What is credit rating and what does it indicates?

An assessment of the creditworthiness of individuals or corporations i.e. how trustworthy an individual or a company to receive a loan from the creditors. If we look into with investor’s perspective how safe the investment made in any companies debt instrument, It is based upon the history of borrowing and repayment as well as the availability of assets and extent of liabilities.

Credit rating is an assessment of the probability of default on the payment of interest and principal on a debt instrument. It is not a recommendation to buy, sell or hold a debt instrument. Rating only provides additional input to the investor and the investor is required to make his own independent and objective analysis before arriving at an investment decision.

Credit Rating Agency (CRA):

  • A credit rating agency (CRA) is a company that assigns credit ratings for issuers of certain types of debt obligations as well as the debt instruments themselves.
  • Rating facilitates investors to factor credit risk in their investment decision.
  • The company ranks the creditworthiness of borrowers using a standardized rating scale that measures expected investor loss in the event of default.

How does credit rating help?

  • To strengthen capital markets through greater transparency for investors
  • To educate market participants on complexity levels of instruments, by leading more investors to invest in instruments that are appropriate for them
  • The third-party analysis is particularly useful for smaller and less sophisticated investors, as well as for all investors to use as an external comparison for their own judgment.

How it works:

Issuer and CRA are the main two players involved in this procedure, When any company wants to issue any bonds or securities into the market, they tend to rate this debt instrument by any credit rating agency to improve the goodwill of their product. This intern also helps it attract more customers. Higher the rating of the debt lower is the risk associated with that debt and vice-versa.

The intended buyer of the debt instrument often looks at the credit rating of the debt scheme before investing their funds so that they can have a fair idea about the risk associated with their investments.

An agreement happens between the issuer and CRA, later the issuer company provides the information required for the CRA to rate the securities. CRA performs the analysis of the issuer companies instrument which is going to introduce into the market or its an existing one.

Domestic Credit Rating Agencies.

  • CRISIL (Credit rating information services India ltd)
  • ICRA (Investment information and credit rating agency)
  • Nomura capital (India) Pvt. Ltd.
  • CARE
  • Brickworks Rating
  • SME Rating Agency of India Ltd.

The below listed are worldwide popularly known as Big Three entities in the CRA industry.

Big Three:

  • S&P
  • MOODY’s
  • Fitch group

Rating Scale:

Many different CRA’s adopted notations as per the guidelines provided by the regulator SEBI and RBI for the banking sector, with respect to different securities and debt instruments.  In India popularly rating is denoted with AAA, AA, A, Baa, Ba, A1, etc…

Source: https://www.rbi.org.in/Scripts/BS_ViewMasCirculardetails.aspx?id=9893

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Manjunath CB

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