A credit rating is a comprehensive tool for assessment of the financial strength of corporates and the Government entities. A credit rating agency is a company which provides an independent evaluation of the creditworthiness of debt securities issued by governments and corporations especially their ability to meet principal and interest payments on their debts. These rating provided by rating agencies on an entity allow it to easily borrow money from financial institutions or public debt markets. Credit ratings are also important at the country level. Foreign Institutional Investors rely on credit ratings given by the credit rating agencies for investment in a particular country.
In India, CARE, CRISIL, FITCH India, ICRA, Brickwork Ratings and SMERA and INFOMERICS are the seven domestic rating agencies approved by RBI for the purpose of risk weighting their claims for capital adequacy purposes. Banks have the options to select credit rating agencies of their choice for both risk weighting and risk management purposes.
Reserve Bank of India has permitted banks in India to use ratings of international rating agencies like Fitch; Moody’s; and Standard & Poor’s for risk weight mapping for the long term and short term ratings. Short term debt is rated on a different scale than long tenor debt, because the ability of the issuer to meet obligations in the short term is related to different parameters than the ability to repay in the long term. This is in view of the ability to repay short tenor obligations is based more on financial liquidity than the issuer’s growth or risk potential. The rating scale is divided into “Investment Grade” and “Speculative Grade,” with both categories divided into three sub-levels. For example, an “A” rating is divided by Standard & Poor’s and FITCH into: A-, A, A+ and A3, A2, A1 by Moody’s. Besides rating decision the rating agencies comment on the credit outlook. The ‘Outlooks’ are also divided into three types viz. negative, stable and positive on the basis of financial and accounting parameters and data analysis. The ‘outlooks’ provided by the credit rating agencies on an entity or the country projects the probability for nonpayment of debt which may cause deterrent effects the investment decisions of the investors on such entity/country.
While assessing the credit rating of a sovereign the rating agencies utilize a large number of economic and other ratios. The most important variables examined include: Economy Characteristics, Monetary Environment, Foreign Trade, Security instability etc.