Rating Agencies and Their Importance

Rating agencies are institutions that assess the financial strength of large-scale borrowers – usually companies or governments. They particularly analyze and rate their ability to meet their debt obligations. 

What are Credit Rating Agencies?

Credit rating agencies are agencies which provide ratings to represent objective analyses and independent assessments of companies, entities or countries that issue such debt securities. These ratings are an indication to the buyers of this debt how likely they are to be paid back.

Core Functions Of a Credit Rating Agency

• Compiling financial data essential for loan decisions and insurance.
• Statistical assessment that is involved in ascribing a rating to a borrower.
• Providing investors an objective analysis of the organization’s ability to pay back.

What are These Ratings?

A credit rating issued by a rating agency is an assessment of the creditworthiness of securities issued by corporations, governments and other entities. The ratings given to such securities are mostly represented as AAA, AAB, Ba3, CCC etc. It is very similar to a marking system wherein the highest rating AAA  is given to a borrower who has the highest probability of paying back. In that way, AAA is considered to be one of the safest debt securities to buy.  

Importance of Credit Ratings

Credit rating represents an objectively analyzed assessment of the creditworthiness of the borrower. So, the scorecard affects the amount that companies or governments are charged to borrow money. A downgrade, in other words, pushes down the value of the bonds and raises interest rates. These, in turn, influence the overall investor sentiment concerning the Borrower Company or Country. 

If a company perceives to have undergone a downturn in fortunes and its rating is lowered, investors might ask for higher returns to lend to it, thereby judging it to be a riskier bet. Similarly, if the economic and political policies of a country look gloomy, its ratings are downgraded by global credit agencies thereby influencing the flow of investments in that country.

On a macroscopic level, these changes affect economic policies of a nation. An endorsement from a convincing rating agency makes life easier for countries and financial institutions issuing bonds. It basically tells investors a firm has a track record and indicates how likely it is to be able to pay back the money.  

Who are These Credit Rating Agencies?

Globally, Standard & Poor’s (S&P), Moody’s and Fitch group are recognized as The Big Three credit rating agencies. In terms of acceptability and influence, these three collectively have a global market share of 95% as per the CFR report, USA 2015. The Indian credit rating Industry has also evolved with the emergence of professionally competent agencies like CRISIL, ICRA, ONICRA, CARE, CIBIL, SMERA, and others.  

A brief overview of Indian Agencies

This doesn’t mean that the rating can be the sole deciding factor in selecting a fund. Investors can use data from one rating agency or compare ratings from different agencies to weigh risks and potential of different mutual fund schemes.