoretical
considerations of the role of reputation in sovereign debt and related
empirical evidence indicate that defaulting sovereigns suffer a severe
decline in their standing with creditors. We factor in credit reputation
by using an indicator variable that notes whether or not a country has
defaulted on its international bank debt.

Rating	Definition
‘AAA’	Extremely strong capacity to meet financial commitments. Highest Rating.
‘AA’	Very strong capacity to meet financial commitments.
‘A’	Strong capacity to meet financial commitments, but somewhat susceptible to adverse economic conditions and changes in circumstances.
‘BBB’	Adequate capacity to meet financial commitments, but more subject to adverse economic conditions.
‘BBB-‘	Considered lowest investment grade by market participants.
‘BB+’	Considered highest speculative grade by market participants.
‘BB’	Less vulnerable in the near-term but faces major ongoing uncertainties to adverse business, financial and economic conditions.
‘B’	More vulnerable to adverse business, financial and economic conditions but currently has the capacity to meet financial commitments.
‘CCC’	Currently vulnerable and dependent on favorable business, financial and economic conditions to meet financial commitments.
‘CC’	Currently highly vulnerable.
‘C’	Currently highly vulnerable obligations and other defined circumstances.
‘D’	Payment default on financial commitments.

5.3.1
‘AAA’ Rated Sovereigns:

Stable,
transparent, and accountable political institutions.

The
flexibility to respond to changing economic and political circumstances
relatively quickly and without major disruption.

Openness
to trade and integration into the global financial system.

A
prosperous, diverse, and resilient economy, with high per capita income.

An
efficient public sector with countercyclical fiscal policies, low
deficits, and largely local currency government debt.

An
independent central bank pursuing sustainable monetary and exchange rate
policies; an international currency; low inflation.

Strong,
diversified, well-regulated financial sector and capital markets.

Ample
external liquidity and low external debt.

5.3.2
‘AA’ Rated Sovereigns:

Stable,
transparent, and accountable political institutions.

The
flexibility to respond to changing economic and political circumstances
quickly and without major disruption.

Openness to
trade and integration into the global financial systems.

A
prosperous economy, but slightly more vulnerable than ‘AAA’ sovereigns to
adverse external influences.

An
efficient public sector with countercyclical fiscal policies, variable
deficits, and largely local currency government debt.

An
independent central bank pursuing sustainable monetary and exchange rate
policies; low inflation.

Diversified,
well-regulated financial sector and capital markets.

A low
public and private sector external financing requirement relative to
usable reserves; modest external debt.

5.3.3
‘A’ Rated Sovereigns:

Political
institutions evolving toward greater accountability and more stable,
transparent forms of governance; possibly some geopolitical risk.

Openness
to trade and integration into the global financial system.

A
less diversified economy than for ‘AA’ rated sovereigns, but economic
policies are generally cautious, flexible, and market oriented.

Rapid
trend growth in output and GDP per capita, reflecting progress in economic
restructuring.

A
fairly efficient public sector with moderate fiscal deficits; a less
developed local debt market may necessitate offshore borrowing.

A
fairly independent central bank pursuing sustainable monetary and exchange
rate policies, but flexibility is more limited than at higher rated
sovereigns; moderate inflation.

A
well-regulated financial sector, possibly with some ongoing challenges,
and developing capital markets.

A
public and private sector external financing requirement that is modest
relative to usable reserves; moderate external debt.

5.3.4 ‘BBB’ Rated Sovereigns:

Less
transparent political institutions; system may be in transition or
succession process may be divisive; some geopolitical risk and social
stress possible.

Openness
to trade and growing integration in global financial system.

A
less prosperous economy than in higher rated sovereigns, with more
vulnerability to political and external shocks.

A
record of satisfactory economic performance under adverse external
conditions and well-established support for market-oriented economic
programs; reform to enhance competitiveness, transparency, and flexibility
is under way.

Government
revenue and expenditure flexibility limited by already-high taxes/fees,
collection difficulties, and spending pressures; greater need to borrow
externally than in a higher rated sovereign.

A
fairly independent central bank pursuing sustainable monetary and exchange
rate policies, but market orientation of tools is limited by less
developed financial markets.

An
evolving financial sector, with possible problems creating a significant
contingent liability for the government.

Public
and private sector external financing requirement significant relative to
usable reserves; moderate to high external debt.

5.3.5
‘BB’ Rated Sovereigns:

Political
factors are a source of some uncertainty, with less transparent
institutions and less open process than at higher ratings; possibly some
geopolitical risk and social stress.

Openness to
trade and a growing integration into the global financial system, though
possibly with more restrictions than at higher rating levels.

A low- to
moderate-income economy, with variable economic performance and
vulnerability to adverse political and external influences.

An economy
that is not well diversified or suffers from structural impediments to
growth; wide income disparities.

Government
revenue and expenditure flexibility limited by already-high taxes/fees,
collection difficulties, and spending pressures; absent capital controls,
nonofficial debt tends to be short term and denominated in, or linked to,
a foreign currency.

A central
bank pursuing sustainable monetary and exchange rate policies, but relying
more heavily upon direct means than at higher rating levels; variable
inflation.

The
financial sector comes under stress when economic growth slows, with
possible problems creating a significant contingent liability for the
government

A large
public and private sector external financing requirement relative to
usable reserves; moderate to high external debt.

5.3.6 ‘B’ Rated Sovereigns:

Political
factors are a source of uncertainty, with change in government sometimes
leading to economic policy disarray; institutions are less open and
effective than at higher rating levels; possibly some geopolitical risk
and social stress.

Openness to
trade, but integration into the global financial system is weak and
subject to changing circumstances

A low- to
moderate-income economy, with a variable economic performance and
vulnerability to adverse political and external influences.

The economy
is either not well diversified or suffers from structural impediments to
growth; the private sector is less developed and sometimes dependent upon
government protection/support; wide income disparities.

Macroeconomic
stabilization efforts may be untested; government revenue and expenditure
flexibility limited by already-high taxes/fees, collection difficulties,
and spending pressures; absent capital controls, nonofficial debt tends to
be short term and denominated in, or linked to, a foreign currency.

A central
bank constrained by structural problems or fiscal imbalances and debt
markets that are shallow; variable and sometimes high inflation.

The
financial sector is undeveloped, possibly creating a significant
contingent liability for the government.

A very
large public and private sector external financing requirement relative to
usable reserves; moderate to high external debt.

5.3.7
‘CCC’ and Lower Rated Sovereigns:

A
clear and present danger of default.

May
be in default on bilateral debt (and other classes of debt, in the case of
‘SD’).

Relatively
weak political institutions and an uncertain political environment, with
potentially difficult internal divisions and geopolitical risk.

Sharp
currency depreciation and high inflation, possibly hyperinflation.

High
fiscal and external debt, with a significant near-term debt-servicing
burden.

A
weak financial sector and an acute shortage of credit.

		Local Currency	Foreign Currency
Bond Rating		Local Currency Government Bond Rating	Foreign Currency Government Bond Rating
Ceilings	General	Local Currency Ceiling	Foreign Currency Ceiling for Bonds and Notes
Ceilings	Banks	Local Currency Deposit Ceiling	Foreign Currency Ceiling for Bank Deposits

	Local Currency	Foreign Currency
Bond Rating	Local Currency Government Bond Ratings reflect Moody’s opinion of the capacity and willingness of a government to generate revenues in its own currency to repay its debt to bond holders on a timely basis.	Foreign Currency Government Bond Ratings reflect Moody’s opinion of the capacity and willingness of a government to mobilize foreign exchange to repay foreign currency-denominated bonds on a timely basis.
Ceilings	The Local Currency Ceiling summarizes the general country level risk (excluding foreign currency transfer risk) that should be taken into account in assigning local currency ratings to locally-domiciled obligors or locally-originated structured transactions.	The Country Ceilings for Bonds and Notes and for Bank Deposits reflect the risk of governmental interference at times of external payments crisis, i.e. foreign currency transfer risk. The ceiling for bonds and notes is defined by the probability that a government would resort to a moratorium should it default. It is determined by multiplying the implied default risk associated with existing foreign-currency government bond ratings by the risk that a moratorium would be used as a public policy tool. The foreign currency ceiling for bank deposits in most emerging market countries is typically lower than the ceiling for bonds to reflect the fact that the risk of a bond moratorium is often lower than the risk of a foreign currency deposit freeze.
Ceilings	The Local Currency Deposit Ceiling is the highest rating that can be assigned to the local currency deposits of a bank domiciled within the rated jurisdiction.

