CREDIT CARD & CREDIT RATING AGENCIES

CREDIT CARD&CREDIT RATING AGENCIESBy- Urmimala MukherjeeB.Com LL.B(H)5th SemCREDIT DEFINITIONS CreditTrust given to another person for future payment of a loan, credit card balance, etc.

CreditorA person or company to whom a debt is owed.Card Issuing BankThe financial institution that bills the consumer for repayment and accepts risk for fraudulent activity.

Interest is a fee charged by the creditor, calculated monthly or annually.

Interest ExpensesThe profit the banks make by charging interest. Banks actually receive their money at a lower rates; therefore; making money. As interest rates climb, the less they maketherefore, they increase their rates to youMost credit cards are issued by local banks or credit unions, and are the shape and size specified by the ISO/IEC 7810 standard as ID-1. This is defined as 85.60 53.98mm in sizeCREDIT CARDSIssuing bank logo EMV chip on "smart cards" Hologram Credit card number Card brand logo Expiration Date Card Holder Name contactless chip

Magnetic StripeSignature StripCard Security CodeCREDIT CARD NUMBERINGThe card number's prefix, called the Bank Identification Number, is the sequence of digits at the beginning of the number that determine the bank to which a credit card number belongs.

This is the first six digits for MasterCard and Visa cards.

The next nine digits are the individual account number.

And the final digit is a validity check code.

In addition to the main credit card number, credit cards also carry issue and expiration dates (given to the nearest month), as well as extra codes such as issue numbers and security codes. Not all credit cards have the same sets of extra codes nor do they use the same number of digits.

The concept of using a card for purchases was described in 1887 by Edward Bellamy in his utopian novel Looking Backward. Bellamy used the term credit card eleven times in this novel, although this referred to a card for spending a citizen's dividend rather than borrowing.The modern credit card was the successor of a variety of merchant credit schemes. It was first used in the 1940s, in the United States, specifically to sell fuel to a growing number of automobile owners. In 1938 several companies started to accept each other's cards. Western Union had begun issuing charge cards to its frequent customers in 1921. Some charge cards were printed on paper card stock, but were easily counterfeited.A growing field of numismatics (study of money), or more specifically exonumia (study of money-like objects), credit card collectors seek to collect various embodiments of credit from the now familiar plastic cards to older paper merchant cards, and even metal tokens that were accepted as merchant credit cards. Early credit cards were made of celluloid plastic, then metal and fiber, then paper, and are now mostly polyvinyl chloride (PVC) plastic.

HISTORYTHE FIVE Cs OF CREDIT

C = CapacityC = CapitalC = CollateralC = ConditionsC = CharacterADVANTAGES OF USING CREDIT#1: The use of goods and services as you pay for them.Example: Driving a car as you pay for it

#2: The opportunity to buy costly items that you might not be able to buy with cash.Example: Can you imagine paying cash for a brand new car?

#3: A source of cash for emergency or unexpected expenses.Example: Medical, automotive, etc.

#4: Convenience.Example: Dont have to carry large amounts of cash.BENEFITS TO CUSTOMERSThe main benefit to each customer is convenience.

Compared to debit cards and cheques, a credit card allows small short-term loans to be quickly made to a customer who need not calculate a balance remaining before every transaction, provided the total charges do not exceed the maximum credit line for the card.

Credit cards also provide more fraud protection than debit cards.

In the UK for example, the bank is jointly liable with the merchant for purchases of defective products over 100.BENEFITS TO MERCHANTSFor merchants, a credit card transaction is often more secure than other forms of payment, cash, because they discourage theft by the merchant's employees and reduce the amount of cash on the premises.

For each purchase, the bank charges the merchant a commission (discount fee) for this service and there may be a certain delay before the agreed payment is received by the merchant.

The commission is often a percentage of the transaction amount, plus a fixed fee (interchange rate).

Some small merchants require credit purchases to have a minimum amount to compensate for the transaction costs.

