December 6, 2024 · 11 mins read
Santosh Kumar
Credit rating is a method by which lenders assess the creditworthiness of applicants. It includes a score along with a report that banks, financial institutions, and investors easily understand. The main aim of a credit report is to determine the risk of default associated with an instrument. It describes a person or a corporation's financial assets represented by alphanumeric symbols.
It should be noted that a credit rating is merely a reflection of the applicant's ability to repay the loan. It does not guarantee repayment per se. The report contains the borrower's financial history and current assets and debts,
The guidelines are created by various agencies in India, and there are several benefits to credit rating agencies. Their guidelines help inventors make prudent investment decisions. A higher credit rating indicates lower risk, meaning the instrument is a good investment. On the other hand, instruments with a higher level of risk carry low credit ratings.
Investors mainly use these ratings to help them find a risk-reward ratio. Higher-risk instruments offer greater returns than low-risk instruments.
In this article, we will analyse what credit rating agencies are, how credit ratings work, and the benefits of credit rating agencies in India.
A credit score is a 3 digital number representing the borrower's creditworthiness. Credit rating agencies analyse the risks associated with a financial instrument when it is offered to a business or an investor. The lender factors in the credit score to decide whether the borrower can repay the loan and should be granted the instrument.
The creditworthiness of the borrower is determined by their past transactions, both borrowing and lending. The statement of liability is matched with the statement of assets to determine whether they can meet financial obligations. Individuals and businesses must maintain a good credit rating to get a loan in the future.
The credit score is calculated by several weighing factors, which are:
1. Payment History: 35%
2. Credit Utilisation: 30%
3. Credit History Duration: 15%
4. Credit Mix: 10%
5. New Credit: 10%
Thus, you can maintain a healthy credit score if you have paid your debts on time and have a low credit utilisation ratio with a healthy credit mix. Remember to check your credit report regularly and keep the utilisation ratio below 30%.
However, if you have to use a credit percentage higher than 30%, make sure to repay the dues on time to prevent your credit score from decreasing.
A credit rating agency evaluates the company's or individual's credit behaviour by analysing various factors. These factors include the borrower's income and credit lines to ascertain whether they can repay the debt or if a default risk is involved.
Credit agencies are regulated but the Securities and Exchange Board of India (SEBI), which also reserved the right to authorise such agencies under the SEBI Regulations, 1999 of the SEBI Act, 1992.
Credit rating agencies monitor borrower credit behaviour and assign ratings. These entities can rate companies, nonprofits, countries, organisations, securities, and even government bodies for their creditworthiness.
They consider the borrower's financial statements, type of debt availed, borrowing and lending history, repayment capacity, past credit repayment record, and more. Each of these factors contributes a specified percentage (mentioned above), and the computer calculates a score—the credit score.
Credit agencies do not have the authority to provide a judgment on whether the borrower should be given credit or not. It provides the score and additional inputs that simplify decision-making for the lender.
Several entities may check the credit rating of a borrower before granting credit. The borrower can be a company or an enterprise, including the following:
1. Banks, non-banking financial institutions (NBFCs), and private lenders
2. Debt issuing companies
3. Investment banks
4. Retail investors
5. Institutional investors
6. Other business entities
Read More:: How to Change Address for Credit Card
In India, credit rating agencies assign alphanumeric symbols to denote the creditworthiness of a business entity. It also shows the repayment capacity of the company and the risk associated with the instrument. The credit scale categories are:
1. AAA
2. AA
3. A
4. BBB
5. BB
6. B
7. CCC
8. CC
9. C
10. D
The above scale is in high to low order. This means AAA is the highest rating category that indicates excellent creditworthiness and lowest risk of default. While D is the worst, any grade below BB is considered poor creditworthiness and may deter investors.
Read More:: How to Check CIBIL Score in Paytm
There are benefits of credit ratings. They are:
Credit ratings rate financial instruments to help investors make informed decisions and increase confidence in the market.
Credit ratings foster the growth of both the primary and capital markets.
Without credit ratings, there is a greater risk of default on instruments that would otherwise be rated as poor. In the absence of sufficient subscriptions, credit ratings encourage investors to absorb capital from the market.
Small investors typically invest in low-risk instruments due to assured returns. Credit ratings denote profitability in an instrument, thus helping investors invest in safe instruments.
As the market absorbs higher-rated credit instruments, credit rating agencies maximise capital utilisation by credit ratings.
High-rated securities are much more lucrative for large investors or corporations. Credit rating agencies tend to minimise floating costs associated with credit instruments by introducing credit ratings.
Read More:: How to Check Your CIBIL Score on PhonePe
Credit rating agencies are important for a number of reasons. They are as follows:
Credit rating agencies assess the risk of default, allowing lenders to determine whether the borrower has the capacity to repay the debt. This assessment is critical to managing market risk exposure, loan approval, and interest rate determination.
These agencies maintain a sufficient capital allocation in the market by categorising buyers based on their past credit behaviour. By rating instruments, investors can choose instruments with greater returns or assured returns, and borrowers with a healthy credit rating generally have access to low capital instruments.
