Credit Rating

A credit rating is an independent assessment of a public or private corporation’s or government’s creditworthiness and ability to meet debt obligations. It is represented as an alphabetical measure unlike a credit score, which numerically represents an individual’s credit history and current credit health. However, while both credit ratings and CIBIL scores help assess financial reliability, they are not the same. 

 

A CIBIL score is about individuals and shows how likely they are to repay their loans. The CIBIL score is also influenced by factors like credit utilisation, length of credit history, credit mix, and credit utilisation ratio. On the other hand, a credit rating is used for businesses or governments to measure their ability to meet debt obligations. 

One of the major benefits of credit ratings is that they help financial institutions, investors and other parties to make informed decisions. Since these ratings reveal the risk or default probability of entities and their financial instruments, they offer valuable insights.

Different types of credit ratings help lenders and investors assess risk and determine loan terms, make investment decisions, and take other actions. Here are the common types of credit ratings:

 

• Corporate Ratings

Corporate entities raise money through many debt instruments, like commercial papers, bonds, etc. Credit rating agencies assign ratings to such companies.

 

• Bank Loan Ratings

When a bank provides a loan to a corporation or entity, it assumes the risk that the borrower may not be able to repay. The credit ratings given to such loans are called bank loan ratings.

 

• Sovereign Ratings

Central and state governments also raise debt for various purposes, including investments in long-term projects. Sovereign ratings are assigned to these government bodies.

 

• Municipal Bond Ratings

To cover various expenses, municipalities and local bodies also raise debts through bonds. Municipal bond ratings indicate the ability of these bodies to repay the debt on time and in full. 

 

• Structured Finance Ratings

In India, banks aggregate loans such as housing and auto loans, then issue Mortgage-backed Securities (MBS) or Asset-backed Securities (ABS). Rating agencies assess these securities to evaluate their default risk and assign credit ratings.

One of the most important functions of Credit Rating Agencies (CRAs) is that they support transparency and impact the cost and other terms of borrowing. These agencies assess the creditworthiness and potential credit risks of a company or sovereign body by examining many factors including:

 

• Cash flow and income 

• Credit lines

• Net profit

• Payment history

• General economic outlook

 

In India, the Securities and Exchange Board of India (SEBI) has the authority to regulate credit rating agencies. These powers are vested in them under the SEBI Regulations, 1999, in accordance with the SEBI Act, 1992.

Under SEBI, seven credit rating agencies are registered in India that are authorised to compute credit ratings. Check out the details of some of the most popular agencies below:

 

In a circular released in 2022, SEBI has advised all credit rating agencies to follow standardised credit rating scales. Check out the details below:

 

SEBI has allowed credit rating agencies to use modifiers (+/-) with the rating symbols between AA and C. These can indicate the comparative standing with a rating category.

 

For example, a debt instrument rated AAA+ is relatively safer than AAA-, although both enjoy higher degrees of safety compared to a rating of AA.

Credit ratings are crucial for assessing risk, determining loan terms, and making investment decisions. Here's a more detailed breakdown of those who rely on credit ratings:

 

• Financial Institutions

Banks, NBFCs and other financial companies use credit ratings to evaluate the creditworthiness of potential borrowers (individuals, businesses, or governments). This rating helps them make informed decisions about approval and loan terms.

 

• Investors

Retail and institutional investors use credit ratings to assess the risk associated with debt instruments and the overall financial health of a company.

 

• Corporations and Businesses

Corporations rely on favourable credit ratings to secure funding at lower interest rates and attract investors. 

 

• Governments

Governments use credit ratings to attract foreign investment and secure external funding. Ratings can also influence policy decisions related to financial markets and economic growth.

A rating is an opinion formed based on the information or data available at a specific point in time. However, as information evolves over time, the performance of the rated instruments may change. This may be due to market forces, internal policies, and myriad other factors.

 

This may impact a corporation’s or organisation’s future repayment capabilities which leads to an adjustment in the rating. Credit rating agencies usually update ratings every quarter.

While both credit ratings and credit scores are used to assess financial reliability, they differ in several key aspects. Take a look at how they differ to make informed decisions about personal finances, investments, and loans.