All about credit ratings!

Concept- 

Credit rating is the assessment of an entity’s ability to pay back a debt within the stipulated time period. This assessment is based on qualitative factors such as the character of the borrower, the strength of the business along with industry & quantitative factors including income and past repayment history. 

 Credit rating agencies- 

The assessment of the creditworthiness of a company is done by specialised agencies, a.k.a credit rating agencies. These agencies evaluate the qualitative & quantitative factors pertaining to the instrument to assign a credit score to it. 

Some of the popular credit rating agencies in India are Credit Rating Information Services of India Limited (CRISIL), ICRA Limited, Credit Analysis & Research limited (CARE), and India Rating & Research Private Limited, etc. 

Types of ratings- 

Credit rating agencies provide different kinds of ratings such as bond/debenture rating, equity rating, preference share rating, borrowers rating, etc. These ratings are denoted in terms of symbols. For example, an instrument with the highest safety and lowest risk of default is assigned ‘AAA’. On the other hand, instruments that are very likely to default in the repayment obligations are assigned ‘D’.  

Who uses credit ratings? 

Credit ratings are used by the individual as well as institutional investors like mutual fund houses, insurance funds & pension funds houses, intermediaries such as investment banks to assess the risks involved in lending funds. 

How is it useful? 

Credit rating helps to evaluate the likelihood of a debtor defaulting on his financial obligations. A good credit rating enables a business or company to borrow funds easily and at lower interest rates. On the other hand, a poor credit score makes it difficult for a company to borrow funds as investors will hesitate to lend funds to such companies.