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Credit Rating

Definition and Concept:

The act of assigning values to credit instruments by assessing the ability of the
borrower to repay debt and indicating the values through pre-determined symbols
is called Credit Rating.

Credit rating may also be defined as grading bonds with accordance with
their investment quality. It is the current assessment of credit worthiness of the
issuer of the credit instrument with respect to its obligation to repay debt. It is a
means which provides the lenders or investors with a simple gradation system to
judge the relative abilities or capacities of the companies to make timely
repayment of interest and principal on a particular kind of debt.

It is to be noted that credit rating is not a recommendation to the lenders or


investors to purchase or sell or hold the securities. Again, it is not general purpose
evaluation of the company’s liability. In fact, Credit rating is a specific or special
purpose on-going evaluation of risk that remains valid for the life span of the
security. Credit Rating can be done by Credit Rating Agency (CRA). The SEBI has
defined Credit Rating Agency as a body of corporate registered under the
Securities and Exchange Board of India (credit rating agencies) Regulations, 1999.
When a credit rating Agency makes a credit rating of a company, it doesn’t create
any fiduciary relationship between the credit rating agency and the rating users.

Functions of Credit Rating:


1. Indication of risk: Through the study of credit rating, the investors can
assess the degree of default risk involvement in the financial instrument
issued by the company.

2. Gradation : Credit rating is designed for the purpose of grading the bonds
in accordance with their investment quality.
3. Assessment of solvency: Credit rating estimates or assesses the vales of
credit instruments by applying specialized and expert knowledge to assess
the solvency position of the borrower or issuer of the credit instrument.

4. Symbolization: The companies or borrowers whose credit are rated by the


credit rating agencies are expressed through certain predefined symbols,
such as, AAA, AA, A, A+, BBB, BB, B+, C, D, etc. These symbols indicate
the ability of the company or borrower to repay its debt.

5. Assessment of credit worthiness: The creditworthiness and reliability of


the obligator are made available to the investors or lenders by credit rating.

6. Factorial Assessment: In the function of assigning ratings, the credit rating


agency rates the different factors which have influence or impact upon the
instrument. The factors which are taken into consideration by the credit
rating instrument are :

i) Industry risk in which the organization or issuing company belongs.

ii) Market position of the organization.

iii) Operating efficiency of the issuing company.

iv) Track record.

v) Planning and controlling systems which are in the issuing company.

vi) Financial soundness and accounting quality maintained.

vii) Liquidity position of the organization.

viii) Profitability of the issuing company.

7. Country Rating: The credit rating extends to the country rating which is
also known as ‘Sovereign rating’. Here the whole country or nation is rated
to assess its solvency or credit worthiness.
There was belated beginning of credit rating in India. It began in India in 1988 and
its progress was slow at its inception but In recent times, credit rating has gained
importance in India.

The different credit rating agencies working at present in India are:

i) CRISIL (Credit rating information services of India Ltd.)

ii) ICRA (Investment Information and credit rating Agency of India Ltd.)

iii) CARE (Credit Analysis and Research in Equities Ltd.)

iv) ONICRA (ONIDA Individual Credit Rating Agency of India Ltd.)

v) DCR (Duff and Phelps Credit rating Agency Of India Ltd.)

Credit Rating : by CRISIL


In case of debenture /long term investment rating

Highest safety AAA

High safety AA

Adequate Safety A

Moderate Safety BBB

Inadequate Safety BB

High risk B

Subtantial Risk C

Default D