Special Report: How Doing What Is Right Helped Build the Indian Financial System by William Ortel.
This section will trace the construction of an institution that likely helped set the stage for that development by helping Indian companies access credit, and the significant role that anaylytical rigor and ethics had in that institution’s success.
The second part of this interview resonated unusually deeply with me, as I hope it will with you. It is a tangible example of how innovation in finance can make life better for a complex, developing country. Read on, and be sure to subscribe to Inside Investing.
Let’s talk a little bit about CRISIL, because first of all, I have to say you must be very proud to have a book written about a thing that you built with the subtitle, “Doing What is Right.” I would guess that that’s something of a point of pride.
Yes, indeed. I suggested the idea at first in 1986. In 1981 I came back from Harvard, and then I realized that there was a need for something like this.
My then Chairman, who I helped set up another retail housing finance company, which was also the first retail housing finance company in the country, and which is a household name, Housing Development Finance Corporation.
I was working there, and my Chairman wouldn’t let me go. It took me about a year-and-a-half to get his permission. I was given leave of absence, just as I was given leave of absence from ICICI to start HDFC. I was then given leave of absence from HDFC to start CRISIL, and I was supposed to go back to my parent organization.
At that time, interest rates were not differentiated under risk. They were administered. It was like a binary, if somebody was found creditworthy, they got money at a particular rate, and there was no differentiation amongst different borrowers, and their capability to pay back.
A lot of people were not given any money at all, because they were just seen to be black, as we call it, not white or whatever. They were not good. A white was good. There were no shades of gray in between, we realized that they would need to start differentiating on the base of credit risk. There was a need to educate the regulators to free up the administrative mechanism.
People didn’t understand the concept of yield to maturity. Would you believe that, in bonds? Forget yield to call, yield to put, because those call and put bells and whistles didn’t really come out in debentures, but they just took the funds at the rate, because it enabled administered interest rates so there was not seen to be volatility in the interest rate environment.
We had to educate not only the regulators, but issuers of debt, investors in debt. A large number of people, and again, don’t forget we have illiterate people who still have savings.
We have low-educated people who still have savings who want some guidance. We have, of course, the sophisticated intermediaries, and investors. They all needed guidance, and our thought was to create awareness of the concept of credit rating amongst a diverse set of people, and four basic constituents, issuers, investors, intermediaries, and regulators, and address different needs.
One of the most heartening things that I found, we developed a strategy. We had very small capital. We started with 14 million of capital at today’s rate of exchange is would be about $700,000 of capital, and we had to survive…it was a commercial venture! We had no ability to educate through advertising and promotion. I would take every opportunity to address gatherings.
I must have addressed several 100 gatherings in the first two years of the chamber of commerce or institute of chartered accountants, or gathering of business people or whatever, Rotary Clubs, whichever, because it was a new concept. We took the opportunity to be interviewed in the press, because it was a new concept.
Something clicked in the press, and we articulated it well. It got the attention of people, and we took advantage of that to create awareness, and spread the concept widely.
Our strategy was to get strong companies, which were perceived to be strong companies, to begin using the ratings. We figured that they would start spreading the word, that they were the highest of high quality and so on. That was exactly what we did.
We got high companies, or high quality companies come in the first three months. We started spreading the word by advertising. At least we got a flood of enquiries, “What does this mean? How does it work? We also think we are very strong, why don’t we get the same rating?” And so on.
We developed a methodology, which was different from Moody’s and Standard and Poor’s in one or two key respects. The one key respect that essentially was required, was that we decided that we would not work only for investors. We would work for issuers, as well as investors. As well as I told you, the regulator and intermediaries.
Our philosophy was not one against the other; our philosophy was to help make market function better, as you put it. What we said was that, if a company comes to us, an issuer of debt comes to us, wants a rating, and then doesn’t like the rating….They will be free not to use it, we won’t spread the word. We would bury that rating quietly.
In that case, we would give them our analytical feedback, as to what the rating was, and why it was so. For instance, if the operating leverage was too low, the financial leverage was too high, or they didn’t have succession plans, or the poor governance was contrary to what we thought it would be.
For instance, just as an example, there was a company which was selling trucks. Then an associate company which was in the business financing, trucks which these guys made. The board of that associate company was controlled essentially by the truck manufacturer.
We immediately found out that, there was a lack of proper governance. That the board was naturally biased towards supporting this truck manufacturer, as a sales tool for the parent, rather than operating for the good of the shareholders of the finance company.
There were conflicts: In some cases, prudence would indicate not financing somebody for whatever reason. This would mean depriving their parent, or affiliate company, (the truck manufacturer) or business. So be it.
We pointed these kinds of things, and people loved it. No one had talked to them as frankly, as honestly. Never