Are credit ratings reliable?
Are credit ratings reliable?
“Is it reliable? Does it really define the company’s health? By whom has been it issued? And who requested it?”
Those and similar questions concerning the reliability of a company’s creditworthiness assessment, whether positive or negative, are not unusual.
To clarify any doubt, there are just few important notions you should know.
Two different evaluations: credit rating and credit scoring
They may be used as synonyms, but credit rating and credit scoring are two quite different evaluation models.
A credit score is an assessment, obtained with an automated process and the use of a statistical model or an algorithm, of the only company’s financial data and public information that can be quantified. The assessment is conveyed by means of a score and evaluates quantitative parameters only, such as company’s solvency or profitability.
Scoring services can be provided both from credit rating agencies and data providers; they are a useful and affordable solution for small and medium-sized businesses to gain an intuitive and immediate evaluation of the counterparty’s financial statement.
A credit rating instead is an assessment on the creditworthiness of a company or an institution. As it evaluates both quantitative and qualitative parameters – such as board composition, sector analysis, country risk, etc. - it must be drawn up by a financial analyst.
In Europe, only credit rating agencies recognized by the European Securities and Markets Authority can issue credit ratings. The Credit Rating Agencies list is published on the EBA’s website.
Differences between solicited and unsolicited ratings
There are two main reasons for requesting a rating: either to obtain an assessment about the economic and financial statement of your own company, or to receive an opinion on the counterparty’s creditworthiness.
Ratings can be solicited or unsolicited. Solicited ratings are requested by the evaluated entity itself and they are conveyed privately, unless different dispositions. On the contrary, unsolicited ratings are issued upon request of a third entity, and can be both private or public.
Unlike solicited ratings, where credit assessment includes also private data and information provided by the issuer itself, unsolicited ratings are based on public data only. They can also be issued by the Rating Agency without any external commission, generally for promotional purpose.
Who should pay for Credit Ratings and how?
Which business model should a Rating Agency adopt, i.e. who should pay for a credit rating, is a complicated and debated question as it concerns potential conflicts of interest.
To simplify, there are three different business models:
• the issuer-pay model;
• the investors-pay model;
• the subscribers-pay model.
With the issuer-pay business model, the Rating Agency charges the issuer, i.e. the evaluated entity, for the service. Of course, the issuer-pay model is adopted for solicited ratings, where the creditworthiness assessment is requested by the issuer itself.
On the contrary, unsolicited ratings are paid with the investors-pay or subscribers-pay models. In the investors-pay model the credit ratings are paid by the investors, while in the subscribers-pay model rating agencies provide a rating service upon the payment of a subscription fee.
What does s-peek offer?
Requiring an opinion about the creditworthiness of any commercial partner may be expensive, and even unnecessary, for a small or medium size company.
Thus s-peek offers, in addition to a free companies’ classification on three scoring levels, also companies’ fundamental insights, like credit limit evaluation, sectorial comparison and corporate information (available by purchasing FLASH or Extended12M reports).
The level of detail of the information provided is therefore chosen by the user itself, who can easily evaluate partnerships’ opportunities.