Credit rating is a mechanism by which the reliability and viability of a credit instrument is brought out. When a company borrows or when a businessman raises loan, the lenders are interested in knowing the credit worthiness of the borrower not only in the present condition but also in future. Hence, credit rating reveals the soundness of any credit instruments issued by various business concerns for the purpose of financing their business,. In credit rating, the investor is not only able to know the soundness of the credit instrument, but be is also able to analyze between different credit instruments and he can make a tradeoff between risk and return.
1 CREDIT RATING OF INDIVIDUALS, COMPANIES AND COUNTRIES
Credit rating is resorted to: a) Companies b) Individuals c) Countries
a) Rating of Individuals: Individuals go for credit rating when they want to borrow from recognized institutions. In India, we have Onida Individual Credit Rating Agency (ONICRA) which gives credit rating for individuals.
b) Rating of Companies: As per the guidelines of SEBI and RBI, companies have to resort to credit rating when they : (i) accept public deposits (ii) issue credit instruments in domestic market (iii) issue credit instruments in overseas market.
c) Rating of Countries: Credit rating is resorted to by countries for borrowing in international market or for attracting foreign investments or for raising funds from the international institutions like IMF and IBRD.
2 Basis of Credit Rating Various aspects are taken into account by a credit rating agency when a borrowing company applies for rating. They are :
a. Business Analysis
b. Evaluation of industrial risks
c. Market position of the company within the industry
d. Operating efficiency of the company
e. Legal position in terms of prospectus
f. Financial analysis based on accounting quality
g. Statement of profits
h. Earnings protection
i. Cash flow and their adequacy
j. Financial flexibility
k. Track record of management
l. Capacity to overcome adverse situations
m.Goals philosophy and strategy
n. Labor turnover
o. Regulatory and competitive environment
q. Financial position-interest/tax sensitivity
3 Credit Rating Companies in India
Credit rating companies were started in India during the late 1980s. Credit Rating Information Services of India Ltd (CRISIL) was started in 1988 as a subsidiary of ICICI. Information and Credit Rating Services Ltd., (ICRA) was started in 1990, which is a subsidiary of IDBI. In 993, Credit Analysis and Research Ltd. (CARE) was started. 8. The suffix of ―+ (plus) or ―- (minus) signs are used with the rating symbols to indicate the comparative position of the instrument within the group covered by the symbol.
4 Types of Credit Rating We have seen the various rating symbols for different categories of the debt instruments. We can also classify credit rating as types of credit rating which are based on different securities. These are: 1. Equity rating 2. Bond rating 3. Promissory note rating
1. Equity Rating
When different companies are issuing shares, equity rating will enable the investor to choose proper equity share on the basis of the credit rating. While judging the equity rating, the past performance of the company, the earning per share and the turn-over of the company will be taken into account. If a loss making company turns into a profit making one, after wiping off its losses, its equity rating will go up. At the same time, if there is a decline in the dividend rate of an existing concern, compared to its previous years, its rating will get a beating.
2. Bond Rating Bonds are issued both by Government as well as by private sector companies. In the international market, rating of bonds will depends on the rate of interest offered and the value of the currency it represents. If the bond is issued in terms of U.S. Dollar or Pound Sterling, its value will be high and the rating will naturally be on the positive side. But the bonds of under developed countries will have lesser credit rating due to high fluctuations in their currency value. Bonds are also issued in the domestic market by both State and Central governments. Even the local governments, such as Corporation, such as Corporations and Boards also issue bonds for raising long-term finance in India; government bonds are preferred to private bonds as there is a guarantee for repayment of the principal and interest amount.
3. Promissory Note Rating In order to raise short-term loans, promissory note are issued by different commercial companies and depending upon their resources, these promissory notes will have credit rating. But, the issue of promissory notes will have no backing and the person advancing the resources against the promissory notes will undertake greater risks. Depending upon the credit rating, ranging from P1 to P6, promissory notes are preferred as a short-dated instrument. The unutilized resources lying with commercial banks may be invested in promissory notes of a better credit rating so obtained on idle funds.
4. Commercial Papers These are instruments issued by leading non-banking financial companies which can be obtained by companies for raising short-term loans from commercial banks. On due date, commercial banks will present these papers to the NBFC which has issued the commercial paper and funds will be obtained along with interest. Later on, the NBFC will collect the amount from the company which has utilized its commercial paper for raising its short-term loans. In order to enable the commercial banks to discount commercial papers, credit rating is provided to the commercial papers which depends upon the standing of the non-banking financial company NBFC) which is issuing the commercial paper.
5. Sovereign Rating When countries are issuing credit instruments in the international market such as Treasury bills and Bonds, they will be rated according to the economic condition of the country. Generally, the countries in the world are grouped under three categories, viz.,
(a) Countries which are politically and economically well developed.
(b) Countries which are politically stable but economically week.
(c) Countries which are politically and economically unstable or weak. In the first category, we have all the developed countries like U.S.A., U.K., Japan, etc., and their bonds will have high credit rating. In the second category we have countries like India which have slightly lesser credit rating and in the third category we have some of the African countries such as Rwanda, Kenya, Zulu, etc. The credit rating of the third category of countries will certainly be lower. In India, State Bank of India issued in the international market different credit instruments such as India Resurgent Bonds and Millennium Deposits and they were oversubscribed owing to the reputation of SBI,. All the NRIs throughout the world, could subscribe to these bonds and SBI could raise a substantial amount in terms of foreign exchange.