hinking to invest in Market…..??? Moreover you are a risk-averse investor and want to minimize your risk….??? There is an investment avenue for you that are bonds and debt instruments which can give you fixed returns. They yield more returns as compared to the fixed deposits and the national saving certificates. But the question is…, as an investor how do I get the information as to which are the good ones amongst them. The answer would be to go as per the Credit rating given to the securities.
After all What is credit rating…? What is its importance…?? and What does that Indicate…???
There are thousands of companies in India all of them require capital for functioning and they issue securities to get funds.
Credit rating agency is set up in order to protect the interest of the small or retail investors who invest in debt securities of companies. India was the first nation amongst developing nations who started this.
In India, CRISIL (Credit Rating and Information Services of India Ltd.) was setup in 1987 as the first rating agency followed by ICRA Ltd. (formerly known as Investment Information & Credit Rating Agency of India Ltd.) in 1991, and CARE (Credit Analysis and Research Ltd.) in 1994. All the three agencies have been promoted by the All-India Financial Institutions. The rating agencies have established their creditability through their independence, professionalism, continuous research, consistent efforts and confidentiality of information.
Credit ratings are given by different organizations after considering many parameters. A word of caution to investors is that whatever may be the rating given to the securities it does not indicate whether investor should hold or sell and the process followed has many steps which many of the experts have agreed with so the credit ratings become highly subjective if your way of measuring is different, nevertheless this is one of the way to know about safety of your investment. The company and the issuer of credit rating agency are not related it is just for the time that agency has rated the securities of a company and it is up to the company whether to accept or reject the ratings. However these ratings are what is largely followed by investors.
The type and nature of security that is being offered
Timely payment of principal and interest
The probability of the issuer defaulting
Companies approach credit rating agencies in order to get their debt securities rated. Now it is up to company whether to accept the rating and in case it is not happy with the rating it is not obliged to reveal it to public and it may approach another agency, but it has been seen that though it is rated by different agencies rating may not vary to a great extent that one agency awards it with AAA+ and another agency BBB.
In India there are 4 major agencies they are;
CRISIL promoted by ICICI
ICRA promoted by IFCI
CARE promoted by IDBI
Among these agencies CRISIL & ICRA combined have a larger market share.
Rating agencies have different codes for giving their opinion about debt securities issued by companies. The way rating is done and the codes given by agencies are same. Ratings of securities as given by CRISIL in decreasing order of quality are AAA, AA+, AA, AA-, A+, A, A-, BBB-, BBB, BBB+, BB+, BB, BB-,B+, B, B-, C and D. ICRA, CARE and Duff and Phelps have similar grading systems.
AAA - Highest safety - These companies are fundamentally strong and these offer highest safety and guaranteed returns. The principal and interests are done on time.
AA - High safety- These offer high safety and timely returns of principal and interest but the safety assured is low compared to that is provided by triple A
A - Adequate safety- These offer adequate safety about interest and principal returns but changes in circumstances have an affect on these debt instruments.
B - High Risk- Debt securities having this rating are more susceptible to default. The adverse economic conditions can have a greater impact on these companies and hence affect the liability.
C - Substantial Risk- these debt instruments are said to be have certain factors on effect of which these instruments are vulnerable to default. There is a high risk involve.
D - In Default- these are highly speculative instruments and high risk is involved in investing these securities.
As we come down lower the order risk increases and so is the case with returns, because the golden rule of market “higher the risk, higher are the returns” is applicable in this case too.
There are different avenues where credit ratings are applied apart from the debt related securities, some of them are
ICRA and CRISIL are two most prominent and followed rating agencies and they are into rating of banks. They are rating banks based upon six characteristics like capital adequacy, asset quality, management evaluation, liquidity position, system and control in short its acronym is CAMELS.
Is credit rating the ultimate measure…??? The answer would be no because you never know how rapidly there will be changes in economic conditions and what would be their implications on this particular company. Just to say whether the company will be getting huge profits or is it going to incur heavy losses and go bankrupt. One more thing is we never know whether the company has disclosed all its information in the sense the confidential information with the credit rating agency. This is where the accountability of a company and credit rating agencies arise.
IndianMoney.com Research Associate