Explain various Limitations of Credit Rating.
Credit ratings are not founded on numerical equations. Rather, credit rating companies utilize their judgment and involvement in figuring out what public and private data ought to be considered in giving a rating to a specific organization or government. There are several limitations of credit rating. Some of these are as follows:
List of Limitations of Credit Rating.
Biased rating and misrepresentation:
In the absence of quality rating, credit rating is a curse for capital market industry. To avoid biased rating, the expert in rating agency, carrying out detailed analysis of the company, should have no links with the company or the persons interested in the company so that they can make their report impartial and judicious recommendation for rating committee.
Rating is done on the present and the past historical data of the company and this is only a static study. Prediction of the company health through rating is momentary and anything can happen after assignment of rating symbols to the company dependence for the future result on the rating, therefore defeat the vary purpose of the risk indicative of the rating.
Concealment of material information:
Rating company might conceal material information from the investigating team of the credit rating company, in such cases quality of rating suffer and renders the rating reliable.
Rating is no guarantee for soundness of the company:
Rating is done for a particular instrument to assess the credit risk but it should not be considered as a certificate for matching quality of the company or its management.
Finding of the investigation team at times may suffer from with the human bias for unavoidable personal weakness of the staff and might affect the rating.
Once the company has been rated and if it is not able to maintain its working result and performance, credit rating agency would review the grade or downgrade the rating resulting into impairing the image of the company.
Validity of rating:
Validity of the rating ends with the maturity of a debt instrument and it is no longer subsequently benefits the issuer company because the rating is valid for the life time of the debt instrument being rated.
Difference in rating of two agencies:
Rating done by two different credit rating agencies for the same instrument of the same issuer company in many cases would not be identical. Such difference is likely to occur because of the because of the value judgement differences on qualitative aspect of the analysis in two different rating agencies whereas quantitative analysis might be the same and identical.