What Is Credit Rating? Discuss its Types, Importance & Process

What Is Credit Rating?

Credit Rating The technique through which credit quantities of debt or credit instruments are ranked is called Credit Rating. Generally particular alphabets or symbols are used for such ranking purposes. It enables us to ascertain the strength and weakness of debt instruments.

In other hands credit rating refers to the giving of symbols and indicators to credit instruments or Government or any business institutions according to their security or risk. It also ensures how certain is the possibility of repayment of interest and principal amount on a given credit instrument.

According to L.M Bhole Credit rating is designed exclusively for the purpose of grading bonds according to their investment quality.

What Is Credit Rating Agencies

The company that assigns credit ratings to institutions that issue debt obligations is called Credit Rating Agencies. Generally it evaluates the financial condition of the issuer of debt instruments and their ability to make the debt payment.

Normally it provides an opinion relating to future loan or debt repayment by the borrower whereas a credit bureau provides information on past loan repayments by the borrowers.

Types Of Credit Rating

Types of Credit Rating is further classified into 8 types, they are:

1.Bond & Debenture Rating

2.Equity Rating

3.Preference Share Rating

4.Commercial Paper Rating

5.Fixed Deposits Rating

6.Borrower Rating

7.Sovereign Rating

8.Individual Rating

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What Is Bond and Debenture Rating?

The Credit Rating techniques which are issued by corporate governance, government and company are known as Bond & Debenture Rating.

It reflects prospects of payments on the maturity of bonds.

What Is Equity Rating?

The Credit Rating technique which is issued by the company for the rating of equity share capital is known as Equity Rating.

What Is Preference Share Rating?

The credit Rating technique which is issued by the company for the rating of preference share capital is known as Preference share rating.

What is Commercial Paper Rating?

Commercial paper Rating is the technique which is used to rating commercial papers issued by a company known as Commercial paper Rating.

Commercial paper Rating is issued by manufacturer companies, banks, financial institutions and finance companies. Commercial paper is the instrument which is used for short term borrowing. It is used by builders and investors.

What Is Fixed deposit rating?

Fixed Deposit Rating is the technique which is issued by medium term unsecured borrowings programmers is known as Fixed Deposit Rating.

What Is a Borrower Rating?

The Credit Rating technique which is issued or used by the borrower is known as Borrower Rating.

What Is Sovereign Rating?The Credit Rating which is used in rating or checking the credit repayment capacity of the Government of a country is known as Sovereign Rating.

What is Individual Rating?

The Credit Rating technique which is used for the individual is known as Individual Rating.

What Are Credit Rating Agencies?

The company that assigns Credit Rating to institutions that issue debt obligations is called Credit Rating Agencies. Generally it evaluates the financial condition of the issuer of debt instruments and their ability to make the debt payments.

Normally it provides an opinion relating to future debt repayment by borrower whereas a Credit bureau provides information on past debt repayments by borrowers.

Credit Rating Agencies In India

In India there are 7 Credit Rating Agencies are available they are listed below:

• Credit Rating Information Services Of India Limited (CRISIL)

• SME Rating Agency Of India Limited (SMERA)

• Investment Information & Credit Rating Agency Of India Limited (ICRA)

• Credit Analysis & Research (CARE)

• Brickwork Rating (BWR)

• Fitch India

• Onida Individual Credit Rating Agency Of India (ONCRA)

Credit Rating vs Credit Report

• Credit Rating provides credit information about a company or country’s ability to repay a loan, while Credit Reports provide information about individuals’ credit scores.

• Credit Rating Agencies are different from Credit Reporting Bureaus.

• The Credit Rating process is done by Credit Rating Agencies while the Credit Report process is done by Credit Reporting Bureaus.

• Credit Rating technique used for check the Companies and Countries credit information and repayment of loan history, While Credit Reporting technique used for check the individual person’s credit information and loan repayment history

Importance Of Credit Rating

Credit Rating helps to ensure security of debt and minimise the risk of uncertainty of debt. Generally its importance, Benefits and advantages are broadly classified into 4 categories they are:

A. Benefits to Investors

B. Benefits to Company

C. Benefits to Government

D. Benefits to Financial Intermediaries

Benefits to Investors

The credit rating is beneficial to investors in several ways, they are discussed below:

1.Save Guard from Bankcruft Companies

Credit Rating enables investors to learn about economic situation of the company. It helps them to make decisions on their investment and avoid making investment in lower rating companies.

2.Recognisation Of Risk

Credit Rating also enables investors to know the label of risk involve in debt instruments. It helps them to make their investment in a profitable manner.

3.Choice of Investment

The credit rating also helps investors to select their investment platform. It enables them to compare the opportunities available in different investments and choose the best one.

Benefits to Company

For the sake of clarification some of the benefits of Credit Rating to companies are discussed below:

1.Self discipline by companies

The rating process stimulates self discipline tendency among the company. It makes available to the general public and correct information regarding its accounting, financial and managerial systems. As a result it encourages companies to improve their internal organisations.

2.Reduction in cost in publication

The credit rating also enables companies to create a goodwill or image in the market. It encourages investors to invest in companies having high risk credit ratings. As a result it reduces the loss of publications of companies to a large extent.

Benefits to Government

The credit rating also prove as beneficial to the Government. It facilitated the Govt to formulate appropriate policies concerning financial institutions, public sector and remake their proper assessment.

It also encourages people to make investment by providing current and reliable information. It also minimises Govt. responsibility by minimising risk to people.

Benefits to financial intermediaries & Broker

Credit Rating also help financial intermediaries to carry on their work effectively at minimum cost. It enables investors to know the financial position of an organisation for its credit rating and make their investment accordingly.

It also helps financial intermediaries to market their goodwill or product without hard work if the organisation has a high credit rating.

Disadvantages & Limitations Of Credit Rating

For the sake of clarification some of the most important disadvantages and limitations of Credit Rating are discussed below:

1.Credit Rating System or agencies

The credit rating of a company may be based on credit rating agencies. As a result people should fail to get true picture of the company and remain in the dark, so it will cause more have than good indirectly. It creates a question mark in the rating system.

2.Lack of Complkete Knowledge

The lack of complete knowledge about the financial position of a company’s credit rating is considered as another limitation of Credit Rating.

It may find strength when rating special debt instruments of the company is quite high but its position is under down. So it means prove unsafe or cause heavy loss for the organisation and business enterprise.

3.Stastical Study

The credit rating is always based on its existing and historical fact which was already incurred beyond the control of the organisation. so it has been considered as another limitation and drawback of the rating system.

Process Of Credit Rating

The credit rating process includes the following steps;

Step-1:

Requesting For Rating By An Issuer Company

The Credit Rating process generally begins with an entity requesting a credit rating agency to undertake a credit analysis.

Step-2:

Signing agreement

The second step of the credit rating process is signing of agreements. Generally such agreement is made between the rating agency and issuer company. Normally it spells out the terms of the rating assignment.

Step- 3: Forming a Rating Agency

The 3rd step of the credit rating process is to form a team with qualified analysis for the purpose of credit analysis.#Generally the team should visit the company and to make inspection and operation first hand.

Step- 4: Collecting and analysing information

The next step of the credit rating process is to collect financial information of a company and properly analyse it. Then a team should be concerned about the information and prepare a report.

Step- 5: Communicative rating of company

The decision of the external committee should be communicated to the company as a financial decision. The company may provide any further information letter on for the purpose of changing in previous rating.

Step- 6: Credit Rating Reviews

The last and final step of the credit rating process is to make a review of the credit rating. It is concerned with forward looking, creditable credit rating and timely presentation of reports on a continuous basis in each and every year.

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