What is Credit Rating :
A credit rating is a formal evaluation of a company’s financial health and ability to repay debt obligations and the likelihood of the borrower to default on a loan.
Need for Credit Rating :
Cash flows from Foreign Institutional Investors (FII) are overwhelming the Indian capital markets and can dictate to a large extent the future direction of the stock markets. The growth and globalisation of Indian Capital markets have led to an exponential surge in demand for professional credit risk analysis.
Investors need to deploy funds quickly, to take advantage of fleeting opportunities. Most of the times, they must decide in a few minutes (or even seconds) whether to invest in a particular instrument or not. Also, all investors don’t have the time and expertise to study and form a well-informed opinion on all available investment instruments. So, they need brief up-to-date, authentic and value-added information in a user-friendly format that tells them all they need to know to make an informed decision.
Independent agencies have come into operation to fill in these need gaps. They provide ‘rating’ of equity debt, Fixed Deposit (FD), Certificate of Deposit (CD) and other instruments already issued or planned to be issued by corporates.
Credit Rating Agencies
Credit Rating Agencies (or CRAs) provide credit information to creditors, such as banks and businesses, to help them decide whether to issue a loan or extend credit.
There are several firms that investigate, analyse and maintain records on the credit status of individuals and businesses—for example, Equifax for individuals (in the UK), and Dun & Bradstreet for commercial firms. Standard & Poor’s and Moody’s assign ratings to bonds.
Borrowers are rated by CRAs according to the borrower’s creditworthiness or risk profile. It is based on the borrower’s current financial situation as well as past performance in debt repayment, foreclosures, insolvencies and write-offs. Any defaults and history of slow or delinquent payments get a low rating for the issuer.
Credit ratings are expressed as letter grades such as A-, B, or C+. The assessment is made on a particular issuer’s creditworthiness. Ratings range from triple A (very highly rated) to D (already in default).
There is no exact science to rating a borrower’s credit, and different lenders may assign different grades to the same borrower. Such independent, professional and impartial opinions help issuers, including lesser-known companies, access a broader investor base. The corporates also benefit because investors are more inclined to invest in rated instruments than in non-rated instruments. It increases the marketability of their issues. They can raise funds more easily and faster.