Local Currency

Foreign Currency

Bonds and Notes

Local Currency Ceiling

Foreign Currency Country
Ceiling

Bank Deposits

Local Currency Deposit

Ceiling Foreign Currency
Deposit Ceiling

Determining the Ceiling
Rating Scale	Government Foreign Currency Bond Rating	Risk of Moratorium	Foreign Currency Ceiling
Aa3		The lower the moratorium risk is, the higher the Foreign Currency Ceiling as compared to the Foreign Currency rating of the government.
A1
A2
A3			Foreign Currency Ceiling
Baa1
Baa2	Government Foreign Currency Bond Rating
Baa3

Piercing the Ceiling
Rating Scale	For any issuer whose Local Currency Rating is lower or equal to the Ceiling: Foreign Currency Rating = Local Currency Rating		If the Local Currency Rating of an Issuer > Ceiling, a security may pierce depending on the risk of being caught up in a hypothetical moratorium.
Aa1				The higher the risk of being caught, the closer a security’s Foreign Currency Rating to the Foreign Currency Ceiling.
Aa2
Aa3			Local Currency Issuer Rating
A1
A2					Foreign Currency Rating of the security
A3	Issuer Rating	Foreign Currency Ceiling	Foreign Currency Ceiling
Baa1		Range of possibilities with Foreign Currency Rating = Local Currency Rating
Baa2
Baa3

SARC countries Comparison
Country Name	Standard & Poor’s	Moody’s
India	BBB-	Baa3
Bangladesh	BB-	Ba3
Sri Lanka	B	NR
Pakistan	B-	B3

Credit
rating agencies do not downgrade
companies promptly enough. For example, Enron’s rating remained at
investment grade four days before the company went bankrupt, despite the
fact that credit rating agencies had been aware of the company’s problems
for months.

It
has found that the credit agencies are conflicted in assigning sovereign
credit ratings since they have a political incentive to show they do not
need stricter regulation by being overly critical in their assessment of
governments they regulate.

The
lowering of a credit score by a CRA can create a vicious cycle, as not only interest
rates for that sovereign would go up, but other contracts with financial
institutions may be affected adversely, causing an increase in expenses
and ensuing decrease in credit worthiness.

Agencies
are sometimes accused of being oligopolists, because barriers to market
entry are high and rating agency business is itself reputation-based.

Credit
Rating Agencies have made errors of
judgment in rating.

The
international credit rating agencies rates Bangladesh slightly in higher
position. For recent few years Bangladesh drew a lesser amount of foreign
loan namely form World Bank and IMF. They are trying to persuade
Bangladesh to take more loans.

Ratings
agencies, in particular Fitch, Moody’s and Standard and Poor’s have been
implicitly allowed by the government to fill a quasi-regulatory role, but
because they are for-profit entities their incentives may be misaligned.

The
challenge the rating agency mentioned for Bangladesh is low revenue
collection.

Despite
its medium-size economy and evidence of recent economic dynamism,
Bangladesh’s relatively high industrial and export dependence on the
ready-made garments (RMG) sector is a ratings constraint.

Despite
the generally positive trends in the government’s debt trajectory, debt
affordability and fiscal flexibility face more pressure than do most of
Bangladesh’s rating peers.

There
is lack of fiscal flexibility reflected in a high government
debt-to-revenue ratio of 350 per cent.

The
Rating agencies also pointed to the high public and external debt as a
constraint.

The
credit rating agencies must give prompt update to the rating issues so
that the lender or investor can be aware of the real fact.

The
rating agencies should provide their services irrespective of the
political incentives.

They
should not provide lower or unfair score to any entity though there may be
some pressure by the powerful institutions or sovereigns.

The
entry barrier to the Credit Rating Agency industry should be removed.

The credit rating agencies should develop
their operational efficiency and expertise.

The
growth of the export of dynamic readymade garment sector must be ensured.

Robustness
in the remittance flow.

Procurement
of minimum foreign commercial loan and extremely well debt servicing are
the other reasons behind the good score.

Bangladesh’s
reasonable degree of financial and balance-of-payments robustness coupled
with prospects for continued macroeconomic stability reduces the likelihood
of severe stress on the country’s creditworthiness

Political
stability must be ensured.

The
growth stability on the back of prudent macro-economic policy and
microeconomic reforms and growing role of microfinance institutions can
ensure better rating in future.

Prudent
macroeconomic management and sound policies should have been ensured for
price stability as well as a stable exchange rate.

The
strong growth in the country’s foreign exchange reserve has also been
rated favorably.

1.4 Methodology of
the Report:

This report is mainly based on explanatory research and secondary data.
As a theoretical study this report is prepared by gathering the data from
secondary sources.

I have tried my level best to collect most relevant data from the two
rating agencies websites, articles from published journals and daily
newspapers. I also take the help from many other websites to collect data
updates and analyze the collected data to reach the objectives of the report.
In this report I analyze the sovereign rating methodologies separately for the
two rating agencies and describe the determinants considered by both of them.
Finally I conclude the findings with recommendations.

1.5 Limitations:

Everything has its own limitation. My
report is not beyond that. Though I try my best to present myself in this
report as a laborious one, there is some ambiguity for preparing my report
because of various factors.

Factors include the followings:

a.
Six weeks time is not sufficient to gather knowledge on such a
vast topic.

b.
Unavailability of information as it is confidential for both the
rating agencies and the entity rated.

c.
Credit rating is a newly established criterion in the financial
sector of Bangladesh.

d.
The report is prepared based on mainly two leading credit rating
agencies: Standard & Poor’s and Moody’s Investors Service.

Chapter:
02

Overview
of Credit Rating

In the world of credit, an
organization’s credit rating is of utmost importance. A company’s credit rating
determines how easy it is for the company to issue debt and the rate investors
will demand to earn on that debt. An individual, a firm or a government with a
good credit rating can borrow money from financial institutions more easily and
cheaply than those who have a bad credit rating.

2.1
What is Credit Rating?

A credit rating estimates
the credit worthiness
of an individual, corporation, or
even a country based upon the history of borrowing and repayment, as well as
the availability of assets and extent of liabilities.

In other words, it is an estimate
based on a company or person’s history of borrowing and repayment and/or
available financial resources that is used by creditors to determine the
maximum amount of credit it can extend to the company or person without undue
risk.

A credit rating is an opinion on
the creditworthiness of a debt issue or issuer. The rating does not provide
guidance on other aspects essential for investment decisions, such as market
liquidity or price volatility. As a result, bonds with the same rating may have
very different market prices. Despite this fact, and even though each rating
agency has its own rating methodologies and scales, market participants have
often treated similarly rated securities as generally fungible.

2.1.1
Credit Ratings Are opinions And Not Recommendations:

According to rating agencies, ratings are
opinions and not recommendations to purchase, sell, or hold any security. In
the United States rating agencies assert that they have the same status as
financial journalists and are therefore protected by the constitutional
guarantee of freedom of the press. They contend that this protection precludes
government regulation of the content of a rating opinion or the underlying
methodology.

2.1.2What
Makes up Credit Score?

When a person or
company borrows money, the lender sends information to a credit rating agency
which details, in the form of a credit report, how well the person or the
company handled his/ its debt.
From the information in the credit report, the credit rating agency determines
a credit score based on five major factors:

1)
Previous credit performance,

2)
Current level of indebtedness,

3)
Time credit has been in use,

4)
Types of credit available, and

5)
Pursuit of new credit.

