written by | March 21, 2022

Importance of Credit Rating in India

It has taken more than two decades for the notion of credit rating to gain widespread acceptance in India's financial system. In layman's terms, it is a means of determining a company's creditworthiness. It is possible to get credit ratings for firms and organisations in the nation from various credit rating agencies. CRISIL is the most commonly utilised of these agencies in the country. To evaluate if a business is a solvent, it must first determine whether or not it is a creditworthy borrower, which is a Credit Rating’s goal.As is apparent, a strong credit rating indicates that the entity has a history of making timely payments on debts. The credit rating influences the bank's choice to approve loan applications at competitive interest rates in India. 

Did you know?

Credit ratings are influenced by several factors such as payment history, the amount owed, credit history length, new credit and types of credit.

What Precisely Is a Credit Rating?

Credit rating, among other things, relates to the financial risk associated with businesses such as administrations, non-profit organisations, and government agencies. 

Credit rating agencies provide ratings to companies based on their evaluation of their corporate and financial risks, among other things. The organisations compile an in-depth report after considering various other factors, such as the loan's ability.

Also Read: What is a Credit Information Report?

Why Is Keeping a Good Credit Rating Important?

Lenders use credit ratings to judge how responsible a borrower is and, consequently, the interest rate they will charge and the privileges they will provide that borrower due to their decisions. Banks and other lending organisations are notified about your chances of repaying the money you borrow via this procedure. As a consequence, having a solid credit rating is critical.A better credit score entitles you to additional perks, like cheaper interest rates on loans and credit cards. The aim is to keep your credit score as high as possible. Maintaining your focus on these core ideas will make making financial decisions a breeze.A credit rating is beneficial to both lenders and consumers since it contains information such as the following:

Lenders and Financial Institutions

  • Choosing a suitable investment is critical since no bank or lending institution wants to provide money to a customer deemed a high-risk borrower. 
  • They may obtain an idea of the firm's creditworthiness (which is borrowing the money) and the risk associated with it by analysing its credit rating. 
  • They will be better positioned to make an educated investing choice if they keep this in mind.
  • Money security is guaranteed, and payments are made on time: A good credit rating ensures that money will be kept secure and that it will be repaid with interest on time.

Borrowers

  • Loan Eligibility in a Short Time: Lenders will consider you a low- or no-risk borrower if you have an excellent credit rating. As a result, banks will approve your loan application with little difficulty.
  • You should be aware that each bank provides a variety of loan alternatives with varying interest rates that vary from one institution to the next. 
  • Your credit history is one of the most critical variables in determining the interest rate you will be paid on each loan you take out. 
  • You will be charged higher interest rates if you have a poor credit history. The lower the interest rate imposed on the loan, the higher the credit rating.

What Are the Different Types of Credit Ratings?

When establishing credit ratings, all credit reporting agencies use a variety of vocabulary. On the other hand, the descriptions are practically similar. Investor-grade ratings are usually split into two categories: 

Investment Assets

It is implied by these ratings that the investment is a safe one and that the issuer would most likely adhere to the repayment schedule. When compared to speculative-grade investments, these investments are more affordable.Indian credit ratings are considered among the lowest globally, despite the country's enormous population, high GDP, and substantial foreign exchange reserves. Although India has a double-digit deficit, according to the former Indian economic affairs secretary Subhash Chandra Garg, rating agencies are unlikely to downgrade the country's credit rating. With the economy's expansion, he expects the country's debt to continue to rise.

Speculative-Grade Assets

These securities are well-known for carrying a high level of risk. Thus they are accompanied by rising interest rates. Furthermore, the nation has a solid economic base attracting many foreign investors. As a result, it is a desirable location for investors. On the other hand, the rating agency must comprehend the significance of maintaining a constant based on speculation grade credit rating for Indian government debt.

Who Utilise These Credit Ratings?

Investors, as well as go-betweens such as the following, rely on credit rating scores for their decisions:

  • People or organisations who issue debt.
  • Businesses Banks specialise in investment transactions.
  • Corporate entities.

Credit rating intermediaries, such as investment bankers are responsible for assessing credit risk and determining the amount of debt paid back in interest and principal.

