Credit rating plays an essential role in the financial world by providing an independent opinion on the creditworthiness of borrowers. Some of the important reasons why credit rating is important are:
- Facilitates Investment Decisions: Credit ratings provide a standardized measure of the creditworthiness of the issuer of debt instruments, making it easier for investors to make investment decisions.
- Helps in Pricing of Debt Securities: Credit ratings also help in determining the interest rate that the issuer must pay on the debt security. Higher-rated securities are considered less risky, and therefore, carry lower interest rates than lower-rated securities.
- Helps in Lowering Cost of Capital: Companies with a higher credit rating can access capital markets at lower costs than companies with lower credit ratings. This is because investors are willing to invest in highly rated securities at lower interest rates, which, in turn, lowers the overall cost of capital for the issuer.
- Helps in Risk Management: Credit ratings help investors in managing their risk exposure by providing them with an independent opinion on the creditworthiness of the issuer.
- Helps in International Trade: Credit ratings are useful in international trade as they provide a common framework for assessing the creditworthiness of issuers across countries.
- Regulatory Compliance: Regulatory bodies such as the Securities and Exchange Board of India (SEBI) and the Reserve Bank of India (RBI) require companies to obtain credit ratings for their debt instruments. This is to ensure that investors are adequately informed about the creditworthiness of the issuer.
- Helps in Corporate Governance: Credit ratings can also help in improving the corporate governance of companies. Companies with higher credit ratings are perceived to have better governance practices, which can, in turn, enhance their reputation and access to capital.
Overall, credit rating is an important tool in the financial world that helps in facilitating investment decisions, lowering the cost of capital, managing risk, and ensuring regulatory compliance.