What is a credit rating?
A credit rating evaluates the credit worthiness of a company or a government that issues debt in the form of bonds open to investors.
It indicates the likelihood of defaulting on a loan, in the opinion of a credit ratings agency such as Standard & Poor's (S&P), Moody's and Fitch. Agencies evaluate the qualitative and quantitative information, including non-public information.
Why do they exist?
Credit ratings give investors an idea of the risk they are taking buying bonds issued by a company or government. The highest rating is AAA and this suggests that it is highly unlikely the bond issuer will default on their repayments, making it a less risky investment than, say, a company that had a C rating. The flip side is that the rate of return will be lower due to less risk.
Are credit ratings the same as the credit scores used to assess customers?
No. Personal credit scores awarded by consumer credit agencies assign numerical values to information contained in an individual's credit report. A poor score indicates that, in the past, other individuals with similar reports have often defaulted on loans and other debts. It does not take into account future prospects or changed circumstances as credit ratings try to do.
Why is it in the news?
Because of the decision by S&P to downgrade the US government from AAA status to AA+. The agency cites the political gridlock in Washington over raising the national debt ceiling as the main reason. However, Moody's and Fitch, the two other major ratings groups, still rate the US as AAA.
Is Britain's credit rating likely to get downgraded?
S&P has indicated that it does not expect the UK to lose its AAA rating. Despite the ongoing economic uncertainty, it is hoping to see improvements as a result of the Coalition government's spending cuts.