WHAT IS A CREDIT RATING?
An overview of the credit risks associated with a financial instrument or a financial entity is a credit ranking. It is a ranking granted to a specific entity on the basis of the entity’s credentials and the degree to which the entity’s financial statements are sound, in terms of past borrowing and lending. It is in the form of a comprehensive report focused on the financial history of the entity’s borrowing or lending and creditworthiness, derived from the accounts of its assets and liabilities, with a view to understanding its ability to repay debt in a timely manner.
It denotes a corporation or a company’s creditworthiness. It is provided by CRISIL, ICRA, CARE, SMERA, ONICRA, and Fitch India, which are credit rating agencies in India. It is not used for individuals. On the other hand, on the basis of the credit information report, credit ratings are provided by the credit bureaus. To measure your creditworthiness, these ratings are used by your creditors. These two words are frequently interchanged, but not the same. Let’s look at the credit rating and credit score in more detail.
IMPORTANCE OF CREDIT RATING FOR BORROWERS
Here are the credit rating benefits:
- Easy Loan Approval: You would be seen as a low-risk borrower with a high credit rating. Banks would also readily accept your loan application.
- Considerate Rate of Interest: One of the most significant variables that help lenders assess the interest rate on the loan you take is your credit rating. The higher the credit value, the lower the interest rate.
DIFFERENCE BETWEEN CREDIT RATING AND CREDIT SCORE
The key differences between the credit rating and the credit score are given in the following sections:
- A credit rating represents the creditworthiness of a government or a corporation, while a credit score is used to estimate the probability that you can pay on time for your credit obligations.
- For those governments or companies that have a healthy ability to fulfill all financial obligations followed by a double-A, A, Triple-B, Double-B, and so on, until D for failure, a credit rating is expressed in a letter grade format such as Triple-A scores. It is possible to add pluses and minuses to these scores as well.
- On a scale of 300 to 900, credit scores are typically expressed in numbers. The closer the rating is to 900, the greater the creditworthiness of that individual.
Both scores are, however, given by third parties who are autonomous.
HOW DO CREDIT RATINGS WORK IN INDIA?
In order to determine a credit rating, each credit rating agency follows its own algorithm. However, credit history, credit form, and length, credit usage ratio, credit exposure, etc., are the major factors. Each month, these credit rating agencies collect lenders’ credit details. Banks, financial institutions, and investors use this rating to determine whether to invest money, purchase bonds, or provide a loan or a credit card. The higher the ranking, the greater the probability of having money at preferred interest rates.
WHAT IS A CREDIT SCORE?
A credit score is a 3-digit number that reflects the capacity of the borrower to repay debts on time. A mathematical algorithm based on the information given in the credit report produces this score and is designed to predict risk. Depending on the following details, the credit bureaus prepare your credit score:
- History of payments.
- Amount(s) that is owed.
- New credit.
- Types of credit that has been used.
- Length of credit history i.e., time since account activity was started.
Although each of the three bureaus differ in the score produced, the factors are taken into account are often the same.
WHO ISSUES CREDIT SCORES IN INDIA?
Companies that have registered under the Credit Information Companies (Regulation) Act, 2005 have been approved by the Reserve Bank of India to provide credit scores or ratings based on past performance reported by various member credit institutions and banks. The three major credit bureaus in India, namely CIBIL, Experian, and Equifax, issue credit ratings.
Both credit ratings and credit scores are the terms used to assess the probability of debt recovery. While both can sound similar and are used interchangeably occasionally. But both of them are distinct.
For businesses, credit ratings are and credit scores are for the person. It is important to evaluate both before using any credit product to know your current status.