The introduction of credit rating agencies was made in the 20th century. Since then, they have played a significant role in the financial world. They rate individuals and organizations based on their habits that when appropriately assessed, portray a clear image. Anyone with a lack of creditworthiness does not have a way to hide. Isn’t that great? Yes, we think the working of a credit rating agency is beneficial to get justice every time someone lends or borrows money.
Purpose of Credit Rating Agencies
Assessing what the credit rating agencies do is very straightforward. However, what’s not very simple to understand is how they do it. What all factors someone to assign a certain credit score to a person? We can undoubtedly say that there’s no complicated formula to evaluate any institution. Still, the information is not leaked out.
Nevertheless, the purpose is to assign a rating to an individual or an organization that borrow or lend money. Their respective activities of repaying or collecting money from there creditors and debtors influence their evaluation. The financial industry depends a lot on these ratings to evaluate their risk.
Credit rating agency enable the right balance between risk and reward
For all those investors who are ready to lend money always evaluate the risk and return on investment as a critical factor. After having a numerical rating of a person, they can easily shoot up the interest rate to balance the reward from more risky borrowers.
All borrowers who want to borrow from financial institutions can access their terms and conditions while taking this decision. No person wants a company with some strict conditions to hinder the quality of finance they borrow.
How do credit rating agencies rate the organization?
Now, as creditworthiness works both ways that is for the creditor and the debtors, one can quickly figure out the ability to repay and disburse debt. Every investor looks for an unbiased person who can repair debt on time. Also, the creditor should have the right terms and conditions.
What the credit rating agency does evaluate each organization subjectively. There’s no uniform formula for everyone. It’s just about the institution’s habits to repay debt. The credit rating agency also assesses the balance sheet of the organization and looks for the income statement. They figure out their attitude towards repaying debt and scrutinize everything carefully.
Levels of Credit
Credit rating can be different for a debtor and creditor. However, we can easily figure out which debt is assigned which category. The following are self-explanatory levels of credit.
- High-grade credit
- Upper moderate level
- Lower moderate level
- Slightly speculative
- Highly speculative
- Huge risk to invest
- Partially in default
- Wholly in default
Advantages offered by credit rating agencies
As mentioned above, the working of a credit rating agency itself suggests that it’s meant to benefit the financial system of a country. And, we assuredly say it does. How? Let’s find out.
- A balance between risk and return
Credit rating agencies help us to assess the risk for assault an investment and accordingly, the investors can set the interest rate to balance out. For the debtors with a lower credit rate, the interest rate is high and vice versa.
- Institutions can improve based on their credit rating
Having a bad habit of not repaying instalment loan time is never beneficial for anyone. The institutions with a low credit rating can certainly have an incentive to improve. They can recognize the problems in repayment and contact the best credit repair services as soon as possible.
- Eliminate the doubt factor
The debtors who are in doubt that their habits are not up to the mark can have a sigh of relief. For all the institutions who have a good credit rating can have an even better number if they follow proper guidelines to improve.