Business Credit Rating

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Business Credit Rating
  1. What is a Bank Loan Rating?

Bank Loan Rating is used by banks to determine risk weights concerning loan exposures, in line with the Reserve Bank of India’s (RBI’s) Guidelines for Implementation of the New Capital Adequacy Framework under Basel II framework. RBI and SEBI have listed out authorized external independent agencies to carry out Bank Loan Rating for this purpose.

The rating agency opinions on the likelihood of the financial obligations being serviced on time and in full, as specified in the terms and conditions of the facility. The rating takes into account the long-term and short-term risk associated with the facility depending on the original maturity of the facility. Credit ratings may also indicate that the credit risk associated with a specific credit facility or specific security.

  1. What is kind of Bank Loan Rating? Is external Credit Rating is mandatory for availing a loan?

Rating of the facility can be external and internal. While credit rating generally denotes a rating assigned by a credit rating agency, there is also a mechanism of internal ratings by banks. A mechanism of the internal credit rating of borrowers was in existence in banks much before external credit rating of bank loans were introduced under Basel II regulations. RBI’s guidelines on ‘Risk Management Systems in Banks’ issued in October 1999, indicated that measurement of credit risk through credit rating/scoring depends on the Bank’s management decision.

Indian banks have been extensively using the opinion of external rating agencies. Even though banks do not require credit rating by external rating agencies for all loans, some are seemed to be asking borrowers to get an external rating. This is being done to enhance its credit assessments.

  1. How is Credit Rating different from Credit Score?

Both credit rating and credit scores are a measure of credit risk and reflect the varying level of probability of default of a given borrower. The difference is in the methodology used by them to assess the credit risk. While credit ratings are forward-looking opinion about credit risk, credit scores assigned by credit bureaus are based on the credit history of a borrower. Credit ratings take into account the risk that a borrower may face during a given time horizon in the future. In contrast, credit scores are based on the past performance of a borrower concerning servicing of debt. The second difference is that credit scores are assigned to a particular borrower, while credit ratings can be assigned to a specific facility.

  1. What is the loan which needs to be rated?

Fund based as well as non-fund-based facilities sanctioned by Banks, which includes Cash Credit, Working Capital Demand Loans, Packing Credit, FCNR Loans, ECBs, Letter of Credit, Bank Guarantees, Bill Discounting, Project Loan, Forward Contract, etc. beyond a threshold limit are subjected to Bank Loan Rating.

  1. What is the threshold loan amount which needs to be rated?

It is recommended by RBI to rate facilities above Rs 10crs for calculating capital requirement, and as clarified by RBI, Credit rating is not mandatory for MSE borrowers. Banks insist on credit rating to meet the Capital Adequacy guidelines issued by RBI by assigning risk weightage to various loans. Higher Risk weightage is assigned to the facilities where the rating is on the lower side than speculative.

Various banks insist on external rating for loan exposure more than Rs 10 Crs to enhance their credit assessments. It is in the interest of the borrowers to get their credit rating done as it would help in credit pricing of the loans taken by them from banks.

  1. What are the agencies authorized to carry out Bank Loan Rating?

In India, RBI and SEBI have allowed below external rating agencies to rate Bank Loan:

  • CRISIL Ltd.
  • CARE (Credit Analysis & Research Ltd.)
  • ICRA Ltd.
  • Brickworks (Brickwork Ratings India Pvt Ltd.)
  • India Rating (FITCH Ratings India Pvt Ltd.)
  • Acute Ratings & Research Ltd. (Erstwhile SMERA Ratings Ltd.)
  • What is the Benefit of Bank Loan Rating?
  • Better Credit Rating has benefits to Lenders as well as Borrowers. Few of them are
  • Credit selection – to decide whether to lend or not to a particular borrower
  • Pricing – Bank decide to price based on the rating to the loan
  • Favourable Terms – Better rating opens a window for better terms offered by the lender, e.g., waiver of third-party guarantee or additional collateral cover, longer tenure for term loans
  • Portfolio Analysis – Banks segregate the borrowers based on the rating.
  • Customer Service – Banks like to retain the high rated borrowers by offering favourable offering.
  1. What are the factors that affect Credit Rating?