Although all these
factors are included in credit score calculations, they are not given equal
weighting. Here is how the weighting breaks down:

Source: www.investopedia.com/articles

As we can see by the pie graph,
the credit rating is most affected by a person or company’s historical
propensity for paying off his/ its debt. The factor that can boost the credit
rating the most is having a past that shows the person or company pay off his/
its debts fairly quickly. Additionally, maintaining low levels of indebtedness
(or not keeping huge balances on other lines of
credit), having a long credit history, and refraining from
constantly applying for additional credit will help your credit score.

2.1.3
The Purposes of Credit Rating:

Credit ratings are aimed at
reducing information asymmetries by providing information on the rated
security. They can also help solve some principal-agent problems, such as
capping the amount of risk that the agent can take on behalf of the principal.
In addition, ratings can solve collective action problems of dispersed debt
investors by helping them to monitor performance, with downgrades serving as a
signal to take action.

Indeed, a rating from a
recognized rating agency, while not intended to do so, effectively reduces the
burden on investors to research the credit- worthiness of a security or issuer.
Credit ratings are typically among the main tools used by portfolio managers in
their investment decisions and by lenders in their credit decisions. The
reliance on ratings also reflects regulatory requirements in most countries.

2.2
Why credit rating is important?

Credit ratings are
extensively used by investors, regulators and debt issuers. Most corporate
bonds are only issued after evaluation by a major rating agency and in the
majority of cases the rating process is initiated at the issuer’s request.
Ratings can serve to reduce information asymmetry. Issuers willing to dissolve
some of the asymmetric information risk with respect to their creditworthiness
and yet not wishing to disclose private information can use rating agencies as
certifiers. In such a case, ratings are supposed to convey new information to
investors.

The benefits of
credit rating to the issuers, investors, creditors and its values to the
economy and capital market is described below:

Benefits to the Issuers:

§
Credit
Rating of an issue would ensure due compliance with the relevant legal
regulatory provisions of the Securities & Exchange Commission and the
central bank of the country.

§
Credit
rating agency’s opinion would help the issuer company to broaden the market for
their instruments. As ‘name recognition’ is replaced by objective opinions, the
issuer company may access the securities market more comfortably.

§
Credit
rating may help in stabilizing issuers’ access to the market even when the
market price of listed equities is relatively unfavorable in the prevailing
market conditions.

§
Credit
ratings of Entities would confer upon the companies a greater confidence of the
market and enhance a greater access to the financing sources.

Values
to the Investors & Creditors:

§ Credit rating gives market
participants timely access to unbiased, objective, independent, expert,
professional opinion on the quality of securities in a user friendly manner
that may be relied upon for investment decisions

§ Rating opinion would facilitate
the investors to decide their portfolios by choosing investment options in the
market according to their profiles and preferences.

§ Credit rating would affect
significant contribution towards developing the stock market investor
confidence and enhancing the quality and perfection of the securities market,
through provision of credible information for guidance of institutional and
individual investors.

Values
to the Economy & the Capital Market:

§ Credit rating assists the
regulators in promotion and enhancement of the precision of the financial
markets.

§ Assists in qualitative
development of the money and capital markets and enhancement of transparency of
financial information and governance of the corporate sector in Bangladesh.

2.3 History of Credit Rating:

Credit
ratings provide individual and institutional investors with information that
assists them in determining whether issuers of debt obligations and fixed-income securities will be able to
meet their obligations with respect to those securities. Credit rating agencies
provide investors with objective analyses and independent assessments of
companies and countries that issue such securities.

Globalization
in the investment market, coupled with diversification in the types and
quantities of securities issued, presents a challenge to institutional and
individual investors who must analyze risks associated with both foreign and
domestic investments. Historical information and discussion of three companies
will facilitate a greater understanding of the function and evolution of credit
rating agencies.

Henry
Varnum Poor first published the “History of Railroads and Canals in the
United States” in 1860, the forerunner of securities analysis and
reporting to be developed over the next century. Standard Statistics formed in
1906, which published corporate bond, sovereign debt and municipal bond ratings. Standard Statistics
merged with Poor’s Publishing in 1941 to form Standard
and Poor’s Corporation, which was acquired by The McGraw-Hill
Companies, Inc. in 1966. Standard and Poor’s has become best known by indexes
such as the S&P 500, a stock market index that is both a tool for investor
analysis and decision making, and a U.S. economic indicator.

John
Moody and Company first published “Moody’s Manual” in 1900.
The manual published basic statistics and general information about stocks and
bonds of various industries. From 1903 until the stock market crash of 1907, “Moody’s
Manual” was a national publication. In 1909 Moody began publishing
“Moody’s Analyses of Railroad Investments”, which added analytical
information about the value of securities. Expanding this idea led to the 1914
creation of Moody’s Investors Service which, in the
following 10 years, would provide ratings for nearly all of the government bond
markets at the time. By the 1970s Moody’s began rating commercial paper and bank deposits,
becoming the full-scale rating agency that it is today.

Fitch Ratings:

John
Knowles Fitch founded the Fitch Publishing Company
in 1913. Fitch published financial statistics for use in the investment
industry via “The Fitch Stock and Bond Manual” and “The Fitch
Bond Book.” In 1924, Fitch introduced the AAA through D rating system that
has become the basis for ratings throughout the industry. With plans to become
a full-service global rating agency, in the late 1990s Fitch merged with IBCA
of London, subsidiary of Fimalac, S.A., a French holding company. Fitch also
acquired market competitors Thomson BankWatch and Duff & Phelps Credit
Ratings Co. Beginning in 2004, Fitch began to develop operating subsidiaries
specializing in enterprise risk management, data services and finance
industry training with the acquisition of Canadian company, Algorithmics, and
the creation of Fitch Solutions and Fitch Training.

2.4
Credit Rating Industry in Bangladesh:

Although rating agencies started
in 1907 (Moody’s to be precise) in USA, in Bangladesh it is a very recently
developed industry. There are only three credit rating agencies in Bangladesh
namely Credit Rating Agency of Bangladesh Limited (CRAB), Credit Rating
Information and Services Limited (CRISL) and Financial Analysis & Rating
Agency (FARA). In Bangladesh, credit
rating agencies are regulated by Credit Rating Agency Rules – 1996.

Credit Rating Information and
Services Limited (CRISL)
started its operation as a public limited company as the first credit rating
agency in Bangladesh in 2002. It has the goodwill in the market that it is very
stringent in its operations and conservative in assigning Credit Rating.

Credit
Rating Agency of Bangladesh Limited (CRAB) was set up in 2003 by leading
financial/investment institutions and individuals as an independent and professional
full service Credit Rating Agency. ICRA Ltd, India subsidiary of international
Credit Rating Agency Moody’s Investors Service, USA is the technical partner of
CRAB. CRAB is a Public Limited Company.

Financial
Analysis and Rating Agency (FARA) is yet to start its operation. It has got
license to operate as a rating agency very recently.

This
industry is growing very rapidly to those Basel II adopting countries.
Bangladesh has also adopted Basel II and has started to implement it from January 2009.
That is why the market for rating agencies is increasing in line with growth of
the private sector. More and more issuers and borrowers are being forced by
banks to rate them to potentially save capital under the new capital accord.

Because
the industry is growing and only two companies are operating here meaning a low
level of competition, this industry is very profitable in Bangladesh now.

Human
resource being the key resource, this industry does not require intense
investment in fixed asset meaning a strong threat of new entrants being lured
by the profitability of the industry. But regulator has the tendency of not
allowing new firms in this industry fearing this may lead to deterioration in
credit rating quality which is protecting the monopoly of the existing
companies helping them generate an extreme revenue and profitability growth.

Chapter:
03

Classification
of Credit Rating

The existence of various types of
credit rating allows the topic to become very complex, but with a little
assistance it can be easy to understand. The issue of types of credit scores
can be discussed both with a national and international focus. This credit
score or rating allows the consumer to understand their financial capabilities,
as well as, alerts potential lenders of a good or bad risk. When looking at
types of credit rating, one needs to understand a few essentials. Typically,
the lower the credit score, the more derogatory is the standing of that
individual.

