Your Ultimate Guide to the Credit Rating Process

Your Ultimate Guide to the Credit Rating Process - student project

These days, one of the top financial goals for anyone without any doubt, is to have a knack for grasping personal finance basics.
These goals go simply beyond knowing about stock trading, futures & options, algorithmic trading, bitcoins, or all the fancy finance buzzwords.
Having a great understanding of the credit rating process, or how to maintain a great credit score in fact, should be one of the foremost target areas you should aim for.
So what is the credit rating process all about?
What are the types of credit ratings? Who are the entities that rate us on our ability to pay off loans in a whiff?
And what’s the difference between a credit rating and a credit score?
Just follow through with this guide to get all your questions answered.
What is the credit rating process?Before delving further into the types of credit rating, it would be pertinent to note what the credit rating process means.Simply put, the credit rating process is a defined procedure by an entity to assign a numerical parameter of your creditworthiness to the individual in question.It is an independent assessment of your timely ability to repay your loan.The entity is typically a credit rating agency, bank, or any independent credit bureau that assigns credit ratings to individuals.The individual here could imply a person, a corporation, a firm, or even a country or a government.Here’s what the credit rating process entails for a typical individual:

  • Evaluating your past debt payments (how prompt have you been in repaying your previous loans),
  • Your credit exposure (how many outstanding loan accounts do you have),
  • Your credit utilization ratio (a percentage, defined by the amount of revolving credit you use upon the total credit available to you),

Amongst many other similar factors.An independent credit bureau carries all of this out and makes it available as a detailed report.This report also contains your credit score.Another important thing to note is that a credit score is entirely different from a credit rating- although both are used interchangeably, they mean different things:

  • A credit rating implies the creditworthiness of a sovereign, whereas a credit score refers to an individual’s creditworthiness,

 

  • A credit rating is expressed in a rating scale, ranging from AAA (the highest grade), to D (the lowest grade), including plus signs or minus signs too, which is mostly assigned by banks' internal credit rating departments or credit rating agencies, whereas a credit score is expressed in a numerical rating scale, ranging from 300-900.


What are the types of credit ratings?The types of credit rating differ from entity to entity- more so when it comes to the terminology employed.Typically, credit ratings are classified into two broad categories:

  1. Investment grade: Which ranges from AAA to BBB;

 

  1. Non-investment grade: This ranges from BBB- to D (default grade, the lowest grade in the hierarchy).

 

  • Investment grade ratings denote a high level of creditworthiness, which means timely honor of the terms of repayment. This is encapsulated in the form of lower rates of interest as compared to the latter category of credit rating, i.e. Non-Investment grade ratings;

 

  • Non-investment grade ratings, as the name suggests denote a lower level of creditworthiness, ranging from the likelihood of delayed repayments until complete default- which is compensated by charging higher rates of interest than Investment grade ratings

Credit ratings can also be classified based on duration of maturity:

  1. Long-term ratings- Loans maturing beyond a year,

 

  1. Short-term ratings- Loans maturing within a year

Who does credit ratings?Credit rating is typically undertaken by credit rating agencies, other than banks and independent credit rating bureaus.Here are some of the top credit rating agencies in India, that you should know about:

 

  • Incorporated in 1987, CRISIL Ratings Ltd. (a subsidiary of CRISIL Ltd., an S&P Global Company) is a credit rating agency serving investors, lenders, issuers, market intermediaries and regulators

 

  • It covers banks, NBFCs, PSUs, manufacturing companies, financial institutions, state governments, urban local bodies, etc.

 

  • It helps investors make informed investment decisions by providing credit ratings for companies, organizations, and banks

 

  • The ratings generated by the agency range from AAA to D

 

 

  • ICRA Ltd. (formerly Investment Information and Credit Rating Agency of India Ltd.), is an independent and professional Information and Credit Rating Agency

 

  • Formed in 1991, ICRA offers guidance and information to institutional and individual investors and creditors

 

  • It covers commercial banks, NBFCs, PSUs, manufacturing companies, and municipalities

 

  • It specializes in assigning corporate governance ratings, mutual funds ratings, structured finance ratings, performance ratings, etc.

 

 

  • Established in 1993, Credit Analysis and Research Ltd. (CARE), is a seasoned credit rating agency 

 

  • It covers diverse sectors such as infrastructure, manufacturing, the financial sector, and banks and non-financial service companies

 

  • The agency provides ratings to companies related to debt market instruments, as well as capital market instruments

 

  • CareEdge Ratings’ (CARE Ratings Ltd.) manages and operates its wholly-owned subsidiaries, some of them being CARE Advisory and CARE Risk Solutions Pvt. Ltd.

