1

Credit Rating

Meaning & Definition of Credit Rating (Measurement of Risk):

 Credit rating means evaluating the creditability of companies and
instruments.

 Credit rating makes a qualitative and quantitative assessment of a

borrower’s creditworthiness as well as of the instrument such as
bonds/debenture/equity shares etc.

 It indicates the relative degree of risk in the security instrument. In other

words, it indicates probability of timely payment of interest and principal
amount on a debt instrument. It also helps the investors whether to invest
in the shares/debentures of a company.

 Generally, ratings are denoted in an alphabetical and alphanumeric symbol

which helps the investors to differentiate between different debts
instruments and shares of the company on the basis of underlying degree
of risk.

Objectives of credit rating:

1. Building goodwill of the issuer in the capital market by delivering true and
fair information regarding the creditability of the companies issuing debt and
share capital instruments.

2. Providing a fair risk-return structure of various debt and capital

instruments to the investors.

3. Enabling an investor to get an indication of the debt servicing capacity

of a product issued by a company.

1
 2

Benefits /Importance of Credit Rating:

Benefits of Rating to companies:

1. Easy to raise resources: By notifying their ratings, the company can

easily obtain capital from the public. The investor always tries to invest in
the high rated instruments.
2. Helps in building image: The companies whose securities are highly
rated and circulated in the market enjoy goodwill in the eyes of customers,
shareholders, investors and creditors. Such companies easily procure funds
from the market since investors are confident to good and timely return on
their investment and borrowers of timely return of interest and principal
amount.
3. Recognition to unknown companies: Credit rating companies
facilitates the unknown companies to be recognized in the market after
rating their securities. It enables the firm to make issues from the public
easily.
4. Benefits to brokers and financial intermediaries: In Highly rated
companies, brokers feel easy to convince their clients to select an
investment proposal. This saves time, energy, costs and manpower of the
brokers and financial inter-me diaries.
5. Reduction of costs in public issues: A company with high rating can
economize and minimize cost of public issues by controlling expenses on
media coverage, conferences and other publicity stunts.
6. Wider audience for borrowing: A company with a highly rated
instrument can approach the investors easily and extensively for the
resource mobilization using the press media.
7. Lower cost of borrowing: A company with high rated instrument has
the opportunity to reduce the cost of borrowing by quoting lesser rate of
interest on fixed deposits as the investors always prefer those companies
which are safe in payment of interest and return of principal amount even
with the lesser rate of interest.
8. Rating makes capital and debt market more efficient and transparent.

2
 3

Benefits to Investors:
1. Choice of investment: Credit rating provides choice of investment to
the investors. When several alternative credit rating instruments are
available at a particular point of time in the capital market, investors can
make choice depending upon their own risk profile and diversification
plan.
2. Saving investors’ time and energy: Credit rating saves investors’
time and energy in knowing about the fundamentals of a company, its
actual strength and weakness, management details etc. and enables
them to take a quick decision regarding available investment
opportunities based on their risk-return preferences.
3. Credibility of issuer: Rating gives a clue about the credibility of the
issuer company. Absence of business links between the rater and rated
firm establish ground for credibility and attract investors.
4. Independence of investment decisions: For making investment
decisions, investors have to seek advice of financial intermediaries, the
stock brokers, merchant bankers, the portfolio managers etc. , but for
rated instruments, investors need not depend upon the advice of these
institutions as the rating symbol suggests itself the credit worthiness of
the instrument and indicate the degree of risk involved in it.
5. Safeguards against bankruptcy: Highly rated instrument of a
company gives an assurance to the investors of safety of instrument and
minimum risk of bankruptcy.
6. Easy to understand: Ratings are based on easily understandable
symbols. Investors can easily understand them and make a proper
decision about the choice of investment.

Disadvantages of Credit Rating:

Important disadvantages /shortfalls of credit rating may be outlined as
under:
1. Competitive ratings: Due to prevailing competition among credit
rating agencies, companies may try to purchase (Bribe) the rating
agency to influence good rating.
2. Based on Assumption: In the process of finalizing credit rating,
rating agency makes some assumptions. Further, on the basis of

3
 4

information provided by the issuer, the credit rating agency allots the
rating to these issuers. Thus, if the information delivered by the issuer/
assumptions made by them are incorrect/ not up to mark, it may affect
the quality of rating.
3. Inexperienced, unskilled or overloaded staff may not do justice to
their job and the resulting ratings may not be perfect.
4. The rating is not permanent but subject to changes and moreover the
agencies cannot give guarantee for the investors.
5. Credit rating provides simply a guidance to reach the decision.
However, the final decision has to be taken by the investor himself.
xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx
xxx
Types of Credit Rating:
A. On the basis of instruments and users - There are three types of
credit rating which are as follows:
1. Financial Instrument Rating
2. Customer/Borrower Rating – Means analysis of creditability of a
customer for whom credit rating is to be made.
3. Borrower Rating: means analyzing the capability of the borrower to
pay back the loan or credit facility

