Importance of Credit Ratings in Capital Markets

In Capital Markets, every investor assesses risk differently based on his or her skills for credit evaluation. For the market to function smoothly, regulators need to protect investor’s interest against any malpractices. This leads to the need for Credit Rating in the Capital Markets.

Here is where Credit Rating Agencies come into play

A Credit Rating Agency (CRA) evaluates and assesses Creditworthiness of instruments like corporate bonds, government bonds, certificates of deposit, municipal bonds, preferred stock, and other debt obligations.

A CRA evaluates a prospect debtor by analyzing both qualitative and quantitative aspects estimating their ability to repay their debt alongwith interest obligations.

In the absence of CRAs, it would become impossible for investors to themselves assess the quality of all the debt instruments at individual level.

List of Credit Rating Agencies in India

Initial Big Four:

1. CRISIL (Credit Rating Information Services of India Limited)
2. ICRA (Investment Information and Credit Rating Agency of India)
3. India Ratings and Research (Formerly known as Fitch Ratings India)
4. CARE (Credit Analysis and Research Limited)

Next in Line:

5. Infomerics Ratings
6. Acuite Ratings & Research (erstwhile SMERA)
7. BWR (Brickwork Ratings India)
8. ONICRA (Onida Individual Credit Rating Agency of India)

Though there are several own variations of rating of each agency but typically, credit ratings follow a scale of AAA (the highest rating) to D (lowest). There are eight tiers:

1. AAA
2. AA
3. A
4. BBB
5. BB
6. B
7. C
8. D

A suffix of ‘plus’, ‘stable’ and ‘minus‘ is put before each of the aforesaid rating to indicate the likely scenario of the rating movement expected in near future. It just gives an indicative direction only and the actual rating may be different from the projected ones.

Entities that benefit from Credit Rating

1. Investors: Credit Rating helps investors to make investment decisions. It allows them to choose instruments based on their risk tolerance and expected returns. CRAs regularly evaluates debt instruments and make sure that it rightly reflects the current condition of the market and the issuer. This saves time and effort of the investor, and assures safety of investors by letting them invest in highly rated instruments with such ease of understanding. A gap of information exists between the issuer and the lender and CRAs bridges this gap.
2. Issuers: High Credit Rating improves corporate brand image. It is better to have corporate image based on facts as opposed to perception. Credit Rating helps companies to reduce their borrowing cost. Lenders shall be willing to accept lower interest rate for higher credit rating. Obtaining Credit Rating opens more borrowing avenues for a company.

Points to note before making investments based on Credit Ratings

1. Credit Ratings are based on past performance. Though it is regularly updated (normally on a quarterly basis for listed companies) but the frequency might not be very high.
2. Issuing company might hide facts from the CRA with malicious intentions. A detailed analysis and crosschecking is recommended, if one wants to be more thorough with their assessment.
3. Rating for different instruments of the same company can vary also. Hence, it is advisable to check the rating for each instrument.
4. In common market parlance, the rating issued by Top 4 Rating firms normally have relatively higher weightage than that issued by other rating firms for same issuer company.

Hence, Credit Rating Agencies do provide meaningful information for assessing the performance of any company. However, it is advised that the prospective investor also does his own independent assessment and do not rely solely on Credit Rating Agency Report.