CHAPTER-01

Credit Rating Services

Credit Rating is an assessment in terms of alphanumeric symbols to convey the creditworthiness of
an individual, company financial instruments or a country. It is a simple and easily understood tool
enabling the investor or lender the relative degree of risk associated with a loan amount on a debt
instrument or a financial obligation.

Credit rating is just an opinion about the creditworthiness of the instrument. However, it does not
give any assurance of repayment of the rated instrument. The rating is representative of the financial
history and current assets and liabilities of the rated instrument. A credit rating does not provide
recommendations to buy, hold or sell a debt instrument.

Credit Rating – Introduction

A credit rating is an opinion expressed by the credit rating agency on the debt repayment ability of
the Issuer.

When we talk about fixed income securities, the topic of credit rating has to be around the corner.
Credit ratings have assumed a significant role in today’s investment world, and rightly so.

The credit rating agencies save investors a lot of time in researching their potential investment
products and also keeping a tab on any events that may affect the credit quality of the product.

Credit rating can be considered as a reasonably good proxy for the credit quality of a fixed income
security. The credit quality of one particular Issue may be different from the fundamentals of the
Issuer; there are several ways in which credit quality of an Issue may be enhanced.

Credit Rating – Meaning

Credit Rating is an assessment in terms of alphanumeric symbols to convey the creditworthiness of

an individual, company financial instruments or a country. It is a simple and easily understood tool
enabling the investor or lender the relative degree of risk associated with a loan amount on a debt
instrument or a financial obligation.

Credit rating is just an opinion about the creditworthiness of the instrument. However, it does not
give any assurance of repayment of the rated instrument. The rating is representative of the financial
history and current assets and liabilities of the rated instrument. A credit rating does not provide
recommendation to buy, hold or sell a debt instrument.

It just represents a guideline to help the investors or lenders for making an investment decision. A
high credit rating represents a good investment with very low risk of non-payment on a loan,
whereas a poor credit rating represents investments with a high level of risk of default. Investors
expect a risk return trade off. The investors who want high returns invest in low rated instruments
and get compensated for high risk involved with it.
Credit Rating – Definitions

According to Moody’s Investor Service, an International Credit Rating agency, “Ratings are designed
exclusively for the purpose of grading bonds according to their investment qualities”.

According to ICRA, a leading Credit Rating Agency in India, “Ratings are opinions on the relative
capability of timely servicing of corporate debt and obligations. These are not recommendations to
buy or sell, neither the accuracy nor the completeness of the information is guaranteed”.

Objectives of Credit Rating:

1. To rate the debt instruments as objectively as possible in order to build market confidence in
them.

2. To promote the growth of primary market in particular and capital market in general;

3. To ensure absorption of capital issues by the investors since inadequate subscription would
leave the projects high and dry;

4.To protect the interests of investors especially the small and gullible investors by giving
adequate clues in the form of ratings regarding safety and/or profitability of investments;

5.To ensure optimum allocation of capital as market absorbs highly rated credit instruments.

Need of the study:

Credit rating is a process by which risk associated with a credit instrument is evaluated. However,
it does not indicate market related risk or predict prices or yields of credit instruments. It is an
expert opinion on the relative ability and willingness of an issuer to make timely payments on
specific debtor related instruments.

The ratings are usually expressed either in alphabetic or alphanumeric symbols. They enable the
investor to differentiate between debt instruments on the basis of their credit quality. Thus,
credit rating is a symbolic indicator of the current opinion of the relative capability of the issuer
to service its debt obligations in a timely fashion. Ratings indicate safety, liquidity and
profitability of debt instruments.

Significance of Credit Rating:

In an open economy a number of companies, both national and foreign, enter the capital market
with their instruments to raise money. The investors are very often at a dark to evaluate the
company and its debt instruments.

A third party who is expert in analyzing the financial position of the company and who is credit
worthy can help the investor in his judgement. A credit rating agency takes up this function.

The credit rating agencies provide a yardstick to measure the risk inherent in an instrument. A
prospective investor makes use of this yardstick to assess the risk level in relation with the
expected rate of return.
 Merits of Rating to Company:

1.Lower Cost of Borrowing:

A company with a highly rated instrument has the opportunity to reduce the cost of borrowing
from the public by quoting a lesser interest rate on fixed deposits or debentures or bonds.
Investors usually prefer to invest in safe securities though yielding a marginally lower rate of
return.

2.Extensive Borrowing:

A company with a highly rated instrument can approach the investors extensively for resource
mobilization using the press media. Investors in different strata of the society could be attracted
by higher rated instruments. The investors understand the degree of certainty about timely
payment of interest and principal on a debt instrument with better rating.

3. Rating as Marketing Tool:

Companies with rated instruments improve their own image and avail of the rating as a
marketing tool to create a better image in dealings with its customers and constituents, lenders
and creditors. Even consumers feel confident in the utility products manufactured by the
companies carrying higher ratings for their credit instruments.

4.Self-Discipline by Companies:

Rating encourages the companies to come out with more disclosures about their accounting
system, financial reporting, management pattern, etc. The company gets opportunity and
motivation to improve upon its existing practices to match to the competitive standard and
maintain the standard of rating attained by it or make improvement upon the rating.

5. Reduction of Cost in Public Issues:

A company with a higher rated instrument is able to attract the investors and can raise funds
with least efforts. Thus, the rated company can economise and minimize cost of public issues by
controlling expenses on media coverage, conferences and other publicity stunts.

Limitations of credit rating:

1. The absence of accountability limits the process of credit rating. Lack of experienced and
skilled staff may not do justice to their task and it may lead to inappropriate ratings.

2. There is a huge scope of biased rating as there is no fixed mathematical formula for the
calculation of rating.

3. Rating does not guarantee any financial strength to the investors. It is changeable over the
period of time

4. Ratings are based on the past and present performances of a company and it may get altered
by the future events of a company.