3.1
Categories of Credit Rating:

Along with Standard & Poor’s’
and Moody’s Investors Services most of the internationally recognized credit
rating agencies provide rating services in the following market segments:

The various major types of credit
rating are described below in details:

3.1.1 Personal credit ratings:

An individual’s credit score,
along with his or her credit report, affects his or her ability
to borrow money through financial institutions such as banks.

The factors that
may influence a person’s credit rating are:

In different parts
of the world different personal credit rating systems exist.

3.1.2 Corporate Credit Rating:

Corporate
credit rating is a suite of ratings services that are meant to help demonstrate
a corporation’s financial strength to its potential business partners or
investors and to improve access to the global credit market.

Standard
& Poor’s corporate services include:

To form our
ratings opinions, our credit analysts review a broad range of business and financial
attributes that may influence a financial institution’s creditworthiness. Our
business risk profile analysis incorporates such factors as country risk,
environment, company position, business and geographic diversification, and
management strategy. Our financial risk profile analysis incorporates such
factors as risk management, capitalization, earnings, funding and liquidity,
accounting, and governance.

Sovereign and
international Public Finance Ratings globally rates and provides credit
assessments of various debt securities issued by state and local governments,
public authorities, and agencies, and government-owned entities. Standard &
Poor’s rates 123 sovereigns. In the sub-sovereign market Standard & Poor’s
began rating local and regional governments (LRGs) outside the United States in
the late 1980s and has since then expanded its coverage in public finance
sectors such as housing, healthcare, higher education, non-for-profit entities,
government related entities (GRE) as well as provide Financial Management
Assessment (FMA).

Local and Regional
Governments ratings (LRGs): Since the 1980s our presence in the sub-sovereign
market has expanded exponentially, from only a handful of ratings to more then
315 regional and local governments today in 29 countries. In Europe alone,
Standard & Poor’s rates 230 public sector entities. Capital-market issuance
has been one of the key drivers of this growth, although not the only one.
Regions and municipalities use credit ratings for a variety of purposes, such
as to facilitate their public companies access to the capital markets and financial
institutions, improve their own ability to enter into project finance and
structured transactions, obtain favourable financing terms from financial and
commercial counterparties, attract private investment, draw events to their
territory and enhance their external and internal marketing and communications.

Housing,
Healthcare, Higher Education: The growth in LRG ratings has enabled Standard
& Poor’s to consolidate its position as the market leader, and to expand
its coverage in public finance sectors by providing credit ratings and credit
assessments to housing associations, healthcare, higher education, and
non-for-profit entities. Financial Management Assessment (FMA) is an in-depth
interactive assessment of financial management practices, tools, and policies
of a public sector entity. Public sector entities include local and regional
governments (LRGs) and government-related entities/companies (GREs).

Government-related
entities/companies (GREs): GREs are enterprises potentially affected by extraordinary
government intervention during periods of stress. GREs are often partially or
totally controlled by a government and they contribute to implementing policies
or delivering key services to the population. Some entities with little or no
government ownership might also benefit from extraordinary government support
due to their systemic importance or their critical role as providers of crucial
goods and services. Standard & poor’s rates approximately 500 GREs
world-wide.

3.1.6 Public
Finance U.S:

3.1.7 Sovereigns:

In recent years,
there has been growth in new rating mandates from countries and regions that
view ratings as a means to attract foreign direct investment. In turn, this has
highlighted the importance of credit ratings and opinions, as investors seek
independent expertise in new frontiers.

3.1.8
Structured Finance:

Structured Finance
is one of several financial sectors for which Standard & Poor’s provides
its credit ratings services. Slightly different, and more complex than the
ratings it provides for other sectors, analysts who specialize in rating
structured financial instruments closely evaluate, among other things, the
potential risks posed by the instrument’s legal structure and the credit
quality of the assets held by the Special Purpose Entity (SPE). Standard &
Poor’s analysts also consider the anticipated cash flow of the underlying
assets and any credit enhancements that could provide protection against
default.

3.2 Credit Rating Services in
Bangladesh:

In
Bangladesh CRAB and CRISL offer the following Rating Services:

3.2.1
Entity Ratings:

Entity ratings are
a measure of a company’s intrinsic ability and overall capacity for timely
repayment of its financial obligations. They are mandatory ratings required for
any regulatory compliance or voluntary ratings that may be sought by companies
to enhance corporate governance and transparency. These ratings are useful for
benchmarking a company against its peers, enhancing investors’ confidence,
market profiling, reducing time for future debt ratings, enhancing a company’s
standing for counterparty risk purposes and facilitating credit evaluation for
bank borrowings and bank lines.

3.2.2 Financial Institution Ratings:

These ratings will
assess the creditworthiness of financial institutions, i.e. commercial and
merchant banks, non- banking finance companies, housing finance companies etc.
While each of these entities have the same function, i.e. leverage on own funds
and lend to others on a cost plus basis, there are significant differences in
terms of scale of operations, products and services offered, product delivery,
regulatory aspects, and their internal control systems. Ratings of financial
institutions focus on the risks that can possibly affect the operations of a
finance company – operating risks, financial risks and management risks.

3.2.3
Corporate Debt Ratings:

Such ratings specifically
assess the likelihood of timely repayment of principal and payment of interest
over the term to maturity of such debts as per terms of the contract with
specific reference to the instrument being rated. A missed or delayed payment
by an issuer in breach of the agreed terms of the issue is considered as
default. The rating is based on an objective analysis of the information and
clarifications obtained from the issuer, as also other sources considered
reliable.

3.2.4 Equity Ratings (Initial public Offerings and Right Offerings):

Equity rating
makes assessment of the relative inherent quality of equity reflected by the
earnings prospects, risk and financial strength associated with the specific
company. The rating is not intended to predict the future market price of the
stock of a company, but to evaluate the fundamentals of a company, which
ultimately act as important inputs in the price behavior of the stock of such a
company over the medium term and long term. In the short term, the rating helps
in reconciling the market sentiment with respect to the stock of a company to
the long term fundamentals as reflected by the equity grade.

3.2.5 Structured Finance Ratings:

(Included under
this category will be asset backed securitization, mortgage backed
securitization, future flow transactions etc) Structured Finance Ratings are
opinion on the likelihood of the rated structured instrument servicing its debt
obligations in accordance with the terms. An SFR is generally different from
the corporate Credit Rating of the originator and is based on the risk
assessment of the individual components of the structured instrument. These
components include legal risk, credit quality of the underlying asset, and the
various features of the structure.

Insurance Companies
Rating/Claims Paying Ability Rating:

Such ratings
assess the ability of the insurers concerned to honor policy-holder claims and
obligations on time. Rating provides an opinion on the financial strength of
the insurer, from a policy-holder’s perspective which may act as an important
input influencing the consumer’s choice of insurance companies and products.
The rating process involves analysis of business fundamentals, competitive
position, franchise value, management, organizational structure/ownership, and
underwriting and investment strategies. The analysis also includes an
assessment of company’s profitability, liquidity, operational and financial
leverage, capital adequacy, and asset/liability management method.

Mutual Funds Schemes Rating:

Mutual Funds
Schemes rating is designed to provide Investors, Intermediaries and Fund
Sponsors/Asset Management Companies with an independent opinion on the
performance and risks associated with various Mutual Fund Schemes. Funds
ratings incorporate various qualitative and quantitative factors affecting a
fund’s portfolio. Such analyses focus on the resilience to economic changes,
assessing asset quality, portfolio diversification and performance, and
liquidity management.

Such rating
assesses the level to which an organization accepts and follows the codes and
guidelines of corporate governance practices, reflected into the distribution
of rights and responsibilities among different participants in the organization
such as the Board, management, shareholders and other financial stakeholders
and the rules and procedures laid down and followed for making decisions on
corporate affairs.

3.2.9Clientele Rating for Banks/Financial Institutions:

Clientele rating
service has been designed to assist the management of the loan portfolios of
banks/financial institutions by bringing in the present and prospective clients
under continuous evaluation and monitoring of CRAB’s rating unit. Clientele
rating provides banks/financial institutions on a continuous basis with
opinions on the relative credit risks (or default risks) associated with the
existing and/or proposed loans of the clients.