 

 

  • India Ratings and Research (Ind-RA), a wholly-owned subsidiary of the Fitch Group, is one of the leading SEBI-recognized and RBI-accredited credit rating agencies

 

  • Ind-RA offers its services to banks, insurance companies, corporate issuers, finance, and leasing companies

 

  • Its client base also includes urban local bodies and managed funds, structured finance, and project finance companies

 

  • It has seven branch offices, spread across India

 

 

  • Acuite Ratings & Research Ltd. (formerly known as SMERA Ratings Ltd.) is also a top SEBI-recognized and RBI-accredited rating agency

 

  • It offers ratings to companies serving structured finance, corporate, and financial sectors

 

  • It has a wide range of primary services, including bond and bank loan ratings, economic analysis, and financial research services

 

  • It largely caters to small-sized private corporations, public sector undertakings, and companies in the financial sector


In India, credit rating agencies are regulated and governed by SEBI (Credit Rating Regulations), 1999, of the SEBI Act, 1992.Importance of having a great credit scoreHaving a great credit score (between 700-749) comes with its perks.Other than getting the privilege of concessional interest rates, easier credit approval, and higher loan amounts, there are many other admirable benefits of having a healthy credit score.Here are some of the benefits you can get if you have a great credit score:

  • Greater negotiating power: 

 

  • Having a great credit score empowers you to avail the terms and conditions of the credit on your terms.
  • You can easily negotiate lower rates on credit cards or new loans
  • You also get access to more credit providers and exclusive interesting offers 

 

  • Higher Borrowing Limits:

 

  • Your borrowing capacity depends on your income record and credit repayment history, and having a good credit score helps 
  • You can easily avail higher borrowing limits on your loans and advances, due to the confidence companies place in you to repay on time

 

  • Easier approvals by renters:

 

  • Most landlords approve tenants after looking at their credit history, and having a bad credit score would only act to your detriment here
  • A good credit score can save you from much of the unavoidable time and hassle of renting a place 

 

  • Better insurance rates:

 

  • Not only landlords, but even insurance companies utilize information from your  credit report and insurance history to develop your risk score
  • Having bad credit scores equates to penalties in the form of higher premiums

 

  • Credit checks for onboarding employees:

 

  • Some companies verify your credit scores, as a part of the background verification process
  • A good credit score here thus helps with your employability prospects

How can you ensure a good credit score?It's a no-brainer that having a great credit score should be a must-have financial goal on your bucket list.
A good credit score ensures a host of benefits:

  • Getting lower rates of interest,
  • Access to better borrowing terms,
  • Lower insurance premiums, 
  • Faster credit approval process,


Amongst so many other benefits we discussed above.
Taking these steps would help you ensure a great credit score:

  • Checking your credit utilization ratio:
  •  The credit utilization ratio is a measure of the credit utilized by the credit available.
  •  Maintaining this ratio between 30-50% ensures control over your monthly spending
  • Also, avoid exhausting your credit limit month after month to ensure a stable credit utilization ratio and timely payment of your bill

 

  • Limiting your credit card applications:
  • Applying for too many credit cards or availing too many loans indicates imbalanced control over your credit habits
  • Thus, avoid applying for too many credit cards or loans at a time and prioritize your financial needs efficiently
  • Try having no more than 2 credit cards at a time

 

  • Checking your CIBIL score at timely intervals:
  • Keep tracking your CIBIL report at timely intervals for any errors or mistakes
  • Some of these errors could be closed loans not yet recorded in your report, which could negatively impact your credit score

 

  • Paying your credit card bills timely:
  • Paying your credit card bills before the due date helps build a positive credit record
  • Aim to pay off your credit card bill fully, then the minimum due to get a good credit score

 

  • Checking your loan eligibility:
  • Always choose a loan option strategically, rather than in an ad hoc manner
  • This maximizes the chances of your loan application getting accepted, as well as improving your credit score

 

  • Maintaining a balanced credit mix:
  • Try to avoid unsecured loans, or loans without any collateral backing as far as possible (for e.g: personal loans, education loans, business loans)
  • Having a healthy mix of secured loans with unsecured loans, if any your portfolio helps balance out the risk factor significantly, improving your credit score

 

  • Get at least one credit product:
  • Having no credit product in your name means having no credit history, which makes it difficult to get any loans sanctioned in the future
  • The rates of interest are also higher for individuals having no credit history, so aim for availing at least a credit product in your name to build your record


These are just some of the easy ways for you to maintain a good credit score.SummaryIn this article, we talked all about:

Let this guide be your starting stone toward developing sound financial habits and a disciplined routine in handling debts.