Credit rating system plays a vital role in the life of the company as well as in investors. In case of the company , it helps in arranging the source of finance in the capital market and in case of investors it gives protection to the investors against risk by indicating the credit worthiness of the borrower . Fair and good credit ratings motivate the public to invest their savings. Credit rating can be defined as the credit threat linked with the financial instrument or body. In other words, credit rating can also be defined as the opinion about the credit quality of the financial instrument/ entity. Under this the credit rating agencies give the rating to the entity based on their testimonials and the extent to which their past borrowings and lending mentioned in their financial statements are reliable.
The tools used by these credit rating agencies are very simple, easily recognizable and the investor can easily distinguish between the debt instruments. they are either in alphabetical or in alphanumeric symbols. These symbols point towards the current views about the debt instruments. It conveys the message to the investors, regarding the ranking of defaults loss probability when compared with other rated instruments.
Purchasing or selling of securities is not recommended by the credit rating agencies. It is related with an act of assigning values by estimating worth or reputation of solvency, and honesty so as to repose the trust in person’s ability and intention to repay.
The ratings assigned are generally regarded in the investment community as an objective evaluation of the probability that a borrower will default on a given security issue. Default occurs whenever a security issuer is late in making one or more payments that it is legally obligated to make.
If , we talk about the bonds, the situation is different. The bond is lawfully in default if, it fails to pay the interest and the principal amount in time. Sometimes the companies repay back to the bond holders otherwise companies are declares as insolvent.
Different kinds of credit ratings
Some of the different types of credit rating are mentioned below:
- Bond or debenture rating agencies which do the rating of debentures and bonds issued by government or corporate.
- Equity rating agencies which do the rating of the equity shares issued by companies.
- Preference share rating agencies which do the rating of the preference shares issued by companies.
- Commercial paper rating agencies which do the rating of the commercial papers which are issued by manufacturing companies, finance companies, banks and financial institutions
- Fixed deposits rating agencies which do the rating of medium term unsecured borrowings
Dr. Himani Gupta
Dept of Management Studies