credit rating is the opinion of the rating agency on the relative ability and willingness of the...

8/6/2019 Credit Rating is the Opinion of the Rating Agency on the Relative Ability and Willingness of the Issuer of a Debt Inst

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Credit rating is the opinion of the rating agency on the relative ability and willingness of the

issuer of a debt instrument to meet the debt service obligations as and when they arise.

A credit rating estimates the credit worthiness of an individual, corporation, or even a

country. It is an evaluation made by credit bureaus of a borrowers overall credit

history. A credit rating is also known as an evaluation of a potential borrowers ability

to repay debt, prepared by a credit bureau at the request of the lender. Credit ratings

are calculated from financial history and current assets & liabilities. A credit rating

tells a lender or investor the probability of the subject being able to pay back a loan.

A poor credit rating indicates a high risk of default of a loan, and leads to high interest rate,

or the refusal of a loan by the creditor.

It should be noted that a credit rating is assigned to the investment instrument and not to the

company issuing it as a whole.

Credit Rating Agency (CRA):

A Credit Rating Agency is a company that assigns credit ratings for issuers of certain types of

debt obligations as well as debt instruments.

Four Main Credit Rating Agencies in India:

1. Credit Rating Information Services of India Limited (CRISIL), Associate of

Standards & Poors

2. Credit Analysis & Research Ltd. (CARE Ratings)

3. Investment Information and Credit Rating Agency of India Limited (ICRA),

Associate of Moodys Investors Service

4. Fitch Ratings

Who needs credit ratings?:

1. Commercial Banks

2. Mutual Funds

3. Investment Banks

4. Leasing companies

5. Insurance companies


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6. Bond Issuers

Why the need of Credit Rating:

As said earlier, credit rating is an opinion expressed by an independent professional

organisation, after making a detailed study of all relevant factors. Such an opinion is of greatassistance to investors in making investment decisions. It also helps the issuers of debt

instruments to price their issues correctly and to reach out to investors and win their

confidence.

Regulators like Reserve Bank of India (RBI) and Securities & Exchange Board of India

(SEBI) often use credit rating to determine eligibility criteria for some instruments. For

example, the RBI has stipulated a minimum credit rating by an approved agency for issue of

Commercial Paper. Credit Rating also proves as a valuable input in establishing business

relationships of various types.

Rating Methodology:

A certain methodology is adopted by rating agencies to ascertain the credit worthiness of the

debt issuers.

In brief, following aspects are taken into consideration while assigning a rating:

Industry Risk

Market position

Ownership

Earnings & Performance

Cash flows

Management structure and composition

Capital & Debt Structure

Corporate Governance

Other factors like (for financial institutions): Capital adequacy & Liquidity, Quality ofasset, Asset/Liability structure, Sourcing of funds, cost of funds,

Monitoring and Revision of Ratings:

A rating assigned does not remain static forever. It may go revision due to factors like change

in economic environment, corporate restructuring, management of the organisation, etc.

therefore the need of revision of ratings arises.

One needs to note that, a rating is an opinion given on the basis of information available at a

particular point of time. As time goes by, many things change, affecting the debt servicing

capabilities of the issuer, one way or the other. It is, therefore, essential that as a part of their

investor service, rating agencies monitor all outstanding debt issues rated by them. In the


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context of emerging developments, the rating agencies often put issues under credit watch

and upgrade or downgrade the ratings as and when necessary, although after making

intensive interaction with the issuers.

Each rating agency uses different rating scales for different kinds of ratings. Most common

rating scales are AAA, AA, A, BBB, BB, B, A+, AA+, B+ and so on.

The role of Credit Information Bureau India Limited (CIBIL) in Credit Rating:

Credit Information Bureau (India) Limited (CIBIL), incorporated in the year 2000, plays a

very vital role in credit ratings in India.

CIBIL Indias first credit information bureau- is a repository of information, which contains

the credit history of commercial and consumer borrowers. CIBIL provides this information to

its Members in the form of credit information reports.

The establishment of CIBIL is an effort made by the Government of India and the ReserveBank of India to improve the functionality and stability of the Indian financial system by

containing NPAs while improving credit grantors portfolio quality. CIBIL provides a vital

service, which allows its Members to make informed, objective and faster credit decisions.

CIBILs aim is to fulfill the need of credit granting institutions for comprehensive credit

information by collecting, collating and disseminating credit information pertaining to both

commercial and consumer borrowers, to a closed user group of Members. Banks, Financial

Institutions, Non Banking Financial Companies, Housing Finance Companies and Credit

Card Companies use CIBILs services.

