Role of Credit Rating Agencies in Finance

Assessing credit worthiness in finance

Abstract

Before we delve into the role of credit rating agencies, we need to understand what is ‘credit’. And why it is required to access the credit worthiness of a company. Let us look at a small example to illustrate this. Assume you are running a shop where you get some raw material for making soaps and create a soap and then sell it in the market, now you need some time to have some sales (generate some revenue) in order to pay back your suppliers. So based on the trust which they have in you, they might extend a credit line to you, eg. 1 lakh rupees and offer a period say 306090 days to make the payment. The more is the trust, you may have better terms to make the payment. Your past behavior with the supplier will mostly shape the credit terms. Now this scenario can exist when there is a 11 engagement between the supplier and the company. But what will happen if a security or borrower is looking to raise funds for their business from a bank or a merchant? How can a merchant bank like UBS, SBI etc. identify the credit worthiness of a company so that they can identify if they can lend money to a companybusiness and at what terms.