3.2.10 Other Rating Services:

CRAB performs
other rating assignments as requested by clients or required by regulatory
authorities.

Chapter:
04

An
Introduction to Sovereign Credit Rating

In recent years, the demand for
sovereign credit ratings – the risk assessments assigned by the credit rating
agencies to the obligations of central governments— has increased dramatically.
By reducing investor uncertainty about risk exposures, sovereign ratings have
enabled many governments, some with prior histories of debt defaults, to gain
access to international bond markets.

4.1 What
is Sovereign Credit Rating?

Simply a sovereign credit
rating is the credit rating of a sovereign entity, i.e. a national
government. The sovereign credit rating indicates the risk level of the
investing environment of a country and is used by investors looking to invest
abroad. It takes political risk into account.

In a broader sense, sovereign
credit ratings give investors insight into the level of risk associated with
investing in a particular country and also include political risks. At the
request of the country, a credit rating agency will evaluate the country’s
economic and political environment to determine a representative credit rating.

4.2
The Development of Sovereign Ratings Business:

Although the rating agencies’
current practice of assigning overall ratings for sovereign risk began only a
few decades ago, Moody’s has been rating bonds issued by foreign governments
since 1919. International bond markets were very active in the early part of
the twentieth century: by 1929, Moody’s was rating bonds issued by roughly
fifty central governments.

The demand for sovereign ratings,
however, abated with the onset of the Great Depression, and after World War II,
the international bond markets came to a standstill. In the 1970s,
international bond markets revived, but demand for sovereign ratings was slow
to materialize. As recently as ten years ago, only fifteen foreign governments
borrowed in U.S. capital markets and felt the need to obtain credit agency
ratings. Because these governments were almost all pristine credits, their
sovereign risk assessments were quite straightforward and noncontroversial.
Other governments were able to obtain credit through other means. A few financially
strong governments gained access to international capital through the
Euromarkets without ratings. Less creditworthy sovereigns generally obtained
international credit from banks, and a few issued privately placed bonds
without credit ratings.

The sovereign ratings business
took off in the late 1980s and early 1990s when weaker credits found market
conditions sufficiently favorable to issue debt in international credit
markets. These governments increasingly tapped the Yankee bond market, where credit
ratings are a de facto requirement. Consequently, the growth in demand for
rating services has coincided with a trend toward assignment of lower quality
sovereign credit ratings. Before 1985, most initial ratings were AAA/Aaa; in
the 1990s, the median rating assigned has been the lowest possible investment
grade rating, BBB-/Baa3.

With the increase in demand for
ratings, agency sovereign rating activity has returned to pre-Depression
levels. Today Moody’s and Standard and Poor’s each rate about fifty sovereigns.
In the last few years, three additional rating agencies—Duff and Phelps, IBCA,
and Thomson BankWatch—have ventured into the sovereign rating business as well.

The growth of sovereign rating
business is shown in the following table:

Sources: Standard and Poor’s;
Moody’s Investors Service.

4.3 Reasons for Sovereign Credit
Rating:

Like
other credit ratings, sovereign ratings are assessments of the relative
likelihood a borrower will default on its obligations. Governments generally
seek credit ratings in order to ease their access to international capital
markets.

·
Obtaining
a good sovereign credit rating is usually essential for developing
countries in order to access funding in international bond markets.

·
Another
common reason for obtaining sovereign credit ratings, other than issuing bonds
in external debt markets, is to attract foreign direct investment.

·
To give investors
confidence in investing in their country, many countries seek
ratings from credit rating agencies like Standard and Poor’s, Moody’s, and
Fitch to provide financial transparency and demonstrate their credit
standing.

4.4 Determinants of Sovereign
Rating:

The two leading
credit rating agencies, Moody’s and Standard and Poor’s, use large number
variables to determine the ratings for different sovereigns. The major eight
variables appear to be the most relevant to determining a sovereign’s credit
rating:

The above
determinants are described below:

Sovereign ratings are gaining importance as more governments with
greater default risk borrow in international bond markets. But while the
ratings have proved useful to governments seeking market access, the difficulty
of assessing sovereign risk has led to agency disagreements and public
controversy over specific rating assignments. Recognizing this difficulty, the
financial markets have shown some skepticism toward sovereign ratings when
pricing issues.

Chapter: 05

Sovereign Rating Methodologies

Sovereign credit ratings receive
considerable attention in financial markets and the press. Sovereign ratings
effectively summarize and supplement the information contained in macroeconomic
indicators and are therefore strongly correlated with market-determined credit
spreads. Moody’s and Standard and Poor’s each currently rate more than fifty sovereigns.
Although the agencies use different symbols in assessing credit risk, every
Moody’s symbol has its counterpart in Standard and Poor’s rating scale.

5.1
Standard & Poor’s Sovereign Rating Methodologies:

Standard & Poor’s is the
global leader in providing ratings and credit-related services for sovereign,
sovereign-supported entities and supranational issuers. Its public sector
coverage extends to local and regional governments. In recent years, there has
been growth in new rating mandates from countries and regions that view ratings
as a means to attract foreign direct investment. In turn, this has highlighted
the importance of credit ratings and opinions, as investors seek independent
expertise in new frontiers.

To assign
sovereign rating opinions Standard & Poor’s use rating letters from ‘AAA’
to ‘D’ considering following definitions:

In the above table ratings from
‘AA’ to ‘CCC’ may be modified by the addition of a plus (+) or minus (-) sign
to show relative standing within the major rating categories.

5.3
Sovereign Characteristics by Rating Category:

A
sovereign rating reflects Standard & Poor’s opinion on a central
government’s willingness and ability to service commercial financial
obligations on a timely basis. In its sovereign analysis, Standard & Poor’s
looks at trends and vulnerabilities to potential shocks in a wide variety of
political and economic factors, analyzing developments with both quantitative
and qualitative measures. Sovereign profiles by rating category illustrate how
the various components of Standard & Poor’s Ratings Services’ sovereign
ratings criteria are combined to produce ratings.

The
sovereign ratings criteria for the above rating categories are described below:

Sovereigns
assigned Standard & Poor’s highest rating, ‘AAA’, typically have strong
political institutions (including well-established property rights and an
effective judicial framework) and adaptable political systems. Sovereigns rated
‘AAA’ are open to trade and finance, which facilitates competition and
specialization and permits the efficient use of resources. The macroeconomic
stability of these sovereigns precludes the development of destabilizing
imbalances and provides an environment conducive to investment.

Most of the
world’s largest industrialized countries have ‘AAA’ rated sovereigns (the U.S.,
U.K., Federal Republic of Germany, and Republic of France), as do a handful of
smaller countries with specific attributes underlying their strength (e.g., the
Grand Duchy of Luxembourg, the State of The Netherlands, the Kingdom of Norway,
the Republic of Singapore, and the Swiss Confederation).

Characteristics of
‘AAA’ rated sovereigns include:

‘AA’ rated
sovereigns have a very strong capacity to service debt on a timely basis, and
their characteristics are similar to those of ‘AAA’ rated sovereigns, differing
only in degree. Thus, their economies are a little more vulnerable to adverse
external influences, fiscal deficits tend to be more variable, and government
and external debt burdens are generally higher. Among the most challenging
issues are pension reforms and labor market flexibility.

Characteristics of
‘AA’ rated sovereigns include:

For ‘A’ rated
sovereigns, ratings tend to be constrained by vulnerabilities associated with a
sovereign’s stage of development, narrowly based economy, need to restructure,
and/or political situation. This diverse group of countries has, for the most
part, enjoyed fairly rapid economic development and diversification in recent
years; a result of their success in economic liberalization. For many of these
sovereigns, some macroeconomic, fiscal, and external indicators may be as
strong as or even stronger than those of ‘AA’ rated sovereigns. However, their
vulnerabilities keep the ratings below what a solely quantitative approach
would suggest.

