Credit Rating helps SMEs in building business credibility

 In the past few years, the financial system of India has started to understand the 'true' significance of credit ratings. It is now considered as a noteworthy part of the framework for credit and investment related decisions. In today’s time banks often lay emphasis on lending and offering financial services to the small and medium enterprises (SME) sector.

It is believed that with the help of ratings, SMEs' access to financial services rises considerably. This becomes all the more important as many banks display reluctance to offer loans to SMEs due to the popular belief of risk in loaning to the SMEs, that come with unproven record and also limited assets.
The independent agency ratings for SMEs can enhance the confidence of the lenders and also widen the scope of financial resources for them.


Definition of credit rating –
It is defined as an opinion on the relative degree of risk that is related with the timely payment of interest and also principal on a debt instrument. Usually, alphanumeric symbol is used to show credit rating.


Role of credit rating agency –
For SMEs, reaching out to a credit rating agency is a good option as they often face problems in securing investments and funds. An RBI report on trends and progress in banking 2010 states that just 13% of the registered SMEs in India enjoy access to finance from formal sources.


The rating agencies review any company's financial viability along with its capability to meet the business obligations. They also review the sales figure, financial composition and also focus on the health of the enterprise. Moreover, the rating agencies benchmark the performance of SMEs within the industry itself.


For rating any entity, they charge a fee which is decided on the basis of the company’s turnover. For one year, these ratings are valid and it can be renewed after the completion of time period. Analysts say that good rating raises the chance for SMEs to receive loan.


Basic difference between credit rating agency and credit bureau –
- A credit rating agency offers an opinion related to future debt repayments by borrowers, while on the other hand, a credit bureau gives information on past debt repayments by borrowers.


- A credit rating agency while allocating the ratings uses the information related to a firm's past record in debt servicing, supplied by credit bureaus.
- Credit Bureau information is usually used by the trade creditors, and credit ratings are useful for the financial investors.


Importance of ratings –
Over the years, it has become a known fact that a good rating can help in bagging faster credit for any venture. Few of the agencies in India that rate SMEs are CRISIL Ratings, SME Rating Agency of India (SMERA), Indian credit ratings agency (ICRA), Credit Analysis & Research (CARE), Onicra Credit Rating Agency of India Ltd and FITCH Ratings. They have teamed up with different banks to provide preferential interest rates based on ratings. It is noteworthy that CRISIL enjoys a working arrangement with 35 banks and financial institutions, and SMERA has inked collaborations with 29-financial institutions.


CRISIL has said that the interest rate cut for its clients varies from 0.5-1.25% and almost 35% of the entities have seen decline in the loan processing time. Market experts feel that independent risk evaluation of SMEs by a third party gives credibility to them and also enhances confidence when dealing with MNCs and corporates.


In recent times, the rating schemes for SMEs have gained huge prominence not only in India but across the globe. Standard & Poor’s, a research and rating agency, started an SME rating programme in Japan during 2005.
CRISIL also started rating Indian SMEs in 2005. Just a few days back, it completed its 25,000th SME Rating and also enjoys presence in almost 100-Indian cities. CRISIL rates SMEs under National Small Industries Corporation (NSIC) scheme. SMERA, promoted by SIDBI, assigned its 15,000th SME Credit Rating in March this year. Reports suggest that over 30 public and private sector banks endorse the CRISIL SME ratings and then use them when they carry out internal credit evaluations of the small scale industries. With the help of CRISIL’s rating system, SMEs have successfully saved over Rs 1 bn ($22.5m) in interest costs and are expected to save an overall of Rs 5.6bn ($125m) by 2013. In 2011, CRISIL's Rs 827-crore turnover was primarily pushed by SME ratings and bank loans. It enjoys a rating renewal of 40% from its SME clients.


How to create rating system for SMEs -
Experts feel that creating a rating system for SMEs is not an easy task. The benchmarks which are used for large corporations need to be abandoned while developing a rating system for SMEs. Creating a rating system, similar to the one like CRISIL in India, will solve the purpose of SMEs.
There are two kinds of ratings for SMEs - credit rating of financial instruments and customised rating. Meanwhile, CRISIL has showed inclination to rate close to 100,000 SMEs by 2015.


Conclusion -
Credit ratings can transform the way SMEs are involved in the financial system. The rating agencies need to identify the special steps needed in this direction. They should also start outreach initiatives which will create awareness among SMEs about the benefits of ratings. Rating agencies should also have specialised teams and analytical tools, which are customised for the SME sector.


Credit rating can also be used in the form of a brand building tool by SMEs to boost credibility among suppliers and customers.