HOW CREDIT CARDS WORKCredit cards are issued after an account has been approved by the credit provider, after which cardholders can use it to make purchases at merchants accepting that card.

When a purchase is made, the credit card user agrees to pay the card issuer.

The cardholder indicates consent to pay by signing a receipt with a record of the card details and indicating the amount to be paid or by entering a personal identification number (PIN).

Also, many merchants now accept verbal authorizations via telephone and electronic authorization using the Internet, known as a 'Card/Cardholder Not Present' (CNP) transaction.

HOW CREDIT CARDS WORK(CONT.)Electronic verification systems allow merchants to verify that the card is valid and the credit card customer has sufficient credit to cover the purchase in a few seconds, allowing the verification to happen at time of purchase.

The verification is performed using a credit card payment terminal or Point of Sale (POS) system with a communications link to the merchant's acquiring bank. Data from the card is obtained from a magnetic stripe or chip on the card.

Other variations of verification systems are used by eCommerce merchants to determine if the user's account is valid and able to accept the charge.

These will typically involve the cardholder providing additional information, such as the security code printed on the back of the card, or the address of the cardholder.HOW CREDIT CARDS WORK (CONT.)Each month, the credit card user is sent a statement indicating the purchases undertaken with the card, any outstanding fees, and the total amount owed.

After receiving the statement, the cardholder may dispute any charges that he or she thinks are incorrect.

Otherwise, the cardholder must pay a defined minimum proportion of the bill by a due date, or may choose to pay a higher amount up to the entire amount owed.

The credit issuer charges interest on the amount owed if the balance is not paid in full (typically at a much higher rate than most other forms of debt).

1. Account Number2. New Balance3. Due Date4. Minimum Payment5. Transactions6. Account Summary7. Finance Charges8. Percentage Rate

1.2.3.4.5.6.7.8.16INTEREST CHARGESCredit card issuers usually waive(not-claim) interest charges if the balance is paid in full each month, but typically will charge full interest on the entire outstanding balance from the date of each purchase if the total balance is not paid.

For example, if a user had a $1,000 transaction and repaid it in full within this grace period, there would be no interest charged.

If, however, even $1.00 of the total amount remained unpaid, interest would be charged on the $1,000 from the date of purchase until the payment is received.

The general calculation formula most financial institutions use to determine the amount of interest to be charged is APR/100 x ADB/365 x number of days revolved. Take the Annual percentage rate (APR) and divide by 100 then multiply to the amount of the average daily balance (ADB) divided by 365 and then take this total and multiply by the total number of days the amount revolved before payment was made on the account.INTEREST CHARGES (CONT.)Interest rates can vary considerably from card to card,

and the interest rate on a particular card may jump dramatically if the card user is late with a payment on that card

or any other credit instrument,

or even if the issuing bank decides to raise its revenue.IMPROVING YOUR CREDIT SCOREPay bills on time.Get current and stay current.Dont open a lot of new accounts too rapidly.Correct mistakes.Shop for loan rates within a focused period of time.Keep balances low on revolving credit.Pay off debt.Check your credit report.19GRACE PERIODA credit card's grace period is the time the customer has to pay the balance before interest is assessed on the outstanding balance. Grace periods vary, but usually range from 20 to 50 days depending on the type of credit card and the issuing bank. Usually, if a customer is late paying the balance, finance charges will be calculated and the grace period does not apply. Finance charges incurred depend on the grace period and balance; with most credit cards there is no grace period if there is any outstanding balance from the previous billing cycle or statement (i.e. interest is applied on both the previous balance and new transactions). However, there are some credit cards that will only apply finance charge on the previous or old balance, excluding new transactions.PARTIES INVOLVEDCardholder: The holder of the card used to make a purchase; the consumer. Card-issuing bank: The financial institution or other organization that issued the credit card to the cardholder. This bank bills the consumer for repayment and bears the risk that the card is used fraudulently. Merchant: The individual or business accepting credit card payments for products or services sold to the cardholder. Acquiring bank: The financial institution accepting payment for the products or services on behalf of the merchant. Independent sales organization: Resellers (to merchants) of the services of the acquiring bank. Merchant account: This could refer to the acquiring bank or the independent sales organization, but in general is the organization that the merchant deals with. Credit Card association: An association of card-issuing banks such as Visa, MasterCard, Discover, American Express, etc. that set transaction terms for merchants, card-issuing banks, and acquiring banks. Transaction network: The system that implements the mechanics of the electronic transactions. May be operated by an independent company, and one company may operate multiple networks.