Characteristics of
‘A’ rated sovereigns include:

The ‘BBB’ range is
the lowest within what the investment community commonly refers to as the
investment-grade category. In Standard & Poor’s opinion, the cushion
supporting timely debt service is not as large as at higher rating levels.
Political factors play a larger role here than at higher levels, but orthodox market-oriented
economic programs are generally well established. ‘BBB’ rated sovereigns tend
to be the most heavily immersed in economic reform and liberalization (as are
many lower rated sovereigns), and are at an earlier stage in the reform process
than their more highly rated peers. Median per capita GDP is about US$5,000,
far below the ‘A’ median’s US$11,000. Debt may be high, and there is likely to
be greater reliance upon short-term debt and debt indexed to, or denominated
in, a foreign currency than at higher rating levels. Capital markets are less
developed, and the financial sector may be small and/or encumbered by weak
economic performance and supervisory shortcomings.

Characteristics of
‘BBB’ rated sovereigns include:

The ‘BB’ range,
the highest in what is commonly referred to as the speculative-grade category,
reflects significantly more political risk, with political factors possibly
disrupting economic policy. Income is low to moderate, and lack of diversity
and structural impediments may restrain economic growth. As at higher levels,
the central bank pursues sustainable monetary and exchange rate policies, but
market-oriented tools are not well developed. The financial sector is likely to
come under stress when economic growth slows, and capital markets have a short
track record. Debt and debt service are usually high and variable.

Characteristics of
‘BB’ rated sovereigns include:

In the ‘B’ range,
political factors tend to be a source of uncertainty when the economic
environment deteriorates. Orthodox economic policies are usually not well
established. Much of the private sector may be dependent upon government
protection. Financial sectors tend to be weak. Absent capital controls,
nonofficial debt tends to be short term and denominated in or linked to a
foreign currency. The narrowness of the economic base, fiscal imbalances and
shallow debt markets constrain central bank flexibility. Timely debt service is
vulnerable to adverse external influences while income is low to moderate, and
fiscal deficits, inflation, and external debt tend to be high.

Characteristics of
‘B’ rated sovereigns include:

Below the ‘B’
category, at ‘CCC’ or ‘CC’, there is a clear and present danger of default.
Governments may have already missed payments to official bilateral creditors,
with Paris Club rescheduling under way. There is considerable economic, and
perhaps political, turmoil. The currency is weakening, inflation is rising, and
the short-term debt service burden is a huge challenge. At the selective
default (‘SD’) level, there have already been some missed payments or a
coercive exchange offer on debt to commercial banks and/or bondholders.

Characteristics of
‘CCC’ or lower rated sovereign include:

The listed characteristics are a
summary, not any sort of checklist, and sovereigns in any given rating category
may have some traits more commonly found in higher or lower rated sovereigns.

5.4 Moody’s Sovereign Rating Methodologies:

There are two major approaches to
Moody’s sovereign ratings:

1. Local currency vs. foreign
currency

2. Creditworthiness of the
government vs. the risk of sovereign interference

5.4.1 DEFINITIONS:

The
definition of local and foreign currency bond ratings and local currency and
country ceilings are given in the following chart:

5.4.2 WHAT DO GOVERNMENT BOND
RATINGS MEAN?

Moody’s bond ratings are opinions
about creditworthiness. When applied to a given government, they reflect the
credit risk facing an investor who holds debt securities issued by that
government. While Moody’s sovereign bond ratings process takes into
consideration a number of economic, financial, social and political parameters
that may affect a government’s creditworthiness, the outcome – the rating – is
strictly construed as assessing credit risk. Therefore, one cannot directly
infer general assessments about a country’s economic prosperity, dynamism,
competitiveness or governance from Moody’s government bond ratings.

5.4.3 LOCAL CURRENCY AND FOREIGN
CURRENCY BOND RATINGS:

Local
currency bond ratings:

Local currency government bond
ratings reflect Moody’s opinion of the ability and willingness of a government
to raise resources in its own currency to repay its debt to bond holders on a
timely basis. The key question is the extent to which a government is able and
willing to alter – if and when necessary – domestic income distribution in
order to generate enough resources to repay its debt on time.

Two implications can be drawn
from this: assessing default risk first relies on a cost-benefit analysis to
repay the debt, and, second, requires an evaluation of the government’s
resources (solvency risk), as well as its ability to mobilize resources in a
timely fashion (liquidity risk).

To determine whether a government
will punctually face debt payment streams, it is necessary to assess the
possibility and associated costs of:

(1) Raising additional taxes or
cutting spending which both expose the sovereign to the risk of dampening
growth and fueling social discontent.

(2) Liquidating assets, risking
depletion of productive national resources; or

(3) Obtaining monetary financing
from the central bank, with the risk of undermining the monetary authority’s
credibility and fueling inflation.

Foreign
currency bond ratings:

Foreign currency sovereign bond
ratings reflect the capacity of a government to mobilize foreign currency to
repay its debt on a timely basis. There is one important analytical difference
between local and foreign currency government ratings. While local currency
creditworthiness depends exclusively on the government’s capacity and
willingness to raise finance in its own currency to repay its debt, a
government’s default in foreign currency can also be precipitated by strains in
the capacity of a non-sovereign to service its foreign currency debts.

Until the late 1980’s, emerging
market governments were very often the main or exclusive borrowers of foreign
currencies. This created a direct link between a balance of payment crisis –
triggered by a current account deficit difficult to finance – and a
government’s default in foreign currency. This link has weakened with financial
liberalization and the move towards currency convertibility.

In a country in which a high
current account deficit would be associated with a high level of private sector
foreign debt, a confidence crisis – fueling further capital outflows – might
well lead to a currency crisis. A currency crisis would impact the government’s
creditworthiness in two possible ways: the Government’s own foreign currency
denominated debt burden will mechanically increase, and the foreign currency
resources it could mobilize – for instance the foreign exchange reserves – may
have already been depleted. It follows that in the assessment of a government’s
foreign currency credit risk, the strength of the whole country’s external
position must be taken into account.

5.4.4 Foreign and Local Currency
Ceilings:

To capture the risk of
governmental interference in private agents’ creditworthiness – the best
example being the imposition by a government of a moratorium on foreign
currency debt – Moody’s has devised various analytically based rating
practices. These practices, based on historical evidence and economic and
financial analysis, serve either as an absolute constraint (the foreign
currency bank deposit ceiling) or as a sometimes permeable constraint (the
foreign currency country ceiling for bonds and notes) or simply as a prime
reference (the local currency country ceiling) for the determination of
non-sovereign ratings in local or foreign currency.

5.4.5 FOREIGN CURRENCY COUNTRY
CEILINGS FOR BONDS AND NOTES

The “country ceiling”
generally indicates the highest ratings that can be assigned to the
foreign-currency issuer rating of an entity subject to the monetary sovereignty
of that country or area. This is a critical parameter for assigning foreign
currency ratings to securities in a particular country.

It reflects the degree of
interference that sovereign action can impose on the capacity of a
non-sovereign to meet contractual obligations. The lower the ceiling, the
larger the potential gap between a company’s local currency rating – which
reflects its intrinsic economic and financial strength – and its foreign
currency issuer rating. The higher the ceiling, the lower its potential
influence on private sector foreign currency securities’ ratings, with the
extreme case of an Aaa ceiling effectively indicating there is no ceiling.

The nature of Moody’s foreign
currency ceiling has changed over time, reflecting changes in the world economy
and the structure of financial markets. The analytic rationale for the
existence of a ceiling was that all domestic issuers are potentially subject to
foreign currency “transfer” risk – i.e., the inability to convert
local currency into foreign currency in order to meet external payment
obligations in a timely manner. In other words, the ceiling accounts for the
fact that a government confronted by an external payments crisis has the power
to limit foreign currency outflows, including debt payments, of all issuers
domiciled within a country, be they public sector or private sector.

