What is a credit rating?
Meaning: Credit rating is a mechanism by which the reliability and viability of a credit instrument is brought out. Credit rating reveals the soundness of any credit instruments issued by various business concerns for the purpose of financing their business.
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 conditions but also in future. In credit rating, the investor is not only able to know the soundness of the credit instrument, but he is also able to analyze between different credit instruments and he can make a trade off.
Benefits of Credit rating:
Credit rating offers various benefits from the point of view of investors, companies, regulating authorities and public. Credit score of a company matters a lot when it comes to boost confidence in investors. Good credit rating reflects how much a company is financially strong and secure.
Benefits of credit ratings from the point of view of investors:
- The investors can choose their investments on the basis of good credit ratings.
- As the credit rating is done by professionals, the investors can rely on the credit rating.
- It gives scope for the investors to forecast about the future of their investments.
- A comparative study between different credit instruments enables the investors to choose their investments.
- Even unknown securities could be purchased based on credit rating. It also enables the investors to go for a diversified investment.
- As there is periodical review of the companies by credit rating agencies, the investors have the opportunity of swapping their weaker investment with a stronger investment, based on the credit rating.
- The investors can minimize their existing loss by choosing effective future investment. Thus, credit ratings acts as hedge for the investors.
- Liquidity, safety and profitability are duly considered through credit rating mechanism by investors.
Benefits of good credit ratings from the point of view of companies:
- Companies will be able to raise funds from the market as their debt instruments are backed by good credit rating.
- Credit rating acts as a motivation for companies to either improve their position or maintain their existing position, if they are in a higher level of credit rating.
- When companies of equal standing are issuing their credit instruments, better placed companies are identified with a positive signal on the credit rating such as A+.
- In the market, companies with a higher rating will be in a position to provide better liquidity for their credit instruments.
- When companies are raising funds in the overseas market, credit rating enables them to mobilize more funds.
- Good Credit rating will provide better security from the lenders' point of view. This will enable the companies to sell their credit instruments easily.
Benefits of credit ratings from the point of view of Regulating authorities:
- The regulatory authorities can discipline financial institutions by insisting on good credit rating before going for public issue.
- By imposing various conditions in credit rating, the financial soundness of the companies is maintained.
- Any down-grading of credit rating will send clear signals to the regulating authorities to closely monitor the functioning of the company concerned.
- The general economic condition in the company could also be analyzed by the regulating authorities from the credit rating of various companies.
- Good Credit rating also provides authority, responsibility and accountability to the regulating authorities.
Benefits of credit ratings from the point of view of public:
- Any unknown company or infant company cannot try to cheat the public by offering an unusually higher rate of interest, as without credit rating, the reliability of the company will be in question.
- Proper credit rating also channelizes the savings of the public to productive purposes and prevents unwanted conspicuous consumption, such as investing in gold.
- Public can also discriminate their investments and go in for better credit instruments on the basis of good credit rating.
- Off-shore savings can be attracted through credit rating. Individuals settled abroad can choose investment in domestic companies based on credit rating.
- Legal action could be taken when credit rating companies fail to fulfill their obligations. This will instill confidence in the minds of the investors.