Credit Rating

Credit rating is essentially the symbolic indicator of the current opinion of a rating agency on the relative ability and willingness of the issuer of a financial debt instrument to meet the debt service obligations as and when they arise. It provides a relative ranking of the credit quality of debt instruments or their grading according to investment qualities. In other words, credit rating provides a simple system of gradation by which the relative capacities of companies (borrowers) to make timely repayment of interest and principal on a particular type of debt can be noted. 

Credit rating, however, is neither a general-purpose evaluation of a corporate entity nor an overall assessment of the credit risk likely to be involved in all the debts contracted or to be contracted by such issuers. A rating is specific to a debt/financial instrument and is intended to grade different and specific instruments in terms of, credit risk associated with the particular instrument. Although the rating is an opinion expressed by an independent professional organization, after making a detailed study of all the relevant factors, it does not amount to any recommendation to buy, hold or sell an instrument as it does not take into consideration factors such as market prices, personal risk preferences of an investor and such other considerations, which may influence an investment decision.

The technique of credit rating is rating symbols. They group together similar entities in terms of their relative capacity of timely servicing of obligations as per the terms of the contract. Debt instruments rated ‘BBB-’ and above are classified as investment grade ratings. Instruments that are rated ‘BB+’ and below are classified as speculative grade category ratings. Instruments rated in the speculative grade carry materially higher risk compared to instruments rated in the investment grade. Plus and minus symbols are used to indicate finer distinctions within a rating category. The minus symbol associated with ratings has no negative connotations whatsoever. In fact, ratings in a higher rating category such as ‘AA-’ are stronger than ratings in a lower rating category such as ‘A+’. Appropriate prefix and suffixed such as (FD)/ (CD)/ PF/SO/L/M/CP are used to denote specific instrumentals such as fixed deposit/ certificates of deposits, preference shares, structured obligations, long term, medium term, commercial paper and so on.

As a fee-based financial advisory service, credit rating is obviously extremely useful to the investors, the corporate (borrowers) and banks and financial institutions. To the investors, it is, an indicator expressing the underlying credit quality of a debt issue program. The investor is fully informed about the company, as any effect of changes in business/economic conditions on the company, is evaluated and published regularly by the rating agencies. The corporate borrowers can raise funds at a cheaper rate with a good rating. It minimizes the role of name recognition and lesser-known companies can also approach the market on the basis of their rating. The fund ratings are useful to the banks and other financial institutions while deciding lending and investment strategies.