However, the broadening and
deepening of international capital markets since the 1990s and the avoidance of
a generalized moratorium by most governments facing external payments
difficulties in recent years have led us to be more flexible in the application
of country ceilings. Since June 2001, we have looked at each situation
individually to determine if certain securities are eligible to pierce the
country ceiling. The ceiling is now defined by the probability that a
government would resort to a moratorium should it default.

To determine the foreign currency
country ceiling, we therefore multiply the implied default risk associated with
existing foreign-currency government bond ratings by the risk that a moratorium
would be used as a public policy tool for each country.

Note that although issuer ratings
cannot pierce the ceiling, bonds sold under foreign law may be rated higher
than the risk of a general moratorium. The likelihood that an obligation may
pierce the country ceiling depends on two factors: the fundamental credit
strength of the issuer (as indicated by its local currency bond rating), and
the risk of sovereign interference in times of stress. In turn, we can
characterize the risk of sovereign interference as a function of three
parameters:

(1) The government’s probability
of default in foreign currency (i.e. its foreign currency bond rating);

(2) The probability that, confronted
with a crisis, the government will impose a moratorium; and,

(3) The probability that, given a
moratorium, an issuer’s foreign currency debt service may be included in such a
moratorium.

Note that the combination of above (1) and (2)
provides the foreign currency ceiling.

5.4.6 FOREIGN CURRENCY CEILING ON
BANK DEPOSITS

The foreign currency ceiling on
bank deposits specifies the highest rating that can be assigned to
foreign-currency denominated deposit obligations of (1) domestic and foreign
branches of banks headquartered in that domicile (even if subsidiaries of
foreign banks), and (2) domestic branches of foreign banks.

Moody’s maintains foreign
currency bank deposit ceilings that are distinct from foreign currency country
ceilings for bonds and notes. While foreign currency deposit ceilings reflect
the same kind of governmental interference as the Foreign Currency Ceiling for
Bonds and Notes – i.e. foreign currency risk transfer – for emerging market
countries, these two ceilings have been typically placed at different levels on
the rating spectrum. The reason is that our experience since 1998, the year we
saw our first rated foreign currency bond default, shows that when sovereigns
have defaulted on any of their foreign currency obligations, in nearly 40% of
the cases, there was a simultaneous default on foreign currency bank deposits
(three out of eight rated defaults). At the same time, we have two instances
where foreign currency bank deposits have been frozen or where there was a
forced exchange absent a government default. Since slightly less than half the
time FC deposit defaults were cotemporaneous with a government default, and in
some cases, such deposit defaults occurred even without a government default,
it is clear that FC deposit ceilings are either nearly as risky as or perhaps even
riskier than a FC government bond. On the other hand, out of 8 rated government
bond defaults, in only one instance, Argentina, did we see an across-the-board
FC payments moratorium?

Therefore, we can conclude that,
in general, the risk of a payments moratorium on non-sovereign FC bonds is
significantly less than the risk of a government bond default. In addition,
unlike FC bank deposits, we have no examples of a payments moratorium on bonds
absent a government default. In about two-thirds of rated countries, the FC
bank deposit ceiling is at least equal to the FC government bond rating. In
about one-third of the countries, the FC deposit ceiling is one notch lower
than the government bond rating.

This notching practice attempts
to take into account the fact that it is often legally, logistically and
politically easier for governments to impose FC bank deposit restrictions than
it is for those same government to default on their own foreign currency debt.
Although there are numerous exceptions, these factors have been given greater
weight for countries where the government is rated Baa3 or lower, where the
risk of a sovereign credit event is by definition higher. Because, in Moody’s
view, in an external payments crisis, foreign currency bank deposits are the
most likely instruments to be affected by a payments freeze (or
“voluntary” rescheduling or forced exchange) foreign currency
deposits cannot pierce the deposit ceiling.

5.4.7 LOCAL CURRENCY DEPOSIT
CEILING

Moody’s local currency deposit
ceiling is the highest rating that can be assigned to the local currency
deposits of a bank domiciled within the rated jurisdiction. It reflects the
risk that an important bank would be allowed to default upon local currency
deposits either due to limited local currency resources or to the imposition of
a domestic deposit freeze. As such, it reflects:

(1) The degree to which the
authorities’ ability to support an important bank may be limited due to a
monetary regime that does not permit the creation of unlimited quantities of
local currency; and

(2)
The risk of a local currency deposit freeze.

The rationale is that in
countries where the central bank can issue emergency liquidity – i.e. fiat
currency countries– the deposits in local currency at systemically important banks
will be assigned the highest possible rating, which is determined by the local
currency ceiling. Indeed, cases of too important to fail banks that have
defaulted on local currency deposits are exceedingly rare. In countries whose
central bank, for institutional or, more rarely, operational reasons, may not
be able to extend emergency liquidity assistance on time – this is in
particular the case of currency boards – the local currency deposit ceiling
will be placed below the local currency ceiling.

5.4.8 LOCAL CURRENCY CEILINGS

The local currency ceiling
summarizes the general country-level risk (excluding foreign-currency transfer
risk) that should be taken into account in assigning local currency ratings to
locally-domiciled obligors or locally-originated structured transactions. It
indicates the rating level that will generally be assigned to the financially
strongest obligations in the country with the proviso that obligations
benefiting from support mechanisms based outside the country (or area) may on
occasion be rated higher.

As a result, local currency
ceilings are typically high, and sometimes much higher than the government’s
local currency bond rating. For instance, as indicated above, local currency
deposits at a bank deemed too big to fail by monetary and financial authorities
in a country may be less risky than claims on the government itself. The reason
is that if the central bank is not prevented in practice or by statute
(currency board), to offer emergency liquidity, it may well be easier for it to
help a bank honor its obligations in local currency vis-à-vis depositors than
for the government to mobilize the resources it needs to remain current on its
own debt.

In establishing this type of
“country risk ceiling”, both quantifiable and non-quantifiable
criteria are relevant:

(1) Is there a substantial risk
of political regime change that could lead to a general repudiation of debt?

(2) Does the country have a
well-established system of contract law, which allows for successful suits for
collection of unpaid debts, seizure of collateral etc.?

(3) Does the country have a deep
financial system which is effective in making payments and avoiding technical
breakdowns?

(4) Is the regulatory/legal
environment malleable, corrupt, or unpredictable?

(5) Is there a tendency towards
hyperinflation?

In sum, although the agencies’
ratings have a largely predictable component, they also appear to provide the
market with information about non-investment-grade sovereigns that goes beyond
that available in public data. The difficulty in measuring sovereign risk,
especially for below-investment-grade borrowers, is well known. Despite this
difficulty—and perhaps because of it—sovereign credit ratings appear to be
valued by the market in pricing issues.

Chapter:
06

Sovereign
Rating to Bangladesh

Bangladesh is a developing
country which economy is growing at a steady upbeat in spite of its political
unrest, lack of financing and investment capacity. That’s why; to improve the
country image and to attract the foreign direct investment the government
started the process to appoint international credit rating agencies four years
ago to assess the economic performance of the country. Eventually the central
bank had appointed S&P and Moody’s to conduct the rating.

6.1
Rating of Bangladesh by Standard & Poor’s:

The
leading U.S credit rating agency Standard & Poor’s after analyzing the
macro and micro economic conditions of the country has issued it the rating:

‘BB-‘ for long term

‘B’ for short term

It
says the country’s outlook is stable. This year S&P has rated 123
governments. The organization has a total of 17 rating categories ranging from
AAA to CCC+ and Bangladesh was placed in number 13 category.

6.2 Evaluation of Bangladesh by
Standard & Poor’s:

Standard
& Poor’s highlighted that the tax-GDP ratio is less than 10 per cent and
domestic and external debts are relatively high, but the negative factor has
been offset by strong economic growth, robust remittance, support of external
donors and prudent macro-economic policies. Increased investment and revenue
will help the country get better rating in future, but slow tax earning and
reduced external aid flow may hamper the rating prospect.

The S&P said in a press release, “We
believe that Bangladesh’s economy is largely free of macroeconomic imbalances
in spite of its low income level, relatively narrow economic profile, and
significant fiscal constraints.” Policy continuity and generally sound
macroeconomic management have supported relatively strong growth, with per
capita GDP rising at an average of 4.2 per cent annually in the past decade.

