What is credit rating?

The measurement of the ability of an individual or a company in repaying the financial obligation based on income and past debt/loan histories is known as credit rating. Thus it determines the borrower’s creditworthiness. Financial calculations by credit bureaus calculate the credit for individual consumers on a numeric scale.

A credit rating also signifies the likelihood a debtor will default. It is also representative of the credit risk carried by a debt instrument – whether a loan or a bond issuance.

Credit ratings determine the interest rate of the credit at which it will be repaid. Better the credit rating, better are the terms of a loan, and if the credit rating is poor, the bank can reject any request for a loan. There are eight different type of credit ratings:

1. Bond/debenture rating

2. Equity rating

3. Preference share rating

4. Commercial paper rating

5. Fixed deposits rating

6. Borrower’s rating

7. Individual’s rating

8. Structured obligation

Investors base their decisions to buy a stock based on a company’s credit rating. Countries with higher credit ratings are more likely to attract bond buyers as foreign capital.

However, a credit rating is just an opinion; it is not an assurance or guarantee of a kind of financial performance by a certain instrument of debt or a specific debtor.

A credit agency evaluates the credit rating of a debtor by analyzing the qualitative and quantitative attributes of the entity in question. The information may be sourced from internal information provided by the entity, such as audited financial statements, annual reports, as well as external information such as analyst reports, published news articles, overall industry analysis, and projections.

There are three main global credit agencies: Moody’s Investor Services, Standard and Poor’s (S&P), and Fitch Group.

Major credit rating agencies in India are Crisil Ratings, Care, Icra and India Ratings.