Demerits of Credit Rating
The disadvantages, limitations or demerits of credit rating are listed below.
Imgage Credits © Sameer Akrani.
- Possibility of Bias Exist : The information collected by the rating agency may be subject to personal bias of the rating team. However, rating agencies try their best to provide an unbiased opinion of the credit quality of the company and/or instrument. If not, they will not be trusted.
- Improper Disclosure May Happen : The company being rated may not disclose certain material facts to the investigating team of the rating agency. This can affect the quality of credit rating.
- Impact of Changing Environment : Rating is done based on present and past data of the company. So, it will be difficult to predict the future financial position of the company. Many changes take place due to changes in economic, political, social, technological, legal and other environments. All this will affect the working of the company being rated. Therefore, rating is not a guarantee for financial soundness of the company.
- Problems for New Companies : There may be problems for new companies to collect funds from the market. This is because, a new company may not be in a position to prove its financial soundness. Therefore, it may receive lower credit ratings. This will make it difficult to collect funds from the market.
- Downgrading by Rating Agency : The credit-rating agencies periodically review the ratings given to a particular instrument. If the performance of a company is not as expected, then the rating agency will downgrade the instrument. This will affect the image of the company.
- Difference in Rating : There are cases, where different ratings are provided by various rating agencies for the same instrument. These differences may be due to many reasons. This will create confusion in the minds of the investor.