The Standard& Poor’s in the
report said resilient garment export sector and a high and rising remittance
flow both play a crucial role in supporting increasingly strong external
liquidity. “These sectors have evolved over the time as two key engines of
economic growth. Garment exports and remittances combined account for about 80
per cent of current account receipts and 25 per cent of GDP,” it said.
Remittances and garment exports continued to expand during the 2008-2009 global
economic recession and it is expected that the trend will continue in the
coming months. “These strengths, combined with significant ongoing donor
support, balance the vulnerabilities posed by the sovereign’s relatively high
public and external debt, significant fiscal constraints, and the low income
levels.

It said Bangladesh’s tax-to-GDP
ratio, at 8.5 per cent, and total revenue to GDP of 11.8 per cent, are very low
due to a combination of low tax compliance, administrative weaknesses, an
agricultural sector that is largely free from taxation and, more broadly, the
prevalence of tax exemptions and holidays.

The international agency said
comprehensive revenue reforms that yield a durable rise in revenue generation
will be needed to reduce the vulnerability of debt service burden and reliance
on external donor support, and to finance higher public investment. Public
investment grew by just 2.9 per cent annually on average in the past decade, compared
with nominal GDP growth of 13.2 per cent annually and hence, economic
performance is increasingly constrained by the lack of adequate infrastructure.

The stable rating outlook
reflects the expectations that a prudent macroeconomic policy-setting will prevail
and microeconomic reforms to gradually address growth constraints will
continue. The ratings could improve if the government implements measures to
expand the low revenue base and improve administrative and collection
efficiency, leading to a material rise in its revenue.

The ratings could also be raised
if rising investment leads to a sustainable increase in
real GDP growth. It, however, said the ratings could be lowered if fiscal
slippages push the trajectory of government debt upward and if external donor
support declines materially.

6.3
Rating of Bangladesh by Moody’s Investors Service:

MOODY’S
Investors Service, announced for the first time its sovereign credit rating for
Bangladesh as Ba3 to foreign and local
currency bond rating just after a week of Standard & Poor’s credit
rating announcement of BB- on April 6, 2010. This is for the first time the
Government of People’s Republic of Bangladesh obtained sovereign credit ratings
from the two internationally reputed credit rating agencies after withstanding
external shocks and political unrest to achieve economic stability.

Moody’s also
assigned Bangladesh:

·
Ba2 to the
country’s foreign currency bond ceiling,

·
B1 to
foreign currency bank deposit ceiling, and

·
Baa3 to long
term local currency bond and deposit ceilings.

6.4 Evaluation of Bangladesh by
Moody’s Investors Service:

In a statement,
the US-based Moody’s said the rating reflected Bangladesh’s reasonable level of
robustness in finance and balance of payments, and the prospects for continued microeconomic
stability. Bangladesh’s relatively robust external position and its strong
foreign currency reserve were reasons behind getting the rating. It added that
these reflect Bangladesh’s recent dynamic apparel exports, large remittance
inflows, minimal foreign commercial borrowing and advantageous external debt
servicing profile.

Aninda Mitra, a vice president
and sovereign analyst for Moody’s said
“The combination of a conservative institutional framework for managing the
economy, supported by capital controls, has ensured better external balance and
price stability than at many other emerging markets at a similar stage of
development,”

Moody’s has assigned Bangladesh
long-term local currency bond and deposit ceilings of Baa3, reflecting the
broader financial, political and legal country risks faced by locally funded or
domiciled credit transactions.

However, Moody’s
found Bangladesh’s relatively high industrial and export dependence on the
ready-made garments sector as a rating constraint, suggesting broader sustained
industrial diversification, supply side and financial sector reforms, and
regional economic integration.

6.5 Rating of Bangladesh in Comparison with Other
Countries:

Although Bangladesh economy
experienced five military coups since its independence in 1971 and recent two
years of military- backed emergency rule, it is growing upward in comparison to
the neighboring SARC countries and some other internationally emerging economic
countries.

Global
Comparison

Country Name

Standard & Poor’s

Moody’s

Bangladesh

BB-

Ba3

Indonesia

Ba2

Thailand

BBB+

Baa1

Vietnam

Ba3

Malaysia

A-

Cambodia

B+

In the global financial arena the
BB- and Ba3 sovereign credit ratings put Bangladesh at a position in the same
category of countries like Vietnam, the Philippines, Indonesia and Turkey. But
Vietnam has negative outlook. It’s a very important that our economy is almost
at par with Indonesia Bangladesh has also
been categorized by Goldman Sachs as one of the Next 11 fast growing emerging
countries after Brazil, Russia, India and China, which are referred to as BRIC
countries.

6.6
Impact of Sovereign Rating on Bangladesh Economy:

The
ratings by Standard & Poor’s and Moody’s reflect the economic parameters of
the country. The ratings will help bring Bangladesh to the attention of
investors.

It is expected that the sovereign
rating by Standard & Poor’s and Moody’s will have following impacts on
Bangladesh economy:

·
Sovereign
credit rating has given Bangladesh much needed access to foreign financial
markets and made it a lucrative destination for foreign investors.

·
The
private sector will now get advantage in getting foreign loans and it will
reduce import and export costs.

·
Importers
will be benefited as letter of credit confirmation and guarantee costs will be
lower as the whole world now knows the economic condition of the country.

·
The
rating provides a strong vote of confidence in the future economic prospect.

·
The
rating would help reduce costs of international trades.

·
The
rating will help the private sector float bonds in the international market.

·
The
cost of country risk for unrated Bangladesh is about two to three per cent and
it is expected that the rate will reduce by 0.5 to 1.0 percentage points.

·
The
rating also enables the government to raise low-cost capital in the overseas
financial markets and further diversify its funding sources.

·
Many
international agencies time to time release different reports on Bangladesh and
it will eliminate any confusion about the country.

In
brief, we can say that now Bangladesh is appearing on the investor radar simply
because of its fundamental appeal. The ratings discussed above prove the
positive sign of Bangladesh as it has positive demographics, rising
consumption, and stable growth.

Chapter:
07

Findings,
Recommendations and Conclusion

7.1
Findings:

Following are some of the
findings of the report regarding Credit Rating focusing the Sovereign Rating to
Bangladesh:

7.2
Recommendations:

To assign the accurate ratings by
the rating agencies following recommendations should be implemented:

And to keep the rating score up
growing Bangladesh government should implement following recommendations:

7.3
Conclusion:

In order to reach a conclude the
report it can be infer that credit rating services are of great importance it
today’s crucial world where every entity is highly concern about their own
interest. Credit Rating Agencies help the investor to have check on the entity
or sovereignty in which he is willing to invest. On the other hand they also
help the entity or sovereignty to attract the investment from both the local
and foreign investors by assigning the rating scores reflecting its
creditworthiness and economic prospects. Bangladesh got the sovereign rating
for the first time from Standard & Poor’s and Moody’s. Despite of political
unrest, lower revenue collection, huge burden of external debt and recent world
economic recession, its economy continued a stable growth. The Standard &
Poor’s and Moody’s assigned the score mentioning positive and stable growth
outlook. This Rating will help Bangladesh to explore new opportunities Such as
Foreign Direct Investment, access to international financial markets and to
accelerate the further economic growth.

Bibliography

Newspapers and Magazines:

·
www.thedailystar.net
: S&P gives good rating to Bangladesh.

·
www.thefinancialexpress-bd.com: S&P
gives Bangladesh ‘BB-‘ long-term rating.

·
www.businessweek.com/news: April 12, 2010, Bangladesh Gets First Sovereign Rating from Moody’s
(Update2).

·
www.bangladesheconomy.wordpress.com : April 12,
2010, Bangladesh gets Moody’s rating, outlook stable.

·
www.gurumia.com:
Bangladesh scores high on sovereign rating.

Website of Credit
Rating Agencies:

·
www.standardandpoors.com

·
www.moodys.com

·
www.crab.com.bd

·
www.crislbd.com