IIBF CCP INTRODUCTION & OVERVIEW OF CREDIT | CREDIT RATING
CREDIT RATING:- In this article, we will get to read to what is Risk, how it is measured, the meaning of Credit Rating, the Objectives of Credit Rating, what is Internal & External Rating, the Methodology of Rating, Internal & External Comparison, Model Rating Formats & Model Credit Rating.
The risk that the borrower might not repay a loan or meet his or her contractual obligations is known as Credit Risk.
In a traditional sense, it refers to the risk that the lender might not receive his/her owed principal & interest, which would interrupt his/her cash flows & increases collection cost.
Although it is not possible to know exactly who might default on their obligations, but still a proper assessment & management of credit risk can lessen extent of a loss. Interest payments from the borrower or issuer of a debt obligation are a lender’s or investor’s reward for assuming credit risk.
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Understanding Credit Risk
When a lender offers credit or loan, in any form such as mortgages, credit cards, or some other types of loans, there is a risk that the borrower might not repay the loan amount.
Credit risk is calculated based on the borrower’s overall ability to repay the loan as per the original terms. The credit risk can be measured by the 6 Cs:
- Collateral &
- Cash Flows.
Factors Affecting Credit Ratings In India
There are some other factors that also affect the credit ratings on a borrower in India:
Borrower’s history: The agencies do consider the past history of the borrower including their history of borrowing & when they have re-paid their loans. Similarly, when the borrower delays the repayment it severely affects the borrower’s rating.
Future economic potential of the company: The credit rating of a borrower is also determined on the basis of its future potential. If the borrowers present a profitable future based on projections, current performance, etc., then, the credit rating will give them a positive rating.
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FACTORS AFFECTING CREDIT SCORE IN INDIA
The credit bureau takes into account various factors that helps in the calculation of an individual’s credit score by taking into account the below factors:
- 35% = Payment history
- 30% = Credit utilisation
- 15% = Credit history length
- 10% = New credit
- 10% = Credit mix
Consumers who bring a higher credit risk usually end up paying higher rates of interest on loans.
Some companies or banks establish separate departments who solely look after the assessment of the credit risks from their current & potential customers. Today, the technology has made it possible for the businesses to quickly analyze the data to assess a customer’s risk profile.
The credit rating is an evaluation by a credit rating agency of the entity’s (such as governments, non-profit organisations, and countries, among others) the qualitative and quantitative information on behalf of prospective debtor, including any information that the prospective debtor provides & other non-public information that the credit rating agency gets, to do the analysis.
This rating is duly given to entities after analysing their business & finance risk & a detailed report is prepared after taking into consideration some additional factors such as the ability to repay the debt.
Credit Rating Agencies are the persons who prepare the Credit reporting or Credit Score (a subset of credit rating) which is a numeric evaluation of an individual’s credit worthiness.
Types of Credit Ratings
Different Credit agencies use various terminology to determine the credit ratings. Though the terms are very similar & the Ratings can always be grouped into two:
- Investment Grade
- Speculative Grade
Investment grade: This rating mean that the investment is solid and the issuer is most likely going to meet the repayment terms. These investments will get priced at less when compared to investments of speculative grade.
Speculative grade: These investments are known to bear high risk. Therefore, they are offered at higher rates of interest.
USERS OF CREDIT RATINGS
Credit ratings are mostly used by investors & intermediaries such as:
- Debt Issuers
- Investment banks
- Business Corporations
OBJECTIVES OF CREDIT RATING
Credit rating fulfils the below written objectives:
- Providing superior information to the investors at a low cost;
- Providing a sound basis to make proper structure of risk-return;
- It keeps the borrowers under healthy discipline, and
- It assists in the framing of public policy guidelines on institutional investment.
Thus, credit rating in financial services represent an exercise in faith building for the development of a healthy financial system.
CREDIT RATING IN INDIA
Seeing the services or tasks that the credit rating agencies provide, it has gained significant importance in the Indian financial market in the last 20 years.
In simple terms, credit rating is the assessment of the entity’s creditworthiness after the consideration of the quantitative & qualitative attributes of the borrower. These attributes can be the financial statements, industry analysis, annual reports, reports that are provided by analysts, news pieces, projections for the next quarter which helps the agencies in determination of the rating to be given to the entity.
There are a no. of credit agencies in the country which rate companies and organisations after measuring (proper analysis) their ability to repay the borrowed amount.
WHO EVALUATES CREDIT RATINGS IN INDIA?
The top credit rating agencies in India are listed below:
- CRISIL: Credit Rating Information Services of India Limited,
- ICRA Limited,
- CARE: Credit Analysis and Research limited,
- India Rating and Research Private Limited, etc.
REGULATION OF CREDIT RATING AGENCIES:
SEBI (Credit Rating Agencies) Regulations, 1999 of the Securities and Exchange Board of India Act, 1992 regulates all the above & other credit rating agencies in India. These agencies measure the likelihood of an entity i.e borrower turning into a defaulter.
IMPORTANCE OF CREDIT RATING
Likely Possibility: When a credit rating agency upgrades a borrower’s rating, the rating suggests that the chances are that the company will repay the credit.
While on the other hand, when the credit rating of a borrower gets downgraded, the rating suggests the company’s ability to repay is reduced. Once the borrower’s credit rating downgrades, it becomes difficult for it to borrow money as it will be considered a high-risk borrower. Financial institutions might hesitate to lend money to the companies with low credit rating.
So, that makes it important to take note of what is the importance of credit rating:
- Its qualitative and quantitative assessment of creditworthiness of borrower.
- It helps investors take a sound investment decision after considering (risk-return relationship) the risk factor and past repayment behaviour.
- In the case of the non-popular companies, credit ratings help them in improving their corporate image.
- Acts as a marketing tool for companies & also as a resource which is helpful when raising money.
- Lenders tend to offer loans at a lower interest rate if the borrower has a higher credit rating.
- Credit ratings encourages better adherence to accounting standards, detailed information disclosure, & improved financial information.