The system of rating got institutionalized following the Great Depression in 1933, when the US Controller of Currency enacted a rule that banks could only purchase securities, which have minimum investment rating.

The need of credit rating is different for different parties depending on the benefits it offers to the various parties utilizing these services, viz., investors, issuers, intermediaries and the regulatory authority.

Investors:

• Rating will supplement the investors’ credit evaluation process

• It facilitates comparison of relative value between competing securities.

• It helps in recognizing the risk involved in the investment

Issuers:

• A company with highly rated instrument has the opportunity to reduce the cost of borrowing by quoting less interest rates.

• A company with rating can approach a wider section of investors for resource mobilization.

• Companies with rated instruments can avail of the rating as a marketing tool to create better image in dealing with its customers, lenders and creditors.

• Rating encourages the companies to come out with more disclosures about their accounting system, financial reporting and management pattern.

• Smaller and not so well known companies can access markets.

• Encourages financial discipline as borrowers attempt to obtain ratings by improving financial structured reducing operating risks

Financial Intermediaries

• Th ratings help them in pricing the debt.

• It shifts the burden of establishing credit quality from intermediary to a rating agency thereby easing the due diligence requirement.

• With high credit rated instruments, the brokers can convince their clients to select a particular investment proposal. This saves their time, cost manpower in convincing their clients.

Regulatory Authority

By identifying the risks, rating helps in channelising savings into productive investments

Credit rating serves the objective of protecting the investors

What is Credit Rating :

• Rating reflects the borrower’s accountability, expected capability and inclination to pay interest and principal in a timely manner

• Rating is an isolated function of a credit risk evaluation. Rating is useful in differentiating credit quality.

• Rating will involve issue-specific evaluation.

What  Credit Rating is not:

• Rating is not a general purpose evaluation of the issuer.

• It is not a recommendation to buy/sell/hold a security

• Rating is not an extensive audit of the issuing company.

• Rating is not a one-time assessment of creditworthiness valid over the future life of the security.

Factors that contributed to the growth of Credit Rating:

• High level of defaults in U.S. capitak markets in 1970.

• Regulators stipulation for mandaory ratings.

• Investors awareness of ratings for risk assessment and risk management.

• It helps intermediaries for pricing and placement of financial instruments.

• The increasing role of capital and money markets.

• Globalization of credit markets.

• The continuing growth of information technology.

• The growth of confidence in the efficiency of the market mechanism.

• The withdrawal of government safety nets and the trends towards privatization.