Rating is a classification system based on the firm's or individual's historical and current qualitative and quantitative data that is used to estimate whether an organization or individual will be able to meet its financial obligations on time. The results have been converted into clearly understandable, universal symbols in order to make the classification easier to understand. Symbols have universal comprehensibility. Rating is a standard and objective assessment provided by professionals who evaluate and impact a debtor’s credibility, ability to repay borrowing on time and on schedule, and, as a result, its position in money and capital markets. A government, a financial institution, a company, or an issued financial asset can all be rated.
Ratings compose of powerful and helpful symbols that aid capital market and money market institutions, credit suppliers and demanders, investors, agents, and regulators in their assessments.
Credit ratings are critical in assisting companies and governments in obtaining funds from the capital markets. Governments and companies that want to borrow funds from investors by issuing bonds instead of utilizing loan from the bank, thanks to their credit ratings, give information about their credit rating to investors who request these issuances. In this way, credit ratings facilitate bond issuing and purchasing processes by providing an effective, widely accepted measure of long-term relative credit risk. By means of the existence of credit ratings, governments and municipalities are used for public projects, companies for expansion and research and development, etc. have the opportunity to be fund-raise from the markets for their activities.
Users of Ratings
Investors: When making investment decisions and managing their portfolios, investors frequently utilize credit ratings to assess credit risk and compare different issuers and debt instruments. Credit ratings can be used by institutional investors and financial intermediaries such as mutual funds, pension funds, banks, and insurance companies to support their own credit analysis and to establish a credit risk cut-off point.
Financial Intermediaries: Investment banks mediate financial savings from investors to issuers. Credit ratings can be used by these institutions to examine the relative risk of various funding instruments and to evaluate them as a factor in setting the interest/dividend rates of debt issuances they organize.
Issuers: Companies, financial institutions, governments, and municipalities use credit ratings when issuing instruments to provide the market with an independent assessment about their creditworthiness and the relative risk of their issuance. Companies that issue bonds or sukuk can use rating based on an accurate and objective assessment to inform the market about their own risks and gain access to find funds at better terms. Therefore, capital costs will decrease and the net return on investments will increase, and as a result company value will increase.
Businesses and Financial institutions: Credit ratings can be used by businesses and financial institutions to measure counterparty risk in credit risk-sensitive transactions.
Banks: Within the scope of the Basel II Accord, banks can use credit ratings to calculate credit risk when calculating capital adequacy. Banks can use the ratings provided by authorized credit rating agencies in the standard method for calculating credit risk. This enables banks to make better use of their capital.
Ratings by Maturity
Long-term ratings are the long-term opinion of the rating agency on the corporate quality of the evaluated institution, based on the basic economic and financial characteristics of the sector. While reaching this conclusion, the level of being affected by factors such as sensitivity to the economic conjuncture and competition involving various risks, legal regulations, technological developments, demand changes, and management quality is taken into consideration.
Short-term ratings, on the other hand, are based on the ability to access liquidity and capital resources on all liabilities with a maturity of up to one year.
Credit rating agencies have created a separate rating system for short-term (<1 year) and long-term (1+ year) liabilities due to different investment dynamics and different investor bases. Short-term ratings are mostly used in the financial bond market. Long-term ratings, on the other hand, are considered more than short-term ratings because they take into account a longer period of time. Because investors, creditors and other interested parties mostly use long-term ratings for credit worthiness measure.
Ratings by Types
Credit ratings provided to the same debtor in foreign and local currencies may differ. The debtor's ability to pay its commitments in that term of cash through generating cash flows in that currency is assessed by the applicable credit ratings.
International Foreign Currency Rating (FC): The ability of the institution to pay its foreign currency liabilities by creating foreign currency is evaluated. All country risks are taken into account, including convertibility and transfer risks.
International Local Currency Rating (LC); The ability of the institution to pay its obligations by creating local currency, regardless of currency, is evaluated according to international criteria. All country risks are taken into account, except for convertibility and transfer risks.
National Local Currency Rating (Tr); The ability of the institution to pay its local currency obligations by creating local currency is evaluated according to national criteria. Country Risks are not taken into account.
It refers to the method or methods used by rating institutions to determine the creditworthiness of their customers and, as a result, the rating notch, including all assumptions, definitions, calculations, classifications, and the rating process, among other things. Credit rating institutions use a variety of methodologies, including statistical approaches, expert opinion-based approaches, and hybrid systems that combine statistical and expert-opinion approaches. It is essential that rating methodologies reflect the credit worthiness of a customer in determining the rating given to that customer, and that this issue is designed to use scientifically proven quantitative and qualitative factors whenever possible.
The aim of rating, segmentation, and classification procedures for the evaluated organizations may necessitate different rating methodologies and criteria. One of the most important segmentation criteria is the industry in which the companies operate, as well as the financial and activity sizes of the companies. Because each segmented group is involved in a distinct industry and operates on a different scale, the variables influencing their creditworthiness and evaluation criteria will differ. The BRSA classifies ratings into categories based on the principal asset type as follows.
- Central administrations, public institutions, international organizations and multilateral development banks
- Companies and Projects
- Structured Finance Instruments