TRANSACTION STEPSAuthorization: The cardholder pays for the purchase and the merchant submits the transaction to the acquirer (acquiring bank). The acquirer verifies the credit card number, the transaction type and the amount with the issuer (Card-issuing bank) and reserves that amount of the cardholder's credit limit for the merchant. An authorization will generate an approval code, which the merchant stores with the transaction. Batching: Authorized transactions are stored in "batches", which are sent to the acquirer. Batches are typically submitted once per day at the end of the business day. If a transaction is not submitted in the batch, the authorization will stay valid for a period determined by the issuer, after which the held amount will be returned back to the cardholder's available credit. Clearing and Settlement: The acquirer sends the batch transactions through the credit card association, which debits the issuers for payment and credits the acquirer.Essentially, the issuer pays the acquirer for the transaction.

TRANSACTION STEPS (CONT.)Funding: Once the acquirer has been paid, the acquirer pays the merchant. The merchant receives the amount totaling the funds in the batch minus either the "discount rate," "mid-qualified rate", or "non-qualified rate" which are tiers of fees the merchant pays the acquirer for processing the transactions. Charge backs: A chargeback is an event in which money in a merchant account is held due to a dispute relating to the transaction.Charge backs are typically initiated by the cardholder. In the event of a chargeback, the issuer returns the transaction to the acquirer for resolution.The acquirer then forwards the chargeback to the merchant, who must either accept the chargeback or contest it. A merchant is responsible for the chargeback only if he/she has violated the card acceptance procedures as per the merchant agreement with card acquirers.

REWARDSMany credit card customers receive rewards, such as frequent flyer points, gift certificates, or cash back as an incentive to use the card.

Rewards are generally tied to purchasing an item or service on the card, which may or may not include balance transfers, cash advances, or other special uses.

Depending on the type of card, rewards will generally cost the issuer between 0.25% and 2.0% of the spread.

Networks such as Visa or MasterCard have increased their fees to allow issuers to fund their rewards system.

Some issuers discourage redemption by forcing the cardholder to call customer service for rewards. FEES CHARGED TO CUSTOMERSLate payments or overdue payments Charges that result in exceeding the credit limit on the card (whether done deliberately or by mistake), called over limit fees Returned cheque, fees or payment processing fees (eg phone payment fee) Cash advances and convenience cheques (often 3% of the amount)Transactions in a foreign currency (as much as 3% of the amount). A few financial institutions do not charge a fee for this. Membership fees (annual or monthly), sometimes a percentage of the credit limit. Exchange rate loading fees (these may sometimes not be reported on the customer's statement, even when they are applied)

TYPES OF CONSUMER CREDITSales Credit: when you buy goods and services with a credit card or a charge account.Example: Charge Accounts or Credit Cards

Cash Credit: when you borrow money.Example: Loans

TYPES OF CREDIT CARDSTravel and Entertainment Cards: you must pay entire bill each month except for travel-related expenses.No credit limit, minimum monthly payments at 18% APR on travel-related expensesExample: American Express

Company or Retail Store Cards: permit you to charge purchases only with the merchant issuing the card.Credit limit, minimum monthly payments, APR variesExample: Macys Card

General Purpose Cards: issued by banks and can be used at many places around the world.Credit limit, minimum monthly payments, APR/fees varyExamples: Visa and MasterCard

TYPES OF CARDS IN INDIAPremium Credit Cards Cash Back Credit Cards Gold Credit Cards Airline Credit Cards Silver Credit Cards Business Credit Cards Balance Transfer Credit Cards Co-branded Credit Cards Low Interest Credit Cards Lifetime Free Credit Cards Rewards There are some additional credit cards that are available in India as well. Rewards credit cards available in India can be subdivided into six categories Points, Hotels and Travels, Retail, Auto and Fuel.

