Fixed Deposits

How does the rating of rating agencies impact fixed deposits?

The investors, off-late, have been scouting for corporate bonds that offer better returns and come with the highest degree of safety.

But how do you judge the safety of such corporate deposits?

For this, you need to have the bonds rated by independent rating agencies such as CRISIL, ICRA, and CARE Ratings. Rating agencies are required to provide an unbiased opinion on the creditworthiness of companies offering the scheme.

The rating is an essential step. It is critical given the fact that a physical asset does not back these deposits, and there have been instances in the past where the issuer was unable to service the interest on time and defaulted on the principal repayment.

Have you ever seen the news that said – CRISIL/ICRA or any other rating agency has rated a company ABC’s fixed deposit at say ‘CRISIL/ICRA FAAA. Such announcements have resulted in a spark in the share price of the company.

Have you ever thought what is the cause of such spike, what is rating, what is Crisil and the likes?

So, let us understand the importance of rating for fixed deposit and how it impacts the market. Besides, we shall see the answers to all other basic queries related to the topic.

Let’s begin.

What is CRISIL?

CRISIL was established in 1987 and is India’s first credit rating agency that was promoted by the erstwhile ICICI Ltd, UTI, and few other financial institutions.

The primary service offered was ratings that catered to the investor, such as equity investors, lenders, and the likes. Also, the ratings were meant for other market participants, such as intermediaries and regulators. The US major Standard & Poors back CRISIL.

What are ICRA and CARE?

ICRA and CARE are other rating agencies that provide similar service to that of CRISIL. While Moody’s backs ICRA, CARE does not have any international backing.

Other companies are – India Ratings (backed by Fitch), Acute Ratings, Brickwork Ratings.

What do these companies rate?

These companies provide a rating, which is nothing but its opinion on the possibility of default on various debt instruments. The debt instruments include a certificate of deposit, bank loans, including working capital loans such as Cash Credit, Bank Guarantee and the likes; commercial paper, non-convertible debentures, asset-backed securities, fixed deposits, etc.

Is rating limited to few sectors?

No, all the manufacturing and services industry is covered by these agencies.

Besides, the companies rated can be public sector undertakings, government-owned companies, private companies, proprietorship, partnership entities, public limited companies, and any such body.

Role of rating agencies

Rating agencies play an invaluable role in helping lenders, borrowers, and investors. These companies tend to bridge the gap and help the lender identify good assets for investment. Similarly, it helps the borrower by indirectly helping them reduce the cost of capital. The rating is related to the interest rate. A high rating typically has a low-interest rate.

How does the rating impact the depositor?

Investors and lenders rely on the rating of such agencies before their internal evaluation is done. This rating is generally considered as a benchmark for pricing and trading of debt instruments.

Besides, the ratings provide insights to the regular while it assesses the credit risk.

Lastly, such ratings are useful for computing capital adequacy – a norm followed in the banking sector and mandated by the Reserve Bank of India to mitigate risk.

How to understand the rating?

SEBI has standardized the scale of rating that is to be used by a credit rating agency (CRA). For any instrument, the following scale is used.

CRAs add the (+) or (-) symbol (for example, BBB+) to show relativity within the category. For a fixed deposit, the scale starts from FAAA to D.

Significance

Rating helps determine the credibility of an entity. It reflects the opinion on the full and timely payment of debt obligation by a company or business entity.

Thus, the ratings help investors differentiate the risk associated with an instrument. For example, HDFC Bank is rated FAAA by CRISIL. It shows that the bank is having the highest degree of creditworthiness, and low risk is involved.

The relation between the interest rate and rating

The institutions that offer high interest on borrowing are typically riskier and has lower creditworthiness. Thus, the rating and interest rate has an inverse relationship.

Let us see an example –

Bajaj Finance Fixed Deposits have an FAAA/Stable rating from CRISIL, which indicates the highest safety and lowest investment risk. This means the possibility of default by the company on repaying the investor is low, and the money invested is safe.

To conclude, we can say that depositors tend to look out for lucrative investment options with corporates. Fixed deposits with corporates are an excellent investment tool. However, this also brings in a high degree of risk of losing money. A rating from CRAs is a great tool that enlightens an investor on the degree of risk he/she is taking. While investing in debt mutual funds, an investor should always look out for the portfolio and allocation to the instruments of different rating categories. This helps to gauge the risk associated.

To know more about the debt funds and to see the best funds to invest with low risk and comparatively better returns than a plain-vanilla bank FD, feel free to download our app on the iOS and Android. Additionally, you may subscribe to our blog and join us in the Facebook group once you sign up at Tarrakki.

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