Importance of Credit rating

Importance of Credit rating

Credit rating set up a link between risk and return. They provide a criterion against which to measure the risk in any instrument. A depositor uses the ratings to estimate the risk level and compares the offered rate of return with his expected rate of return (for the fix level of risk) to full optimization of his risk-return trade-off. The risk perception of a common depositor, in the lack of a credit rating system, largely depends on his familiarity with the names of the promoters or the collaborators. It is impossible for the corporate emitters of a debt instrument to offer every depositor opportunity to start a detailed risk evaluation. It is very rare for different depositor to come at few uniform conclusions to the comparative quality of the instrument. Moreover they do not have the required skills of credit evaluation. Therefore the need for credit rating in today’s world cannot be over optimized. It helps depositors in making investment decisions. It also helps the emitters of the debt instruments to price their issues correctly and to reach out to new depositors.

Commercial Banks

Controller like Reserve Bank of India (RBI) and Securities and Exchange Board of India (SEBI) use credit rating system to determine eligibility criteria for some instruments.For example, the tally has specified a minimum credit rating by associate approved agency for allotting of business paper. In general, credit rating is predicted to boost quality consciousness within the market and establish span of your time, a lot of substantive relationship between the standard of debt and therefore the yield from it. Credit Rating is additionally a valuable input in putting in place business relationships of varied sorts. However, credit rating by a rating agency isn't a recommendation to buy or sale of a security. Depositors usually follow security ratings whereas creating investments. Ratings square measure thought of to be associate degree objective analysis of the credibility that a receiver can neglect a given security issue, by the depositors. Whenever a security institution makes late payment, a default happens. Just in case of bonds, non payment of either principal or interest or each might cause liquidation of an organization. 

 In most of the cases, holders of bonds issued     by a bankrupt company receive solely a little of the number invested with by them. Thus, credit rating may be a skilled opinion given when finding out all accessible data at a specific purpose of your time. Such opinions could prove wrong within the context of subsequent events. Further, there's no personal contract between associate capitalist and a rating agency and also the capitalist is liberal to settle or reject the opinion of the agency. A rating agency can't be command liable for any losses suffered by the capitalist taking investment call on the premise of its rating. 

Credit rating is associate capitalist service and a rating agency is predicted to keep up the best potential level of analytical competency and integrity. Within the long-standing time, the credibility of rating agency needs to be engineered, brick by brick, on the standard of its services provided, continuous analysis undertaken and consistent efforts created. The increasing levels of default ensuing from straight forward handiness of finance, has light-emitting diode to the growing importance of the credit rating.

The other factors are :

i. The growth of information technology.

ii. Globalization of financial markets.

iii. Increasing role of capital and money markets.

iv. Lack of government safety measures. 

v. The trend towards privatization.

vi. Securitization of debt.

Indications of the Assigned Credit Rating symbols assigned to a security issue are an indicator of the following:

i. the nature and terms of the particular security being issued.

ii. The ability and the willingness of the issuer of a security to make payments in time.

iii. The probability that the issuer will make a default in payments.

iv. the degree of protection available to the depositors if the security issuer company is liquidated, re-organised or declared bankrupt.

Posted in: Credit rating,Globalization,privatization,RBI,SEBI