De-jargoned: Credit rating for financial products

While credit rating is mostly for companies and financial instruments, credit scores are for individuals looking to borrow from financial institutions

Recently, Moody’s Investors Service Inc.—a global credit ratings, research and risk analysis firm—upgraded India’s sovereign credit ratings a notch to Baa2 from Baa3. You may consider it akin to a credit bureau upgrading your credit score a notch, but there is a small difference. While credit rating is mostly for companies and financial instruments, credit scores are for individuals looking to borrow from the financial institutions. 

In India, credit rating agencies rate financial instruments such as corporate fixed deposits, bonds, debentures, debt fund portfolios and initial public offerings. These agencies are governed by Securities and Exchange Board of India (Sebi) (Credit Rating Agencies) Regulations, 1999, which provide detailed norms that need to fulfilled. Higher ratings mean that the instrument has better chances of meeting its obligations, and lower ratings mean higher chances of default. 

Credit rating

According to a concept paper by Sebi, “A credit rating is an ‘opinion’ on the creditworthiness or the relative degree of risk of timely payment of interest and principal on a debt instrument...a rating indicates the probability of default of the rated instrument and therefore provides a benchmark for measuring and pricing credit risk." In simpler words, credit ratings indicate the probability of a lender or depositor to the instrument getting back the money, with interest and within the mutually agreed time-frame and policies. 

Typically, credit ratings for companies and financial instruments are assigned in alphanumeric combinations like AAA or AA+. Typically, instruments rated AAA are considered to have the highest degree of safety regarding timely servicing of financial obligations. Such instruments carry the lowest credit risk. 

The Sebi concept paper says that in India, credit ratings started with setting up of Crisil Ltd (formerly The Credit Rating Information Services of India) in 1987. Now Crisil is a division of S&P Global. Apart from Crisil, there are a few more Sebi-registered rating agencies in India. These are: ICRA Ltd, CARE Ratings, India Ratings and Research, and Brickwork Ratings India.

These rating agencies rate various financial instruments as mentioned earlier. Besides that, in many cases, issuers of financial instruments are also required to get credit ratings from two different credit rating companies for the issue. However, a high rating does not mean a ‘buy’ investment advice; there are other factors to look at as well before investing. Moreover, credit rating assigned to an instrument initially, at the time of offering, may change over time. There are many instances when highly rated corporate fixed deposits of a company got downgraded over time, based on a reassessment of the company at a later date.