DISADVANTAGES OF USING CREDIT#1: The reduction of future income.Example: Spending future income now and living beyond your income

#2: Expense.Example: Using credit usually costs money.

#3: Temptation.Example: Easy to spend money you dont/wont have.

#4: The risk of serious consequences if you misuse credit.Example: Failure to pay debts on time, bankruptcy, repossession, damaged credit scoreWHAT IS A CREDIT RATING?A credit rating is an opinion on the relative degree of risk associated with timely payment of interest and principal on a debt instrument. A simple alphanumeric symbol is normally used to convey a credit rating. Credit ratings are calculated from financial history and current assets and liabilities. Typically, a credit rating tells a lender or investor the probability of the subject being able to meet payment requirements for interest and principal repayment.

30Depend on rating agency. Ex.- (S&P)AAAExtremely strong capacity to meet financial commitments. Highest Rating.AAVery strong capacity to meet financial commitments.AStrong capacity to meet financial commitments, but somewhat susceptible to adverse economic conditions and changes in circumstances.

BBBAdequate 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.BBLess vulnerable in the near-term but faces major ongoing uncertainties to adverse business, financial and economic conditions.BMore vulnerable to adverse business, financial and economic conditions but currently has the capacity to meet financial commitments.CCCCurrently vulnerable and dependent on favorable business, financial and economic conditions to meet financial commitments.CCCurrently highly vulnerable.CCurrently highly vulnerable obligations and other defined circumstances.

DPayment default on financial commitmentRATING SYMBOL OR SCOREIt is a company that is responsible for assessing the financial strength of a company or government entity.This includes domestic and foreign companies.The main area that a credit rating agency focuses on is the ability of the company or government entity to meet the interest and principle payments on their debts and bonds.A credit rating agency is different from a credit reporting agency. A credit reporting agency is responsible for compiling financial data that is necessary for loan decisions. A credit rating agency does all the statistical assessments that are involved in placing a rating on a company or organizations credit history..A credit rating agency is responsible for providing investors with information about an organizations creditworthiness.

CREDIT RATING AGENCY (CRA) FUNCTIONS OF A CREDIT RATING AGENCYProvide easy to understand information: Rating agencies gather information, then analyze information to interpret and summarize complex information in a simple and readily understood manner.

Provide basis for investment: An investment rated by a credit rating enjoys higher confidence from investors. Investors can make an estimate of the risk and return associated with a particular rated issue while investing money in them.

Healthy discipline on corporate borrowers: Higher credit rating to any credit investment makes the financial instrument (bond, mortgage security) more attractive to investors. Corporations can borrow money more cheaply if they maintain high credit ratings on their debt.

Formation of public policy: Once the debt securities are rated professionally, it would be easier to formulate public policy guidelines as to the eligibility of securities to be included in different kinds of institutional portfolios.

FUNCTIONS OF CREDIT RATING AGENCIES They provide training to the employees and executives of the companies for better management.They examine the risk involved in a new project, chalk out plans to fight with the problem successfully and thus ameliorate the percentage of risk to a great extent.They offer services to the mutual fund sector through the application of fund utilization servicesThe major industries currently graded by the credit rating agencies include agriculture, health care industry, infrastructure, and maritime industry. ADVANTAGES OF CREDIT RATINGBenefits to InvestorsSafety of investments.Recognition of risk and returns. Freedom of investment decisions. Wider choice of investmentsDependable credibility of issuerEasy understanding of investment proposalsBenefits the Company Easier to raise fundingReduced cost of borrowingReduce cost of public issuesRatings can build up imageRatings facilitates growthRecognition to unknown companiesBenefits to IntermediariesFor brokers ratings make it easier to persuade clients to select an investment proposal of investment in highly rated instruments. 35DISADVANTAGES OF CREDIT RATINGNon-disclosure of significant informationStatic study Rating is no certificate of soundness Rating may be biasedRating under unfavorable conditionsDifference in rating gradesImproper Disclosure May HappenImpact of Changing EnvironmentProblems for New Companies Downgrading by Rating Agency

