Credit Rating is an opinion provided by a Credit Rating Agency regarding the ability and willingness of an entity (Government, corporate, municipality, Bank lending, etc. to fulfill its financial obligations in completeness and within the established due dates.
Such ratings are based on a comprehensive analysis of various factors, including the issuer’s financial health, debt repayment history, industry dynamics, and macroeconomic conditions. They are typically represented by a combination of letter codes or symbols, such as AAA, BB, or C, indicating the entity’s or instrument’s creditworthiness.
A higher credit rating grants borrowers the advantage of securing loans at lower interest rates. Credit ratings also facilitate trading fixed-income securities on the secondary market, providing traders with valuable information for making informed investment decisions.
The following are the major credit rating agencies in India.
- Credit Rating Information Services of India Ltd. (CRISIL)
- Investment Information and Credit Rating Agency of India (ICRA) Ltd.
- Credit Analysis and Research (CARE) Ltd.
- Acuite Ratings & Research Ltd.
- Brickwork Ratings India Private Ltd.
- India Ratings and Research Pvt. Ltd.
- INFOMERICS Valuation and Rating Private Ltd.
Credit rating agencies employ unique terminologies within their credit rating scales to delineate the risk inherent to corporate entities. These credit rating systems are designed for this purpose.
Please see the following image of different credit rating agencies indicating their credit rating uniquely.
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Each credit rating agency uses a different set of terms to highlight the risk associated with different categories of entities as it is a part of the credit rating scale that they have developed for such purposes. But, they can be broadly put under the following categories:
Corporate Ratings: Corporate credit ratings are the assessment of a company’s ability to pay its debts according to an independent credit rating agency. They cover a broad spectrum of corporate debt instruments, including bonds and commercial papers, reflecting companies’ financial health and risk level. Corporate Credit rating enables potential investors and business partners to make a reliable assessment of the full and timely repayment of outstanding liabilities by the company. These ratings evaluate the overall ability of corporations to repay their debt.
Sovereign Ratings: A sovereign credit rating is an assessment of a country’s creditworthiness. These ratings assess the country’s fiscal health and likelihood of repaying sovereign debt. It shows the level of risk (including political risk) associated with lending to a particular country since it is applied to all bonds issued by the government. They are crucial for foreign investors and play a significant role in determining, the level of risk and the borrowing cost for the country on the international stage.
Municipal Bond Ratings: Municipal Bond Ratings: Municipal bond ratings determine the amount of investment risk and interest cost on bonds used for financing government projects. These ratings focused on the debt issued by local government bodies or municipalities, these ratings provide insights into the credit risk associated with municipal bonds, often used to fund public projects.
Structured Finance Ratings: These ratings are applied to complex financial products like mortgage-backed securities (MBS) or asset-backed securities (ABS). They evaluate the risk of default associated with these products, which are structured using pools of assets or other derivative instruments. This rating is based on the difference from corporate credit rating assessment of the risks associated with the individual components of the structured instrument. These components include legal risk, credit quality of the underlying asset, and the various features of the structure and the transaction involved on asset class like Asset-Backed Securitisation (ABS), Mortgage Backed Securitisation (MBS), Collateralised Debt Obligation (CDO), Future Flow Transaction (FFT) where specific sources of future cash flows are identified and earmarked for servicing investors and Partial Guarantee Structures (PGS). These are on-balance sheet liabilities that are credit-enhanced through an external guarantee. The symbols used for SFRs are similar to the Credit Rating symbols, except that the SFRs carry a suffix of SO (for Structured Obligation) within parentheses. SFRs are based on an estimation of the expected loss on the Rated instrument, under various possible scenarios. The expected loss is defined as the product of the probability of default and severity of loss, once the default occurs. An SFR symbol indicates the relative level of expected loss for that instrument, with the risk of loss being similar to in the case of a corporate Credit Rating of the same level.
Bank Loan Ratings: Specifically designed to rate the creditworthiness of bank loans, these ratings help assess the risk of default on loans extended by banks to corporate or individual borrowers. In the Basel-II and Basel-III approaches, the credit risk of exposure is governed by four parameters: the probability of default (PD), the loss-given default (LGD), the exposure at default (EAD), and maturity. A bank loan rating conveys the credit risk that the bank is undertaking by lending to the borrower. The probability of default (PD) refers to the risk that the bank faces in not receiving the payment in full on the due date from the borrower. The process for assigning ratings to bank loans is similar to that followed for rating bonds and debentures. Ratings are assigned on the long- and short-term scales, depending on the original maturity of the facility.