B. On the basis of Execution: Credit Ratings could either be internal or external:

1. Internal: Done by the institution themselves (Particularly, the banks). Most banks
have their own models for rating the creditworthiness of their corporate and retail
clients.
2. External:
 Credit ratings given by independent agencies which are external to the
organization is called external credit agency.
 Certain Independent organizations called Credit Rating Agencies have
professional analysts who provide credit ratings on a contractual basis. Credit
ratings, however, are mainly done for companies that have publicly traded
securities (Debt and share capital) .

4
 5

 Credit rating agencies assess the relative risk and return of securities and
borrowing entities.

S.N Internal Credit Risk Rating External Credit Risk Rating

1 Undertaken internally by the Risk Undertaken by approved External

Management department of the bank.. credit risk rating agencies such as
CRISIL, ICRA, CARE etc.

2 Use internally developed rating models by Use rating models developed by

respective banks respective rating agency.

3 Internal credit ratings are used by financial Both institutional and individual
organizations/banks to determine whether or investors use credit ratings to assess the
not to give a loan and, if so, under what terms. risk related to investing in a specific
instrument..

Meaning of Credit Rating Agency:

A credit rating agency (CRA, also called a ratings service) is a company that
assigns credit ratings to a company or an instrument. A credit rating /credit score
is a 3-digit number that represents the creditworthiness of the borrower which
rates a debtor's ability to pay back debt timely (principal and interest payments)
and the likelihood of default.

The creditworthiness of an individual or a company is decided considering

their lending and borrowing transactions of the past, statements of liabilities
and assets, and their ability to meet the debt obligations.

There are several credit rating agencies in India, however out of them, At present,
there are six credit rating agencies registered with the SEBI (CRISIL, ICRA,
CARE, SMERA, Fitch India and Brickwork Ratings.).

5
 6

Objectives/Functions of credit rating/credit rating agency

1. It makes available reliable information regarding securities at low cost:

2. It creates healthy discipline among corporate borrowers.

3. It helps in the formation of public policy about the credit status of the
securities or their issuers.
4. It offers various advisory and consultancy services to the clients belonging
to different sectors.
5. It provides basis to the investors for determining risk and return among
different securities.

Methodology of Rating:
 The rating exercise starts at the request of the company which is quite
lengthy and time consuming.
 Ratings are assigned after an in-depth study of various factors related to
business, financial management, industry and evaluation of the
strengths and weaknesses of the company and security (debt and share)
instrument.
 Rating is normally assigned after analyzing operating and financial data,
at least of last five years of the concerned entity.

In general, rating is assigned after analyzing the following five broad areas:

1. Economic analysis: This is one of the prime factors of rating methodology.

In the ‘Economic Analysis Context’, it is assessed which factors of the

prevailing economic environment have a bearing on the operations of the
organization and in which direction i.e. positive /negative. What is the existing
government policy to the industry and its impact on the functioning of the
organization and also probable changes therein in the future?

2. Business Analysis: In this context, normally the following aspects are

analyzed:

a. Operating efficiency in the production process of the firm . It basically

covers such points such as use of technology, cost structure, locational
advantages, labour relationship, input availability etc.

6
 7

b. Market position of the company vis-a vis the industry, (Marketing

strengths and weaknesses of the firm vis-a vis its competitors), Marketing
arrangements, value of product to the people and segments of customers etc.
c. Analysis of Industry: It covers demand and supply of the product in the
country, competitors ‘s strengths and weakness, changes in technology and its
adoption at the domestic and international level, future prospectus of
performance of the industry etc.
d. Legal aspects: It covers study of prospectus, accuracy of information, filing of
forms, returns with proper regulatory authorities etc.

3. Financial Analysis: It includes –

a. Evaluation of past and expected future financial performance

b. Debt servicing capacity
c. Financial policy of the company decides cash flow adequacy and level of financial
risk involved in the firm.
d. Financial flexibility – is examined in terms of whether alternative sources of
liquidity are available to the company as and when required.
e. Company’s contingency plans under various stress scenarios.

4. Management Evaluation: It includes the study of the following

aspects-

a. Track record of the management

b. Management’s capacity to overcome adverse situations
c. Goals, philosophy, strategies, control systems, personnel policies, and
performance of group companies.

