Companies, financial institutions, public sector enterprises,
local bodies and others raise funds from the domestic as well
as international money or capital market by issuing debt instruments
which are rated by the rating agencies. Investors also like
to make their investment decisions based on business credit
rating of instruments.
Credit rating plays a significant role in all credit as well
as investment decisions. Credit signifies status of ability
to pay or reputation about solvency and capacity to pay. Rating
is nothing but estimated worth or value in terms of symbolic
grade given to a persons or organizations ability to pay back
the loans raised, with the help of financial position of the
individual or organization. By combining business credit rating, these two words, one can
find out the meaning of credit rating, which is concerned with
an act of assigning symbolic grade of values of estimating financial
position and thus disclosing solvency which indicates ability
or capacity of the issuer about the repayment of loans raised.
II. Concept of credit rating
Credit rating may be defined as an expression, through use of
symbols, of opinion about the quality of credit of the issuer
of debt securities with reference to a particular instrument.
As per the Securities and Exchange Board of India (SEBI) regulations,
credit rating is nothing but an opinion regarding securities
expressed in the form of standard symbol or in any other standardized
form assigned by a credit rating agency. The symbol given by
rating agency for credit rating indicates a credit character
of that particular security and thus it only facilitates to
take a view on credit risk pertaining to that security. However,
it does not directly recommend whether to purchase, sale or
hold that security. Thus, rating is a measure of credit risk
only and hence it does not communicate anything about the degree
of market risk.
Credit rating is considered predominantly in respect of debt
instruments only. In addition to this, leaders like banks and
non-banking finance companies use internally developed credit
rating score models in assessing credit worthiness of their
borrowers or depend on even rating agencies to get rating for
the same. The companies which issue debt instruments cannot
on their own rate instruments.
III. Benefits of credit rating
The rating of debt instruments offer benefits to the interested
parties such as investors, issuers and intermediary agencies
Benefits to Investors
i) Safeguards against Bankruptcy - Credit rating
of an instrument given by the credit rating agency give an idea
to the investors about the degree of financial strength of the
issuer company which enables him to decide about investment.
Highly rated instrument of a company gives an assurance to the
investors of safety of their investment and in the interest
in their investments with least risk of bankruptcy.
ii) Recognition of Risk - Business credit rating provides investors with
rating symbols which carry information in easily recognizable
manner for the benefit of investors to perceive risk involved
in investment. It becomes easier for the investors by looking
at the symbol to understand the worth of the issuer company
because the instrument is rated by scientifically and professionally
analyzing the financial position of the company. In view of
this, there is no need for the investors to incur cost for collecting
credit information and to carry out analysis. The investors
without any knowledge of financial analysis can easily use rating
symbols for investment decisions.
iii) Credibility of Issuer - Rating symbol
assigned to a debt instrument gives an idea about the credibility
of the issuer company. The rating agency is quite independent
of the issuer company and has no business connections or otherwise
any relationship with it or its Board of Directors. Due to absence
of business links between the rating agency and the issuer company
the confidence of investors is enhanced in such rating symbol.
iv) Rating Facilitates Quick Investment Decisions -
Investor can take quick decisions about the investment to be
made in various instruments with the help of credit rating assigned
to various instruments. In view of this, there is no need for
investors to undertake fundamental analysis of a company based
on financial strength of the company, quality of management,
as well as other parameters.
v) No Need to Depend on Investment Advisors or Professionals
- For making investment decisions, investors with no
knowledge of investment may have to seek advice of financial
intermediaries such as, the stock brokers, the portfolio managers,
or financial consultants while investing funds in debt instruments.
However, investors need not depend upon the advice of these
financial intermediaries as the rating symbol assigned to a
particular instrument suggests the credit worthiness of the
instrument and indicates the degree of risk involved in it.
Thus, investors can make direct investment decisions.
vi) Choice of Investment - Several alternative
credit rated instruments are available at a particular point
of time for deploying investible funds. The investors can make
choice of various instruments depending upon their own risk
profile and diversification plan.
vii) Benefits of Rating Surveillance - Investors
get the benefit of credit rating agencies on going surveillance
of the rated instruments of different companies. The credit
rating agency downgrades the rating of any instrument if subsequently
the companys financial performance is not so good or financial
position has suffered because of happening of internal or external
events which necessitates consequent dissemination of information
on its position to the investors.
To sum up, credit rating of debt instruments helps the investors
in managing credit risk in investment decisions.
Benefits of Credit rating to Issuer Company
A company which has obtained business credit rating from rating agency for its
issue of debt security enjoys various advantages. Few of these
advantages are given below:
i) Lower cost of borrowing
ii) Wider audience for borrowing
iii) Rating as marketing tool
iv) Self discipline by companies
v) Reduction of cost in public issues
vi) Motivation for growth
Benefits to financial intermediaries
Highly credit card rated instruments put the brokers at an advantage
to make less efforts in studying the companys credit position
to convince their clients to select a
investment proposal. Rated instruments speak themselves about
the financial soundness of the company and the strength of the
instrument rated by the credit rating agency. This enables brokers
and other financial intermediaries to save their time, cost,
energy and manpower in convincing their clients about investments
in any particular instruments. They utilize their resources
in expanding their clientele and intensifying their business
The other benefits of credit rating in general are given below:
i) Identification of strength and weakness of the Issuer Company
ii) Liquidity and Marketability of Debt Securities
iii) Positive Impact on Capital Market
IV. Limitations of credit rating
While recognizing the benefits of credit rating, it is necessary
to keep in mind certain limitations of the credit rating. Few
of these are explained below:
1) Biased Rating and Misrepresentations
In the absence of quality rating based on objectivity analysis
credit rating is a curse for the capital market. To avoid biased
rating or subjectivity in the credit rating process, executives
working with Credit Rating Agency, who are involved in the process
of credit rating, should have no links with the company or the
persons interested in the issuer company so that they can make
their report impartial and judicious recommendations for rating
committee. Again, rating committee members should also be impartial
and judicious in their decision making.
The companies having lower grade rating do not advertise or
use the rating while raising funds from the public. In such
cases, the credit rating agencies should themselves in the public
interest, advertise the rating symbols assigned to such companies
for public information and make the public aware of the poor
financial position of such companies.
2) Static study
Rating is done on the basis of present and past data of the
company and this only a static study. Disclosure about the companys
health through credit rating is one time exercise and any thing
can happen after assignment of rating symbols to the company.
Dependence for future results on the rating, therefore defeats
the very purpose of risk indicativeness of rating. Subsequent
to the allotment of credit rating many changes may take place
in economic environment, political situation, government policy
framework which may directly affect the working of a company.
With such changes, the purpose for which credit rating was done
3) Concealment of material information
The company which has approached for credit rating may not provide
all material information to the credit rating agency. In such
cases, credit rating given by the credit rating agency may not
reflect true picture of credit risk.
4) Rating is no guarantee for soundness of the company
Credit rating is done for a particular instrument to assess
the credit risk. And therefore it cannot be construed as a rating
for the quality of management of the company or its sound financial
5) Down grade
Once a company has been rated and if it is not able to maintain
its satisfactory financial performance, credit rating agency
would review the grade and down grade the rating resulting into
impairing the image of the company.
Most of the limitations mentioned above can be overcome by taking
precautions at every stage of credit rating process.
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