Credit rating

Recently, Rating agency ICRA revised downwards its outlook for the Indian banking sector to ‘stable’ from ‘positive’ citing moderation in credit growth and profitability due to decline in interest margins.

What is credit rating?

• A credit rating is an independent assessment of a corporation’s or government’s ability to repay a debt.
  • It is different from credit scores, which are assigned to individuals based on their personal history of acquiring and repaying debt.
• It is issued by specialized agencies known as Credit Rating Agencies (CRAs).
• It estimates the level of risk associated with lending money to a business or entity, including national and state governments.
• A high credit rating indicates that, in the rating agency’s opinion, a bond issuer is likely to repay its debts to investors without difficulty.
• A low credit rating suggests it might struggle to make its payments.
• Bonds or securities are assigned credit ratings before issuance, and the interest they pay is determined by these ratings.
  • Lower-rated companies must pay higher interest rates to offset investment risk.
• Investors and lenders use credit ratings to decide whether to do business with the rated entity and to determine how much interest they would expect to receive to compensate them for the risk involved.

About CRAs:

• A CRA is an entity which assesses the ability and willingness of the issuer company for timely payment of interest and principal on a debt instrument.
• CRAs may rate the creditworthiness of debt issuers, debt instruments, and sometimes servicers of underlying debt, but not individual consumers.
• Debt instruments rated by CRAs include government bonds, corporate bonds, CDs, municipal bonds, preferred stock, and collateralized securities such as mortgage-backed securities and collateralized debt obligations.
• CRAs use letter-based scores to indicate the financial stability of the issuer and the likelihood of default.
  • For example, an “AAA” rating from S&P indicates that a company is unlikely to default on its debt obligations, which can be attractive to investors, lenders, and other stakeholders.
• Seven CRAs are registered with SEBI, namely, Acuite, CRISIL, ICRA, CARE, India Ratings, INFOMERICS, and Brickwork.
  • All six CRAs, except Brickwork Ratings, are accredited by RBI as domestic CRAs.
• Concerns with CRAs include rating shopping, opaque and flawed methodologies, and personal bias.
• The way forward includes transitioning from the ‘issuer pays’ model to the ‘investor’ or ‘regulator pays’ model, implementing transparent rating methodologies, and rotating CRAs, among other measures.

Regulation of CRA in India:

• SEBI regulates credit rating agencies through the SEBI (Credit Rating Agencies) Regulations, 1999.
  • These regulations cover eligibility criteria for registration, monitoring of ratings, conflict of interest prevention, and SEBI inspections of rating agencies.
• RBI accredits CRAs as External Credit Assessment Institutions for rating bank loans/facilities.