How a firm’s credit rating impacts investors and borrowers?

The credit ratings are issued by Credit Rating Agencies (CRA) that assess and rates debtors based on their ability to pay back their interests and loan amounts on time.

Here, we would like to make it clear that people often misinterpret credit scores with ratings. Different agencies award individuals with scores (between 300 and 900) while different agencies are there for rating companies (letter grades with symbols like Aaa or B+ up to D). What remains common in both the cases is the fact that higher the scores, better is the borrower’s bargaining power and those with lower or poor scores or ratings are considered ‘risky’.

A firm’s rating is a guide to the investors, lenders, dealers, suppliers, etc., who evaluate the risk of timely payment of interest and principal on a particular debt instrument. Credit rating creates awareness about the concept of rating amongst corporations, merchant bankers, brokers, regulatory authorities, and helps in creating an environment that facilitates the debt rating.  

Below given are a few points that will help you in understanding the key benefits of having impressive credit ratings.

From an investor’s point of view

1. Provide insight: Ratings provide insight to investors about the financial credibility of the applicant entity. This gives investors/ lenders the confidence and helps them decide whether to invest in such companies or not.
2. Encourages trust factor: Good rating ups the image of the company. It creates a place of trust in the eyes of lenders about the applicant entity. High ratings assure them about the safety of instrument and minimum risk of bankruptcy.  In such cases, investors are even happy to do business with entities on low-interest rates and tenures that suit the entities.
3. Saves time and effort: Investors/ lenders save a lot of time, energy, costs and manpower by simply taking a look at the entity’s report. The investors depend on the rating to analyse the financial stability provided by the professional reporting agency.

From borrower’s point of view

1. Provide visibility to lesser-known companies: Entities that get a high rating for their instruments try to ensure healthy financial discipline. If the ratings are good, then investors will be willing to do business or give loan to them.
2. Better prospects: An entity with a good rating can approach more investors/ lenders having an upper hand while negotiating terms like tenure, interest rates, etc.
3. Provides/ interprets complex information at low cost: Firstly, as per the Reserve Bank of India (RBI) guidelines, credit rating agencies are required to provide a report to its clients free of cost. These agencies collect, assess and interpret complex data based on the information provided by financial institutions and other lenders.