Bad credit rating: What does it mean?

Credit ratings for banks have become extremely topical in light of the government’s Retail Deposit Guarantee Scheme. After 12 October 2010 registered banks and financial institutions will need to have a Standard & Poor’s or Fitch rating of BB or above to continue to qualify for the guarantee.

The ratings are based on the credit worthiness and financial stability of the bank or financial institution or their products and range from AAA to D. A rating of BB or above will qualify for a guarantee.

The guarantee is important for both institutions and consumers as it gives assurance that if an institution does fail then customers would get their monies back. The ratings are also useful in that it means that the institution has laid bare its books to international financial analysts to scrutinize.

In determining a rating Standard & Poor’s and Fitch analysts look at a broad range of business and financial attributes such as: country risk, diversification, management strategy, capitalisation, earnings, funding, liquidity, accounting and governance.

The experience of the last few years shows that even with a really good credit rating companies can fail. Just look at Lehman Brothers in the US, a big casualty of the credit crunch. However, ratings should help to protect consumers from investing with institutions with poor governance and undertaking questionable investment practices. With this in mind, consumers should be more aware of an institution’s rating, particularly if the scheme if the government guarantee scheme is not extended after December 2011.

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