NEED/USES OF CREDIT RATING

Credit rating is extremely useful for understanding the risk and return relationship for an investor. Other than an investor, the Credit rating can also be used by the Issuer Company, the Intermediaries and the Regulators. 

■ For Investors: The main purpose of credit rating is to communicate to the investors the relative ranking of the default loss probability for a given fixed income investment, in comparison with other rated instruments. In a way it is essentially an information service. In the absence of professional credit rating, the investor has to largely depend on his familiarity with the names of promoters or collaborators of a company issuing debt instruments. This is not a reliable method of evaluation for investment. 

Credit rating by skilled, competent and credible professionals eliminates or at least minimizes the role of name recognition and replaces it with a well researched and properly analyzed opinion. 

This method provides a low cost supplement to investors. Large investors use information provided by rating agencies such as upgrades and downgrades and alter their portfolio mix by operating in the secondary market. Investors also use the industry reports, corporate reports, seminars and open access provided by the credit rating agencies. 

■ For Issuer Companies: The market places immense faith in opinion of credit rating agencies, hence the issuers also depend on their critical analysis. This enables the issuers of highly rated instruments to access the market even during adverse market conditions. Credit rating gives exact picture about the financial health of a company, in case the company wishes to improve its credit rating. It can take clue from such credit rating. 

Credit rating provides a basis for determining the additional return (over and above a risk free return) which investors must get in order to be compensated for the additional risk that they bear. The difference in price leads to significant cost savings in the case of highly rated instruments. A good credit rating improves the overall reputation of the company in the market and accordingly, investors shall invest their hard earned money with full confidence.

■ For Intermediaries: Rating is useful to Intermediaries such as merchant bankers for planning, pricing, underwriting and placement of the issues. Intermediaries like brokers, bankers to the issue, registrar & transfer agent and dealers in securities use rating as an input for monitoring their risk exposures. Merchant bankers also use credit rating for pre – packaging issues by way of asset securitization/structured obligations. 

■ For Regulators: The Reserve Bank of India (RBI) prescribes a number of regulatory uses of ratings. The RBI requires that a NBFC must have minimum investment grade credit rating if it intends to accept public deposits. 

As per money market regulations of the RBI, a corporate must get an issue of CP rated and can issue such paper subject to a minimum rating. SEBI has also stipulated that ratings are compulsory for all public issue of debentures. SEBI has also made mandatory for acceptance of public deposit by Collective Investment Schemes. Accordingly, rating is required to comply with various regulatory requirements of Indian Laws.