Business model of Credit Rating companies

Akansha Gupta

01 Sep, 2021

In the recent two decades, credit ratings have become increasingly crucial among investors and in the Indian financial industry. Credit rating is essentially an assessment of a company’s credit quality or the debt issuing company’s capacity to pay the instrument. CRISIL Ltd., India Rating and Research Pvt. Ltd., ICRA Ltd. CARE, Brickwork Rating India Pvt. Ltd., SMERA Rating Ltd., and Infometrics Valuation and Rating Pvt. Ltd. are some of the credit rating companies in India.

A credit rating is a three-digit numerical standard measure of a person’s or company’s creditworthiness. A loan application’s credit rating is a critical factor that could make or break it. The credit rating/score indicates whether the borrower has previously defaulted on payments of loans & also whether he is worthy of the trust with the new future loans. The study of the probable credit risks connected with issuing a financial instrument to a person or a corporation is called a credit rating. A lender evaluates if a borrower can repay/ return the loan amount or not, based on their credit score. The capacity to pay debt commitments is evaluated by analyzing the financial statements of liabilities & assets.

Government bonds, corporate bonds, CDs, municipal bonds, preferred stock, and collateralized securities are among the debt instruments rated by CRAs.

In the USA, the 1st credit rating company was when Moody’s began evaluating corporate and railroad bonds in 1909. Since then, credit rating has become commonplace in several nations throughout the world.

Credit rating was 1st practised in India in 1988 when the Credit Rating and Investor Services of India Ltd. was established (CRISIL).

The credit rating industry is highly consolidated, with the ‘Big Three’ credit rating firms owning around 95%of the market. Moody’s Investors Services and Standards & Poor’s (S&P) collectively control 80% of the worldwide market, with Fitch Ratings holding 15%.

Meaning of Credit Rating Company

A Credit Rating Company (CRA) examines and ranks the creditworthiness of a person or an organization. To put it another way, these companies look at a debtor’s income and credit lines to determine whether or not they can repay the loan and whether or not there is a credit risk involved.

According to SEBI Regulations, 1999^[1] of the SEBI Act, 1992, the Securities and Exchange Board of India (SEBI) maintains the power to authorize and govern Credit Rating Companies.

Credit Rating Companies assess a corporation, person or institution and give a rating to them. Companies, state governments, non-profit organizations, nations, securities, local government bodies, and special purpose entities can all be rated by these companies.

The Credit Rating Company offers the report as well as extra insights, allowing the lender to evaluate and make an enlightened choice.

Rating Category Description

Key Functions of Credit Rating Companies

Corporate Credit Rating

The European Central Bank (ECB) recognizes just four rating companies for calculating collateral requirements for banks borrowing from the central bank: S&P, Moody’s, Fitch, and DBRS. These rating agencies give a rating to the firm and its financial instruments, such as bonds.

Business Model of Credit Rating Company

• Issuer Pay-Model – Rating companies charge issuer and financing arrangers a fee for issuing credit rating under the issuer-pay model. These rating companies acquire facts and information from issuers as a part of the rating process and include it into their credit quality assessment, which may be inaccessible to investors and other market players. Because the issuer compensates for the ratings, the companies are capable of making them freely accessible to the market.

Critics of the issuer-pay model argue that receiving paid from the issuers whose securities they are assessing creates a possible conflict of interest.

• Subscription Model – Some credit rating companies use the subscription model, charging investors as well as other market players a fee to view their ratings. Since these companies are funded largely by investors instead of issuers, supporters of this model argue that they’re not really subject to any conflict of interest in their credit risk assessments.

Investment firms who subscribe to a rating service, particularly big investors like hedge funds with long as well as short positions in a wide range of securities , critics argue, could have an undue influence on the agency’s rsting results because it is in the investor’s best interests for the rating to support their investment strategy. Additionally, opponents of the subscription model claim that the rating is also accessible to the paying members, who are often substantial institutional investors. Furthermore, rating companies that use the subscription model might have less accessibility of issuers. While offering forward-looking ratings, information from the management might be helpful.

Conclusion

Credit ratings done by Credit Rating companies are helpful not just for investors but also for the companies searching for capital. A securities, company, or nation with an investment–grade rating can encourage both local and overseas investment. A strong credit rating is essential for developing market economies to demonstrate their creditworthiness to international investors. In addition, a higher credit rating usually translates to a lower interest rate, which reduces the risk of default in a growing rate environment.

Read our article: How to Set Up a Credit Rating Agency in India?