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 creditworthiness assessments are not unusual. To clarify any doubt, there are just few important notions you should know.
Two different evaluations: rating and credit score
They may be used as synonyms, but rating and credit score are two quite different evaluation.
The credit score
The credit score is a creditworthiness assessment calculated by an algorithm or statistical system. The analysis takes into consideration only quantitative parameters; in other words, the credit score is calculated on the balance sheet data of a company and indicates its economic-financial balance.
Credit score services are often available via software or apps and are a useful tool for SMEs to obtain an immediate assessment of the reliability of customers and business partners.
The rating, on the other hand, is an independent assessment of a borrower’s ability to meets its financial debts. In Europe, only Rating Agencies recognized by ESMA (European Securities and Markets Authority), including modefinance, can issue ratings. The analysis takes into account not only the economic-financial situation of the company, but also information that cannot be measured in mathematical terms, such as the management experience of the administrative body and the stability of the country in which the company operates. As it evaluates both quantitative and qualitative parameters, it must be drawn up by a financial analyst and represent a certificate of solvency towards credit institutions and private investors.
Differences between solicited and unsolicited ratings
There are two main reasons to apply for a rating:
- to obtain a certificate of the economic and financial statement of your company;
- to receive an opinion on the counterparty’s creditworthiness.
Ratings requested by the rated entity itself are defined solicited ratings, while ratings requested by a third entity or issued by the Credit Rating Agency without any commission (generally for marketing purpose) are defined unsolicited ratings.
The main difference is the availability of information for the evaluation. Unlike solicited ratings, where the assessment is based also on private information provided by the issuer itself, unsolicited ratings are based on public data only.
Private or public disclosure?
Credit ratings can be disclosed publicly or conveyed privately.
While public ratings have legal value, private ratings are strictly confidential and can be shared with a limited number of people. They can be used for internal evaluation only and public dissemination is not permitted.
At the end of the evaluation process, the Rating Agency has to notify the rated entity of the rating assigned. The rated entity has in turn three days from delivery to appeal if it discovers factual errors in the assessment.
Who should pay for Credit Ratings and how?
By whom Rating Agencies should be paid, it's 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 Rating Agency charges the issuer, i.e. the evaluated entity, for the service. The issuer-pay model is adopted for solicited ratings.
• the investors-pay model; the credit rating is paid by the investors;
• the subscribers-pay model: the Rating Agency provides a rating service upon the payment of a subscription fee.
For small and medium-sized companies, requesting a rating for each possible business partner can be burdensome and even unnecessary.
However, the need for information about the economic and financial conditions of customers and suppliers remains a priority. For this reason, in addition to free classifying companies on three risk degree, s-peek also provides detailed information and insights within the FLASH and Extended12M reports, allowing users to easily assess any business opportunity.
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