USES OF CREDIT RATING :
Credit rating is extremely important as it not only plays a role in investor protection but also benefits industry as a whole in terms of direct mobilization of savings from individuals. Rating also provide a marketing tool to the company and its investment bankers in placing company’s debt obligations with a investor base that is aware of, and comfortable with, the level of risk. Ratings also encourage discipline amongst corporate borrowers to improve their financial structure and operating risks to obtain a better rating for their debt obligations and thereby lower the cost of borrowing. Companies those get a lower rating are forewarned, as it were and have the freedom, if they desire, to take steps on their financial or business risks and thereby improve their standing in the market.
The need for reliable information in channelization of the resources to the most productive uses can hardly be overemphasized. Relevant and reliable information helps the investors to arrive at their investment decisions. These include offer documents of the issuers, research reports of market intermediaries and media reports. In the developed markets, credit rating agencies have also come to occupy a leading position as information providers along with rating of financial instruments. Particularly for the credit related opinions in respect of debt related instruments, such agencies offer independent opinions which are objective, well researched and credible.
Credit rating is useful to investors, issuers, intermediaries and regulators.
For Investors
The main purpose of credit rating is to communicate to the investors the relative ranking of the default loss probabilit for a given fixed income investment, in comparison with other rated instruments. In a way it is essentially an information service. In the absence of professional credit rating, the investor has to largely depend on his familiarity with the names of promoters or collaborators of a company issuing debt instruments. This is not a reliable method. Credit rating by skilled, competent and credible professionals eliminates or at least minimizes the role of name recognition and replaces it with a well researched and properly analyzed opinion. This method provides a low cost supplement to investors. Large investors use information provided by rating agencies such as upgrades and downgrades and alter their portfolio mix by operating in the secondary market. Investors also use the industry reports, corporate reports, seminars and open access provided by the credit rating agencies.
For Issuers
The market places immense faith in opinion of credit rating agencies, hence the issuers also depend on their critical analysis. This enables the issuers of highly rated instruments to access the market even during adverse market conditions. Credit rating provides a basis for determining the additional return (over and above a risk free return) which investors must get in order to be compensated for the additional risk that they bear. The difference in price leads to significant cost savings in the case of highly rated instruments.
For Intermediaries
Rating is useful to Intermediaries such as merchant bankers for planning, pricing, underwriting and placement of the issues. Intermediaries like brokers and dealers in securities use rating as an input for monitoring risk exposures. Merchant bankers also use credit rating for pre-packaging issues by way of asset securitization/structured obligations.
For Regulators
The Reserve Bank of India (RBI) prescribes a number of regulatory uses of ratings. The RBI requires that a NBFC must have minimum investment grade credit rating if it intends to accept public deposits. As per money market regulations of the RBI, a corporate must get an issue of CP rated and can issue such paper subject to a minimum rating. SEBI has also stipulated that ratings are compulsory for all public issue of debentures. SEBI has also made mandatory for acceptance of public deposit by Collective Investment Schemes.