What is Credit Rating

Credit Rating can be analyzed by dividing it in two parts credit and rating. Credit is taking money from a lender for generating some benefits with a promise to pay back the principle and the interest after a specific time. Rating usually denotes to a symbol or on a relative judgment of something on a scale. So the entire term credit rating can defined as a judgment on the quality of a credit, whether the creditor or the borrower is financially sound to meet the obligations i.e., principle and interest.

A credit rating assesses the credit worthiness of an individual, corporation, or even a country. It is an evaluation made by credit rating agencies of a borrower’s overall credit record. Credit ratings are calculated from financial history and current assets and liabilities. Typically, a credit rating tells a lender or investor the probability of the subject being able to pay back a loan. However, in recent years, credit ratings have also been used to adjust insurance premiums, determine employment eligibility, and establish the amount of a utility or leasing deposit. In this era of globalization, the concept of credit rating spread all over the world. With the advancement of finance, credit rating also changes its definition. Apart from rating of a security, an entity and even a sovereign state is now rated by the credit rating agencies. Rating of a sovereign state explains the risk exposure associated with the economic, social and political condition of that country. International investment funds are now crossing the boarders towards a good rated country from a poor rated country. A strong credit rating plays a major role in determining the cost and availability of credit flows, and the failure to maintain a strong rating possibly leads to a reversal of capital flows, a disruption of the financial system and an overall economic downturn.

Credit rating are used by investors, issuers, investment banks, broker-dealers, and governments. For investors, credit rating agencies increase the range of investment alternatives and provide independent, easy-to-use measurements of relative credit risk; this generally increases the efficiency of the market, lowering costs for both borrowers and lenders. This in turn increases the total supply of risk capital in the economy, leading to stronger growth. It also opens the capital markets to categories of borrower who might otherwise be shut out altogether such as small governments, start up companies, hospitals, and universities.