CREDIT RATING SYSTEM

Life is a transaction. Your mother has to keep you in her womb to give you birth. In return, she had to sacrifice some of her freedoms. Likewise, as you grow up, you forever remain a debtor to her. No matter how much you pay her back as a principal for all the materialistic amenities but you won’t be able to repay the interest- lover, care, affection, pain she that she endured for you. But our financial markets are not the same. Here everything is money and each transaction is a business. No matter, whether or not you are transacting with your family members or your long-distance best friend or some unknown persons. To run a business, capital is required. This can be arranged via different sources- loans from commercial or investment banks or issuing debts or through funding via some investors or some other methods.

As an investor one needs to be ascertained whether his or her money will be used judiciously. The reputation and past records of the borrower need to be verified. This was possible when the society was nucleated into clusters. On a very personal level, one could assess the loan repayment capacity of a borrower. But as the societies expanded and merged into a bigger and bigger unit during and post-industrialization, this process became very complex. One reason was the high capital demand and the other was the remoteness of the lender and borrower. Thus, a need emerged for some sort of agency that could benchmark the certainty of principal and interest payment to the investor or lender. This led to the birth of Credit Rating system.

Credit Rating is a collecting of data of the creditworthiness of a borrower within a particular time period. There are different verticals attached to this credit rating system. Across the globe there is credit rating can be applied to the following-

• Individual credit rating
• Government or its agency credit rating
• Equity shares
• Bonds & debentures
• Insurance sector
• Banking sector
• Ratings of companies raising funds domestically and internationally

 This assessment is done by the different evaluating companies. Evaluation is done on the basis of various economical and financial parameters. The evaluation tools and methods adopted vary from entity to entity which is to be evaluated. Some major aspects taken into considerations are-

• Supply and demand of the product or service into which investment is being done
• Government regulations and policies- taxation, interests, etc.
• Economic surveys and forecasting
• Financial analysis- P/L accounts, balance sheet, liquidity, etc.
• Borrower’s management analysis and evaluation
• The creditworthiness of a borrowing country, etc.

It is to be noted higher the credit rating of the debt instrument or debtor- lesser is the return on investment (ROI), lesser is the risk of losing the money and vice versa.

In India, only Securities and Exchange Board of India (SEBI) can authorise and regulate credit rating agencies according to SEBI Regulations, 1999 of the SEBI Act, 1992. Some important credit rating agencies of India are-

• Credit Rating Information Services of India Limited (CRISIL)
• India Ratings and Research Pvt Ltd
•  Investment Information and Credit Rating Agency (ICRA)
• Credit Analysis and Research Limited (CARE)
• Brickwork Ratings India Pvt Ltd
• Infometrics Valuation and Rating Pvt Ltd

However, still, there have been instances when the rating worthiness of these agencies have been jeopardised. Few examples are from the recession of 2008 and the recent chapter of IL&FS in India. Even though a lot of factors are considered and guidelines are followed for a transparent and accurate rating allocation, yet there is always some or the other factor or element that might play unfair or inaccurate in the ranking.