What Is Credit Rating and Why Is It Important?

A credit rating is an assessment of an entity’s ability to pay its financial obligations. The ability to pay financial obligations is referred to as ‘creditworthiness’. Credit ratings apply to debt securities like bonds, notes and other debt instruments. Credit rating agencies (CRAs) provide ‘ opinions’, or judgements, on the creditworthiness of debt securities issued by a wide spectrum of entities, including corporations.

Alphabetical letter grades are used to indicate credit rating: AAA being the highest and safest, with lower grades representing an increasing scale of risk to the investor. It provides an opinion relating to future debt repayments by borrower and provides information on past debt repayments also. Rating Symbol AAA AA A BBB BB B C D

Credit rating is not a recommendation to buy, hold, or sell a debt instrument. It is one of the tools used by investors to make an investment decision. It is also expressing an opinion on the relative degree of risk associated with repayment on maturity of the instrument. This opinion represents a probable estimate of the likelihood of a default.

Companies approach credit rating agencies with compliances, securities on offer, financial performance indicators of the company, defaults, etc. A company can approach more than one credit rating agency to obtain more than one credit rating. Securities and Exchange Board of India (SEBI) regulates the rating agencies in the country. Description (Servicing of Financial Obligations) Highest safety (lowest credit risk) High safety (very low credit risk) Adequate safety (low credit risk) Moderate safety (moderate credit risk) Inadequate safety (inadequate credit risk) High risk (high risk of default) Substantial risk (very high risk of default) Default (could invite default any time)