What is a Credit Rating?
A credit rating is a way of assessing the creditworthiness of entities such as individuals, groups, businesses, non-profit organizations, governments, and even countries. Special credit rating agencies analyze their financial risk to see whether or not these borrowers will be able to pay back loans on time.
The credit rating agencies compile this rating using a detailed report that takes into consideration various factors such as lending and borrowing history, ability to repay the debt, past debts, future economic potential, and more.
A good credit rating improves credibility and indicates a good history of paying back loans on time in the past. It helps banks and investors decide about approving loan applications and the rate of interest offered.
Types of Credit Rating
The various credit agency agencies use similar alphabetical symbols to determine credit ratings. However, these ratings are also grouped into two types of grades – ‘investment grade’ and/or ‘speculative grade’.
- Investment grade: These ratings refer to the fact that the investment made is solid, and the borrower will most likely meet the repayment terms. Thus, they are often priced less.
- Speculative grade: These ratings show that the investments are at a higher risk, and they often have higher interest rates.
Is there a Difference between Credit Rating and Credit Score?
Sometimes, the terms credit score and credit rating are used interchangeably, but they are not the same thing.
As mentioned above, a credit rating is used to determine the creditworthiness of a business or a company rather than individuals. This essentially means the probability of them defaulting on payments. The rating is usually shown as a series of alphabetical symbols, and it is calculated using corporate financial instruments.
However, a credit score is a number, usually between 300 and 900, that is given to individuals to rate their creditworthiness. It is calculated by credit bureaus based on the person’s credit information report, and plays a role in determining whether or not they are approved for loans and credit cards.
What is the Importance of Credit Rating?
Since a credit rating is an assessment of a borrower's creditworthiness, a higher credit rating suggests that the company or entity is more likely to repay the borrowed credit. On the other hand, a lower credit rating might mean that they have a higher probability of turning into a defaulter. This can make it difficult for them to borrow money, as lenders will consider them high-risk borrowers.
However, there are other ways that credit rating is important:
- Lenders and investors can make better and more sound investment decisions by taking into account the risk of the entity who is borrowing the money.
- When lenders know the credit rating of potential borrowers, they can be assured that their money will be paid back in time, with the correct amount of interest.
- When companies have a higher credit rating, they will be seen as lower risk and therefore get loan applications approved more easily.
- Lenders like banks and financial institutions will also offer loans at a lower interest rates for entities that have a higher credit rating.
Thus, having a higher credit rating can help a company raise money and expand, while also reducing the cost of borrowing. And, for lenders, these ratings can help them obtain more detailed financial information and encourage better accounting standards.
What are the Credit Rating Agencies in India?
Credit ratings are evaluated by credit agencies. In India, credit rating agencies are regulated by the SEBI (Credit Rating Agencies) Regulations, 1999, part of the Securities and Exchange Board of India Act, 1992.
Some of the top credit rating agencies in India are:
Credit Rating Information Services of India Limited (CRISIL)
This was one of the first credit rating agencies in India, established in 1987. It rates companies, banks, and organizations using their strengths, market share, market reputation board, etc. The company also operates in the USA, UK, Hong Kong, Poland, Argentina and China and offers 8 types of credit ratings ranging from AAA – D.
Investment Information and Credit Rating Agency of India (ICRA) Limited
Established in 1991, ICRA offers comprehensive ratings to corporates for a variety of situations, such as bank loans, corporate debt, mutual funds, and more.
Credit Analysis and Research Limited (CARE)
From April 1993, CARE has been offering a range of credit rating services. These include areas like debt, bank loans, corporate governance, recovery, financial sector and more. Their rating scale also includes two categories – long term debt instruments and short-term debt ratings.
India Rating and Research Private Limited
Known formerly as Fitch Ratings India Pvt. Ltd., this company offers credit ratings to evaluate the credibility of corporate issuers, financial institutions, project finance companies, managed funds, urban local bodies, etc.
Acuité Ratings & Research
Formerly Small Medium Enterprises Rating Agency of India Limited or (SMERA Ratings Ltd.) this credit rating agency was established in 2011. It has two divisions – SME Ratings and Bond Ratings, and also offers 8 formats of credit rating ranging from AAA – D.
Brickwork Ratings India Private Limited
This credit rating agency rates bank loans, municipal corporations, real estate investments, NGOs, capital market instruments, SMEs, etc.
To check a company’s credit rating, one needs to contact one of the above credit rating agencies.
What are the Different Credit Rating Scales?
The various credit rating agencies offer similar ranges of rating (from AAA – D) to represent a company’s creditworthiness and the risk they pose to investors for long-term and mid-term debt instruments.
Lowest credit risk / Excellent credit rating
Very low credit risk / Very good credit rating
Low credit risk / Good credit rating
Moderate credit risk / Average credit rating
High credit risk / Low credit rating
Very high credit risk / Poor credit rating
What are the Factors that affect Credit Rating?
There are a number of factors that can affect the credit ratings of a company, including:
The company’s financial history:
- Lending and borrowing history
- Past debt
- Payment history
- Financial statements
- Level and type of current debt
The company’s future economic potential:
- Ability to repay the debt
- Projected profits
- Current performance