5. Fundamental Analysis: It includes the study of the following aspects-

a. Company’s credit management policy

b. Evaluation of Liquidity management through a study of capital
structure,
c. Examination of profitability using various ratios.

7
 8

Model of Credit Rating Company: A credit rating company examines and

ranks the creditworthiness of a person or an organization. These rating agencies
give rating to the firm and its financial instruments, on the following two models:
1. Issuer Pay-Model: Under this model, rating companies charge Issuer
Company a fee for issuing credit rating. The rating companies obtain facts
and information from issuers as a part of the rating process and include it
into their credit quality assessment which otherwise inaccessible to
investors and other market players.
2. Subscription Model (Investors pay model): Some credit rating companies
use the subscription model in which they charge investors and other
market players a fee to view their ratings.
Issuer pays Model V/s Subscription Model:

1. In case of Issuer pay model, the credit rating agency has not only public
information but also have access to confidential and quality information about
the issuer for the ratings.
While in case of subscription model, they rely on the information
available on the public domain.

2. In the issuer pay model, ratings are available to the entire market. While in
case of subscription model, ratings are available in restricted form .

3. In the issuer pay model, The information available to all the investors would
be free of charge and will highly aid the small investors. While in case of
subscription model, ratings are available only those who pay for them.

4. In the issuer pay model, An investor can compare the ratings of various
instruments before making an investment decision. While in case of
subscription model, such facility is not easily available.

8
 9

A brief detail about some of the important credit agencies are as

under:-
CRISIL Limited (Credit Rating Information Services Of India Ltd.)
 CRISIL Ltd is a leading and innovative global analytical company, providing
credit ratings to companies and its various instruments.
 CRISIL limited was set up in January 1987 jointly by ICICI ltd., UTI, GIC , LIC,
and domestic and foreign banks as the first credit rating agency in India. Its
headquarter is in Mumbai.
 CRISIL provides corporate reports regularly on public sector and private
sector companies that contain information on their financial, business and
technical aspects.
 CRISIL is a publicly listed company on India’s leading stock exchanges.
 During 1995-96, CRISIL has formed a strategic tie up with Standard and
Poor’s USA. the world’s leading credit rating agency.
 Apart from providing credit rating, CRISIL also provides technical assistance
and training to new rating agencies, advisory and consultancy services, etc. It
is perhaps the only rating agency outside the USA to provide technical
know- how overseas. Till date, it has rated over 95,000 entities.
 As on December 31, 2021, the Company had 3 Indian and 13 overseas
wholly owned subsidiaries.

CARE (Credit Analysis and Research Limited)

(CARE) was promoted in 1993 jointly with investment companies, banks and
finance companies and is the second largest rating agency (in terms of rating
income) in the country.
Apart from providing rating services to financial sector, infrastructure sector,
corporate, public finance, CARE is also engaged in rating IPOs, educational
institutions, shipyards, etc.
Being headquartered in Mumbai (Maharashtra), CARE has geographical presence
in Republic of Maldives, Brazil, Malaysia, Portugal and South Africa and has
recently partnered with four other domestic credit rating agencies in Brazil,

9
 10

Malaysia, Portugal and South Africa to form an international credit rating agency
called ARC Ratings.

Investment Information and Credit Rating Agencies of India (ICRA) :

ICRA Limited (ICRA) is an Indian independent and professional investment information
and credit rating agency. It was promoted by IFCI in collaboration with other
financial institutions in 1991. The main objective of ICRA is to provide information
about the credit risks associated with a firm or an instrument such as debentures,
preference shares, fixed deposits, bonds etc.

It has its shares listed on the Bombay Stock Exchange (BSE) and the National
Stock Exchange (NSE).ICRA has divided its operations in three following
categories:

1. Ratingservices
2. Information services, and
3. Advisory services.

Model Rating Formats of Main Credit Rating Agencies in India

Rating Scale CRISIL Care ICRA

Highest safety: Lowest risk of turning CRISIL AAA CARE AAA ICRA AAA
into a defaulter
High safety: Very low credit risk CRISIL AA CARE AA ICRA AA
Low Risk CRISIL A CARE A ICRA A
Moderate safety: Moderate credit CRISIL BBB CARE BBB ICRA BBB
risk
Moderate risk: Moderate risk of CRISIL BB CARE BB ICRA BB
default
High Risk: High risk of default CRISIL B CARE B ICRA B
Very High risk : Very high risk of CRISIL C CARE C ICRA C
default

10
11

11