Benefits of Credit Ratings:

To Corporates:

For corporates, a good credit rating enables them to have lower interest costs, win confidence

of investors. Also there is a compulsion from the regulators to have credit rating assigned to

certain debt issues.

To Investors:

For investors it is a boon since they can take informed investment decisions, can rely on the

issues / offers, they get an ease of selection of investment products.

Given the benefits of credit ratings, recently, the role of rating agencies has come under the

scanner during the global financial crisis, as many companies and their issues collapsed

despite high rating.

Reasons for this being like, abnormally high payment of fees to the rating agencies for getting

a high / good rating, biasedness of agencies in analysis and judgement, etc.

Also a debate has arised as to who should pay for the rating the company or the investor?

Since every issuer / company has a vested interest in getting a higher rating for the paper

issued by it, to lower the cost of borrowing. Similarly, every investor gains from lowerratings, since he can negotiate for a higher interest rate.


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Measures introduced for improving credit ratings & working of credit rating agencies:

A couple of regulations, circulars towards improving the quality of ratings have been issued

by SEBI in this year. Some of the major ones are:

Standardizing the definition of defaults by bond issuers, and the formula forcomputing default rates.

The rating agencies should recognize default at the first instance of delay in paying

interest or principal on the rated debt instrument.

Rating agency will now have to ensure that its analysts do not participate in any kind

of marketing and business development, including negotiations of fees with the issuer whose

securities are being rated. Also, the employees involved in the credit rating process and their

dependants cannot own shares of the issuer.

Mandatory for rating agencies to publish information about the historical default ratesof their rating categories and whether the default rates of these categories have changed over

time.

Rating Agency should disclose the general nature of its compensation arrangements

with the issuers. It will also have to disclose the details of any relationship it has with the

issuer whose securities are being rated and any of its associate of such issuer and the CRA or

its subsidiaries.

Credit rating agencies to disclose the fees they charge companies for assessing their

debt profile and the default rate on their previous ratings.

The new guidelines ask the credit rating agencies to maintain records (till five years)

of the important factors underlying the credit rating and a summary of discussions with all the

stakeholders involved, as well as decisions of the rating committee, including voting details

and notes of dissent.

In case of unsolicited credit ratings, the rating symbol shall be accompanied by the

word unsolicited and the CRA has to monitor and disclose ratings during the life of the

rated securities, as if it were a solicited rating.

Credit Rating now has also become important on personal / individual level:

Having a good credit rating is important to individuals as well, since a good credit rating can

help individuals to Finance a car, Rent an apartment, Get a home mortgage, Setup utility

accounts, Obtain employment, etc.

Credit card companies, lending companies have become very strict while offering credit these

days, due to rising defaults of loans taken by people. They now check the credit worthiness of

their prospective customers before disbursing a loan or determining the credit limit on credit

cards.

Factors that may influence a persons credit rating are: ability to pay a loan, interest, amountof credit used, saving patterns, spending patterns, debt, etc.


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CIBIL Credit Report is a factual record of your credit payment history compiled from

information received from different credit grantors. Credit grantors are leading Banks,

Financial Institutions, State Financial Corporations, Non-Banking Financial Companies,

Housing Finance Companies, Credit Card Companies, who are Members of CIBIL. The

purpose is to help credit grantors make informed lending decisions quickly and objectively,

and enable faster processing of credit applications to provide speedier access to credit at

better terms to customers.

One can now access its own Credit Information Report (CIR) directly from CIBIL.

One can request a copy of his/her CIBIL CIR, by writing to CIBIL. Complete details can be

had from the following link: http://www.cibil.com/accesscredit.htm

Conclusion:

Credit Rating is the need of the time since investors should be equipped with easy methods to

make their investment decisions. If ratings are assigned in a proper, systematic, transparent

way, then it will be a boon for investors and will go a long way in making the investment

world a safe place.

However, investors should not forget the Contract Law tenet Caveat Emptor. Caveat

Emptor means let the buyer beware. It should be forgotten that everything cannot be

guaranteed and investments cannot be risk-free. Investors should observe caution while

investing their money and be aware themselves before taking their investment decisions.

Investors should self study the facts and information available about the investment products

and the creditability of the issuers, before zeroing on their decisions.

It is equally important for individuals to maintain their good credit history by repaying loans

on time and not breaching any rules of law in respect of investments, taxation, etc. Having a

good credit history and a clean credit report will go a long way in making the individuals

future secure and smooth.

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