While making a credit assessment, the credit rating agencies will look at several factors, divided into qualitative & quantitative which includes the borrower’s level of debt, its willingness and financial ability to repay the debt, its growth prospect, management ability, industry outlook, dependency on customers or suppliers, geographical distribution and presence.

  1. What is Investment grade rating?

An investment-grade rating signifies the rating agency’s belief that the rated instrument is likely to meet its payment obligations. In the Indian context, Bank loan and debt instruments rated ‘BBB-‘ and above are classified as investment-grade rated. Lenders prefer facilities with Investment Grade rating.

  1. What is Speculate grade rating?

Facilities and Debt Instruments that are rated ‘BB+ ‘and below are classified as speculative-grade category ratings, that means the ability to meet the payment obligations is considered to be “speculative”. These are considered to carry materially higher risk and a higher probability of default compared to facilities and debt instruments rated in the investment grade.

  1. Is rating a one-time exercise?

No. To protect the interest of lender and investors, SEBI has mandated that every credit rating agency shall, during the lifetime of the securities rated by it, continuously monitor the rating of such securities and carry out periodic reviews of all published ratings.

  1. What is the validity period of a credit rating?

A rating is expected to remain valid until the rated debt obligation is fully paid or the rating is withdrawn and is subjected to a periodic review to ascertain the validity of the same.

  1. Can the rating be changed once rated?

Rating is an opinion based on information available at a point in time with the rating agency and expectations made based on such information by the agency. However, information and expectations can change significantly over time, thereby affecting the future repayment abilities and thus, requiring the rating to be altered.

A downgrade in the rating indicates that the risk of default of the instrument is higher than what was earlier predicted and an upgrade in the rating indicates the risk weightage assigned has improved over the period due to external and internal factors.

  1. Who pays for the external rating, and what are the charges associated?

The Issuer who wants to get rated pays towards the fees for credit rating. The fee is a percentage of the facility amount,

  • Ranging between 0.04% to 0.10% of the rated bank facility, subject to a minimum amount between Rs 40,000 to 50,000.
  • Annual Surveillance fee would range between 0.01% to 0.07% of the facility amount, per annum with a minimum of Rs 30,000 to 50,000.
  1. How much time does it take for the rating process to be over?

Credit Rating exercise typically takes about 2-4 weeks to complete from the date of receipt of the adequate information to carry out the process.

  1. What is Rating Outlook?

Rating Outlooks indicate the direction in which a rating is likely to move over a one to two-year period. They reflect financial or other trends that have not yet reached the level that would trigger a rating action, but which may do so if such trends continue. The Outlooks could be Stable, Positive or Negative.

  1. What is the grading of Credit Rating?

The Credit rating is divided into Long Term and Short Term. Long term facilities carry a rating from AAA to D, and short terms are rated as A1 to D. A ‘+’ or ‘-‘ signs may be attached to the Long-Term ratings and Short Term facilities with a sign ‘+’, to indicates the comparative standing within the category.

Detail list of rating and their meaning are as enumerated below:

Long Term Credit Rating and its description
AAA AA A BBB BB B C D
Highest degree of safety regarding timely servicing of financial obligations High degree of safety Adequate degree of safety Investment Grade and Moderate degree of safety Non-investment grade and moderate risk of default Non-investment grade & high risk of default Very high risk of default In default or are expected to be in default soon
Lowest Credit Risk Very low credit risk Low credit risk Moderate credit risk. Inadequate Credit Safety High Credit Risk Substantial Credit Risk Default Risk

 

Short Term Credit Rating and its description
A1 A2 A3 A4 D
Highest degree of safety regarding timely servicing of financial obligations High degree of safety Moderate degree of safety Minimal degree of safety In default or are expected to be in default on maturity
Lowest Credit Risk Very low credit risk Moderate credit risk. High Credit Risk Default Risk

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