Credit ratings act as a benchmark to assess risk within the market and enforce appropriate measures. Financial regulators, investors, and policymakers all rely on credit rating agencies for prudent financial decision-making.
Without an independent assessment of credit instruments, the market would be exposed to fraud and unfair practices. Credit rating agencies create transparency within the market by evaluating the borrower's financial status and an instrument's risk.
Read More:: How to Check Your Credit Score in Paytm
1. Assessing Bankruptcy: By rating a financial instrument, credit rating agencies provide a sort of security to investors against the bankruptcy of the issuing company. By knowing the business's financial strength, investors can decide whether they want to make an investment. Highly rated instruments provide investors with peace of mind against the bankruptcy of the company.
2. Understanding Risk: Credit rating offers investors a rating that is easily understood. Investors can gauge the risk of an instrument before investing their money. Without a proper rating symbol, investing in market instruments would be like a shot in the dark.
3. Increases Investor Confidence: The rating of an instrument indicates how reliable the company that issued it is. As credit rating agencies are independent of businesses and have no transaction or connection between them, this gives greater credibility to the agency's rating, thereby attracting investors and increasing their confidence.
4. Eliminates Middlemen: Investors mostly seek the advice of brokers, merchant bankers, investment agencies, and portfolio managers to make investment decisions. However, assessed instruments rated by credit rating agencies give investors the freedom to make decisions independent of these financial intermediaries. They can determine the creditworthiness of the issuer company and make investment decisions by themselves.
5. Provides Flexibility: Many credit-rated instruments are available in the market at any given time. Investors can choose to invest in instruments according to their risk appetite, using the ratings assigned by credit rating agencies.
Read More:: Benefits of RuPay Credit Card
1. Lowers Borrowing Cost: A company that has issued a high-rating instrument can cut borrowing costs by quoting low interest rates. Investors prefer to invest in secured securities, like fixed deposits, bonds, and debentures, even though they yield lower returns.
2. Frequent Borrowing: If the issuing company has a highly rated credit instrument, it can approach investors more frequently and obtain finances, whether individuals or agencies. Investors of all sizes are drawn towards higher-rated instruments. They prioritise timely payments over the risky possibility of higher returns.
3. Boosts Brand Image: An issuing business does not just enjoy frequent and low-cost borrowing but also the credibility of having highly rated instruments. A healthy credit rating can be used as an advertising tool to appeal to lenders, creditors, and customers. Even the end consumer is more encouraged to buy from businesses with highly rated credit instruments.
4. Access to Funds: Positive credit ratings encourage the investor and the business to grow. With seamless access to credit, they can launch new initiatives or expand their business. With highly rated credit products, the issuing company can easily apply for loans from banks and other lenders and pursue its goals.
5. Cost Reduction: Finally, good credit ratings attract investors and raise funds more easily than poorly rated instruments. This means that businesses can cut costs of luring investors and reduce public matters expenses. They will be more independent of spending on conferences and media events and reallocate funds to core initiatives.
Read More:: How to Apply for Student Credit Card
There are various functions and benefits of credit rating agencies in India. They maintain market credibility by assigning risk to instruments for better decision-making. A low credit rating indicates poor creditworthiness, whereas a high one indicates excellent creditworthiness. As the majority of investors lean on assured returns, credit ratings become the pivotal influencer that provides an independent evaluation of a company's creditworthiness. This helps small and gullible investors make wise decisions by themselves without relying on financial intermediaries for advice.
It also helps the company maintain a healthy credit rating, which improves brand value and market credibility and lowers the cost of borrowing. Without credit rating agencies, there would be no market transparency, and investors would have to rely on intermediaries.
Lenders, investors, companies, and policymakers benefit from credit ratings and independent credit rating agencies.
Is credit rating the same as credit score?
While both terms are generally used interchangeably, credit rating refers to the creditworthiness of a business, whereas credit score pertains to an individual's creditworthiness. Both entities are evaluated based on their track records, but the company's financial health will also be considered.
Are credit rating agencies affiliated with government bodies?
No. Credit rating agencies are independent entities that do not require government authorisation for rating instruments. They are free from government control.
What is a credit rating report?
Credit rating agencies provide a descriptive assessment of a business's financial health based on past, present, and future initiatives. Factoring in several criteria, the report is a qualitative and quantitative analysis of a company.
How can my company benefit from a good credit rating?
A healthy credit rating can be significantly beneficial to your business. It can help with financial planning and decision-making, capital restructuring, and improving your brand's reputation. Boosted marketing equity is a major benefit of credit rating agencies.
What is a credit rating certificate?
A credit rating certificate is a document that shows a company's creditworthiness in a rating category. It helps lenders determine whether a loan should be granted and what the rate of interest should be. Investors may look at an instrument's credit rating to determine risk, and companies can improve their brand value and market presence with a good credit rating.
Download the app now
Download the app from PlayStore
