Credit Rating in India

Credit rating has garnered significant importance in the country’s financial market in the last 20 years. In simple terms, credit rating is assessing the creditworthiness of an entity. There are a number of credit agencies in the country that rate companies and organisations after measuring their ability to repay the borrowed amount.

What is Credit Rating?

Credit rating is the financial risk associated with entities such as governments, non-profit organisations, and countries, among others. The rating is given to entities by the credit rating agencies after analysing their business and finance risk. The agencies prepare a detailed report after taking into consideration some additional factors such as the ability to repay the debt.

Types of Credit Ratings

All credit agency agencies use various terminology for determine credit ratings. However, the notations are very similar. Ratings are always grouped into two: an ‘investment grade’ and also a ‘speculative grade’.

• Investment grade:

These ratings mean that the investment is a solid one and the issuer will most likely meet the repayment terms. These investments are priced less as compared to speculative grade investments.

• Speculative grade:

These investments are known to be high risk. So, they come with higher interest rates.

Users of Credit Ratings

Credit ratings are used by investors, and intermediaries like:

• Issuers of debt
• Businesses
• Investment banks
• Corporations

• Institutional and individual investors:

They use credit ratings for assessing the risk that is linked to investing in an issuance, in the context of the portfolio.

• Intermediaries:

These include investment bankers who use credit ratings for evaluating the credit risk and also reaching the pricing of debts.

• Debt issuers:

These include governments, corporations, and municipalities and they use credit ratings as an independent evaluation of their creditworthiness. They also look into the credit risk associated with the debt issuance. The ratings can also provide prospective investors an idea of the quality of the instrument.

• Businesses and corporations:

They look to evaluate the risk involved with a counterparty transaction. Credit ratings help entities that want to participate in ventures and partnerships with other businesses in evaluating the viability.

Who evaluates credit ratings in India?

The credit rating is evaluated by a credit agency in India who takes into consideration the quantitative and qualitative attributes of the borrower. The credit rating agency looks into various information such as financial statements, annual reports, reports provided by analysts, news pieces, industry analysis, projection for the next quarter which in the end helps them determine the rating to be given to the entity.

Some of the top credit rating agencies in India are Credit Rating Information Services of India Limited (CRISIL), ICRA Limited, Credit Analysis and Research limited (CARE), India Rating and Research Private Limited, etc.

What are credit rating agencies?

Credit rating agencies measure the likelihood of an entity turning into a defaulter. All the credit rating agencies in India are regulated by SEBI (Credit Rating Agencies) Regulations, 1999 of the Securities and Exchange Board of India Act, 1992.

Importance of Credit Rating

When a credit rating agency upgrades a company’s rating, it suggests that the company has a high chance of repaying the credit. On the other hand, when the credit rating gets downgraded it suggests the company’s ability to repay has reduced.

Once the company’s credit rating has been downgraded, it becomes difficult for the company to borrow money. Lenders will consider such companies as high-risk borrowers as they have a higher probability of turning into a defaulter. Financial institutions will hesitate to lend money to the companies with low credit rating.

Let’s take a look at the importance of credit rating:

• Credit rating does a qualitative and quantitative assessment of a borrower's creditworthiness.
• It allows investors to make a sound investment decision after taking into consideration the risk factor and past repayment behaviour. In other words, it establishes a relationship between risk and return.
• In the case of the companies, credit ratings help them improve their corporate image. It is useful especially for companies that are not popular.
• The credit rating acts as a marketing tool for companies and also as a resource that is helpful at the time of raising money. It reduces the cost of borrowing and helps in the company’s expansion.
• Lenders such as banks and financial institutions will offer loans at a lower interest rate if the entity has a higher credit rating.
• Credit rating encourages better accounting standards, detailed information disclosure, and improved financial information.

How do credit rating agencies work in India?

Each rating agency has its own method to calculate credit ratings. Agencies rate entities including companies, state governments, non-profit organisations, countries, securities, special purpose entities, and local governmental bodies. At the time of calculating the rating, credit rating agencies take into consideration several factors like the financial statements, level and type of debt, lending and borrowing history, ability to repay the debt, and past debts of the entity before rating them. Once a credit rating agency rates the entities, it provides additional inputs to the investor following which the investor analyses and takes a sound investment decision.

Credit ratings that are given to the entities serve as a benchmark for financial market regulations. However, it should be noted that the ratings should not be considered as advice for investors and instead should be used as a tool to make a sound decision.

