WHAT IS CREDIT RATING?

A credit rating is a measure of an individual or a company’s ability to repay a financial obligation based on income and past repayment history. Banks and lenders usually express creditworthiness as one of the factors in deciding whether to grant a loan. A poor credit rating can represent an inability to pay off debts and limit your funding options. The most common aspects that affect your credit score are your credit history, past payment history, and your credit utilization. The three credit bureaus take this information and create your credit profile, which decides your overall credit rating and score. Credit ratings ascertain not only whether a borrower will be eligible for a loan or debt issue, but also the interest rate at which the loan must be paid back. Credit ratings are only concerned with corporates and governments. Credit score, on the other hand, applies only to individuals. Credit scores are obtained from the credit history sustained by credit-reporting agencies such as Equifax, Experian, and TransUnion. An individual’s credit score is reported as a number

FUNCTIONS OF CREDIT RATING

1. Superior information

Credit rating provides superior information on credit risks for two main reasons,. Firstly, it is an independent rating agency, unlike brokers, financial intermediators, who have rested interest in an issue, is likely to prove a biased opinions. The rating firm may have access to information that may not be publicly available.

2. Business Analysis

Credit rating agencies employ highly qualified, trained and experienced staff to assess risks and they have access to vital and important information and therefore can provide accurate information about creditworthiness of borrowing company.

3. Market position

Credit rating agencies gather information, analyze and interpret it. This helps in understanding the market shares of various products of the company, whether it will be stable, or does the company possess competitive advantage due to distribution network, customer base research and development facilities etc.

4. Legal insurance

Credit rating provides legal insurance to the investment trustees. They can guard themselves against any charge of mismanagement of funds by carefully selecting highly rated securities for investment.

5. Evaluation of industrial risks

Every industry will have its risks which are due to natural or market conditions such as competition or due to the substitutes that have arrives in the market. The extent of risks and measures to overcome them will be taken into account while judging the credit rating of the company.

BENEFITS OF CREDIT RATING

For Companies

1. A company with highly rated instrument has the opportunity to lower the cost borrowings. Investors with low-risk preference would come forward to invest in safe securities and lower rate of return.
2. High credit rated companies channelize the savings of the people into productive investments and develop saving habits among individual.
3. Ratings provides motivation to the company for growth and are encouraged to undertake expansion of their new projects.
4. Credit rating provides recognition to a relatively to unknown issuer while entering into the market through wider investor base who rely on rating grades.

For Investor’s

1. Credit rating gives assurance to the investors against any bankruptcy and provide safety of their investments.
2. Credit rating provide investors with rating symbols which carry information in easily recognizable manner. It becomes easier for the investors to understand the worth of the issuer company.
3. The quality of credit rating done by professional experts of the credit rating agency reposes confidence in him to rely upon the rating for taking investment decisions.
4. Investors have wide choice of investment according to the risk profile and diversification plan and it also provide an unbiased guidance to the investors in making a wise choice of investments.

For Intermediaries

1. Credit rating lends to the financial competence and strength of the company. Through highly rated securities, the corporate borrowers can quote lesser rate of interest on fixed deposits or bonds and risk invaders come forward to invest their money safely in low-risk securities.
2. The ratings are so designed that companies with the clear indication about the credit worthiness of the instrument. Credit rating act as a marketing tool in creating a wise market for the products.
3. Credit rating represents the capability and willingness of an issuer. In order to fulfill their commitments towards the investors, the rated companies strive to improve their financial performance.

ROLE OF CREDIT RATING

1. Credit rating industry is dominated by three big agencies which control 95% of rating business. These three agencies are Moody’s Investor Services, Standards and Poor and Fitch Group. Moody’s Investor Services, Standards and Poor are located in United States of America and dominate international market by 80%. Fitch group is located in United States of America and London and controls market by 15%.
2. These agencies came under heavy criticism after global financial market and they were also failed to identify risky securities that leads to collapse of market. Instead of relying on the three big agencies eurozone countries have encouraged financial firms and big companies to do credit assessment.
3. Rating agencies assess the credit risk of specific debt securities and borrowings. A rating agency provides an independent evaluation of creditworthiness issued by the government or corporations.
4. Rating agencies focus on the type of underlying securities and capital structure to rate structured financial product. They not only rate them but also advise them on how to structure tranches.
5. Rating also gives ratings to sovereign borrowers in most financial markets. Sovereign borrowers include national governments, state governments, municipalities and other supported institutions. It shows sovereign’s ability to repay its debts.

Conclusion

After going through its functions, benefits and role, we must have now got an idea how important credit rating and its agencies are to an individual or a company who is looking forward to invest or grant a loan. However, while rating decisions are ostensibly based on fixed, documented standards, agencies themselves admit that their evaluations are essentially opinions and cannot be verified in courts. That does conclude that an investor or a bank should not blindly believe on these ratings. A wrong loan granted or a wrong investment done can shatter the company or the bank financially. Thus, a middle ground should be found to avoid these cataclysms.

The article was submitted by Rubal Rapta, Ayush Thakur and Divya Dyuti Mishra.