36CREDIT RATING AGENCIES IN INDIACRISIL (Credit rating information services of india limited )ICRA (Investment information and credit rating agency of india)CARE (credit analysis and research limited)Fitch rating india pvt. Ltd. (earlier Duff&phelps credit rating india pvt. Ltd.)ONICRA credit rating agency of india ltd.SEBI-Regulator The capital market regulator regulates rating agencies in most regions. In India, the capital markets regulator, the Securities and Exchange Board of India (SEBI), regulates the rating agencies in the country. SEBI laid down an extensive set of regulations for rating agencies in 1999.38CRISILThe first credit agency setup on January 1, 1988, jointly started by ICICI and UTI with an equity capital of Rs. 4 crores, as public Ltd company. CRISIL is India's leading rating agency, and is the fourth largest in the world.With over a 60% share of the Indian Ratings market, CRISIL Ratings is the agency of choice for issuers and investors. CRISIL inspires trust and confidence the world over. It redefines industry standards constantly, and sets new benchmarks year after year. At the core of CRISIL's credibility, built up assiduously over the years, are its values: Integrity, Commitment, Innovation, Independence, and Analytical Rigour. CRISIL's majority shareholder, Standard and Poor's, is the world's foremost provider of independent credit ratings, indices, risk evaluation, investment research and data.

CRISIL Ratings isIndia's largest ratingagency, having rated more than 24,541 debt instruments, of more than USD 655 billion (Rs.30,71,459 cr.), issued by over 7938 companies.CRISIL hasstrong 60%penetration in the domestic bond market and a 53% market share inthe bank loan rating segment. CRISIL Ratings rates virtually every kind of organization, including industrial companies, banks ,SMEs, non-banking financial institutions, insurance providers, mutual funds, infrastructure entities, state governments, and urban local bodies. Italso rates securitized paper.

CRISIL (CONT.)CRISIL (Core businesses)RatingGlobal off shoring -irevnaResearch Capital marketsInfrastructure AdvisoryCrisil risk solutionsRATING PROCESS

42ICRAICRA Limited (formerly Investment Information and Credit Rating Agency of India Limited) was set up in 1991 by leading financial/investment institutions, commercial banks and financial services companies as an independent and professional Investment Information and Credit Rating Agency.ICRA was set up by IFCI on 16th January 1991. It is a public limited company with an authorized share capital of Rs.10 crores, Rs. 5 crores is paid up. Today, ICRA and its subsidiaries together form the ICRA Group of Companies (Group ICRA). ICRA is a Public Limited Company, with its shares listed on the Bombay Stock Exchange and the National Stock Exchange.

ICRAs major shareholders IFCI (26%), and the balance by UTI, LIC, GIC, PNB, Central Bank of India, Bank of Baroda, UCO Bank and banks (SBI) . Alliance with Moodys Investors Service(The international Credit Rating Agency Moodys Investors Service is ICRAs largest shareholder. The participation of Moodys is supported by a Technical Services Agreement, which entails Moodys providing certain high-value technical services to ICRA. )

ICRA (CONT.)RANGE OF SERVICESRating ServicesGrading ServicesConsulting ServicesRATING METHODOLOGYConsists of four areas : - Business analysis- covers an analysis of industry risk,market position in the country,operating efficiencyo f the company & legal position. Financial analysis - analysis of accounting quality, earnings protection, cashflow adequacy &financial flexibility. Management evaluation - studyof track recordof the managements capacity to overcome adverse situations, goals,philosophy & strategies. Fundamental analysis analysis of liquidity management, asset quality, profitability & interest & tax sensitivity.

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