Different credit rating scales

An individual's creditworthiness is represented by their credit score. Similarly, a company’s creditworthiness is represented by the credit rating symbols assigned to them by the agencies. Credit rating agencies rate Non convertible debentures (NCD), company deposits, and fixed deposits, among others. Let’s take a look at some of the credit rating symbols offered by rating agencies for long-term and mid-term debt instruments.

Factors affecting Credit Ratings in India

Some of the factors that may affect the credit ratings on a company in India are:

• Company’s history: The credit rating agency looks into the past history of the company including their history of borrowing and when they have paid back the debit. The credit rating can severely be affected if the company has delayed the payment or defaulted on loans.
• Future economic potential of the company: The credit rating of a company is also determined based on its future potential. If the company shows that it will be profitable in the near future based on projections, current performance, etc., the credit rating will give them a positive rating, otherwise a negative rating will be given if the future projections do not look promising.

Factors affecting credit score in India

A credit bureau takes into account various factors which helps them calculate an individual’s credit score. The factors that are taken into account are:

• Payment history: 35%
• Credit utilisation : 30%
• Credit history length: 15%
• New credit: 10%
• Credit mix: 10%

Some of the factors due to which your credit score can get affected are:

• Not paying your bills on time: Your credit score can get negatively impacted if you fail to pay your credit card bills or your loan on time. Hence, always make sure to pay your bill by the due date to keep your credit score healthy.
• Credit utilisation ratio: You must ideally maintain a credit utilisation ratio of 30% or less in order to keep your credit score high. For example, if your credit card limit is Rs.1 lakh, then do not spend more than Rs.30,000 on your credit card.
• Delay in payment of loans and bills. Repaying your loan and clearing all the bills on time improves your credit score. You may come across the option of paying the minimum amount which in the long run does not help in improving your credit score. Hence, make sure you repay all your loan and credit card bill on time before applying for a new one in order to keep your credit score healthy.
• Frequently applying for loans and credit cards: Whenever you apply for a loan or a credit card, the lender conducts a credit inquiry. Too many credit inquiries affect your credit score, hence avoid applying for loans and credit cards on a frequent basis.
• Increasing your credit card limit frequently: Looking to increase your credit card limit frequently can be a sign of you depending heavily on credit to manage your expenses due to which not only your credit score falls but the lender may not be willing to offer you a loan in future. Increase your credit limit only if you are sure about repaying the outstanding bill on time.
• Not checking your credit score frequently: Check your credit score at least on a quarterly basis. Sometimes, your credit score may have a small error which in turn may affect your credit score. If you find an error, immediately get it fixed by getting in touch with the credit bureau.
• Having a poor mix of credit: Do not apply for only one type of product. For example, do not apply for a personal loan every time. Having a mix of different types of loans shows that you can handle your finances well which in turn improves your credit score. It goes without saying that you must repay your loans on time to ensure your credit score remains positive.

What’s the Difference Between Credit Rating and Credit Score?

A credit rating is assigned to a company or an organisation by the credit rating agencies after assessing their ability to repay the borrowed amount. Meanwhile, a credit score is computed by credit bureaus after taking into consideration several factors like credit history and repayment behaviour.

FAQ's on cibil/credit-rating

1. What is a credit rating and what does it convey?

   A credit rating is an assessment of your creditworthiness. This is in respect with your financial obligations or debts. A credit rating will be assigned to anyone or any entity who or which wants to borrow money. A corporation, individual, provincial authority or state can be assigned a credit rating.

2. How is credit rating done?

   Your credit rating will be assigned by a credit rating agency after they have assessed your ability to repay the amount which you have borrowed. A credit score on the other hand is computed by credit bureaus. This is done after the bureau has taken into account factors like your repayment behaviour and credit history. A credit score is also assigned to an organisation or a company.

3. How is a rating denoted?

   A credit rating is always denoted by alphabetical symbols like AA+, A-. Keep in mind that the plus and minus symbols reflect the finer distinctions of your credit rating. A minus symbol does not have a negative connotation. If you rating is ‘AA-’, then it is better than ratings like ‘A+‘.

4. What are short-term credit ratings?

   A short-term credit rating is reflective of your creditworthiness within a short span of time. A short-term credit rating will reflect your likelihood to default within a period of one year.

5. How is your credit rating determined?

   A credit score is created and assigned based on the information and details which are there in your credit report. There are a lot of factors that are taken into account like payment history (35%), amount owed (30), length of history (15%), new credit (10%), types of credit used (10%).