It is also determined whether or not there is a credit risk associated with the debt problem. By examining the ratings, prospective investors may be able to gain an insight into the overall quality of the instrument.Businesses and organisations are interested in learning about the degree of risk connected with a transaction with a third party. Companies interested in participating in joint ventures and partnerships with other companies can use credit ratings to help them determine the feasibility of the experience or partnership before agreeing.

Also Read: Steps To Correct Credit Information Report (CIR) Mistakes

What Is the Importance of Credit Rating in India?

If a credit rating agency raises the rating of a firm, it implies that the company has a high likelihood of repaying the debt. When a company's credit rating is decreased, on the other hand, it indicates that the company's capacity to repay debts has been compromised.When a corporation's credit rating is reduced, borrowing money from other sources becomes more challenging. Lenders will classify such businesses as high-risk borrowers since they are more likely to become defaulters. If a company has a poor credit rating, financial institutions will be wary of lending it money in the future.

Examine the significance of a credit rating in this context: Credit ratings are performed on them to determine whether or not a borrower is creditworthy. In addition to taking into account the risk element and historical repayment behaviour, it enables investors to make informed investment decisions. Put another way. It creates a link between risk and profit.

  • The corporations benefit from credit ratings to boost their company image. In particular, it is beneficial for businesses that are not well-known.
  • When it comes to marketing, credit ratings are beneficial for businesses, but they are also a valuable resource for those looking to raise capital. 
  • In addition, it lowers the cost of financing and aids in the growth of the business.
  • Loans will be offered at a cheaper interest rate by lenders such as banks and financial institutions if the organisation has a better credit rating.
  • Enhanced accounting standards, specific information disclosure, and improved financial information are all encouraged by credit ratings.

What Is the Structure of Credit Rating Agencies in India? How Do They Operate?

To calculate credit rating in India, each rating agency has its technique. Companies, state governments, non-profit organisations, securities, unique purpose entities, and local governmental bodies are among the entities rated by rating agencies. These agencies include several elements, such as 

  • the financial statements 
  • the amount and kind of debt owed
  • the lending and borrowing history
  • the entity's capacity to pay back the loan
  • prior obligations 

Credit rating agencies take the same into account when determining the entity's credit rating. Once a credit rating agency has rated an entity, the agency sends further information to the investor, which the investor then analyses and uses to make a prudent investment based on the news.

The credit ratings assigned to companies serve as a baseline for financial market regulation. However, we should highlight that the ratings should not be interpreted as investment advice but rather as a tool to assist investors in making informed investment choices.

What Are the Factors That Influence Credit Ratings in India?

Some of the things that may influence a company's credit rating in India are:

  • Company history: The credit rating agency investigates the company's prior record, including their borrowing history and when they have paid back the debt. If the firm has missed payments or defaulted on loans, its credit rating might suffer greatly.
  • The company's future economic potential: Its credit rating is also affected by its future potential. If the firm demonstrates that it will be profitable soon based on estimates, present performance, and so on, the credit rating will assign a positive rating; alternatively, a negative rating will be given if future projections do not seem promising.

Conclusion

Credit rating, among other things, relates to the financial risk associated with businesses such as administrations, non-profit organisations, and government agencies. Lenders use credit ratings to judge how likely borrowers are to default. We hope this article has cleared any questions you might have about Credit Ratings and their importance in India.Follow Khatabook for the latest updates, news blogs, and articles related to micro, small and medium businesses (MSMEs), business tips, income tax, GST, salary, and accounting.

FAQs

Q: What exactly is a short-term credit evaluation?

Ans:

This grade represents your creditworthiness over a short period.

Q: How is a credit rating assigned?

Ans:

Credit ratings are usually expressed alphabetically, such as AA ( ), A (-).

Q: What is a credit rating, and how is credit determined?

Ans:

After examining your ability to repay the loan, a credit rating agency will assign you a credit score. On the other hand, credit bureaus are responsible for creating credit ratings.

Q: What exactly is a credit rating in India, and how is it determined by calculating?

Ans:

Your credit rating score via credit rating scale assesses your credit power.

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