How will credit ratings help to keep the tap of bank funding open?
The COVID-19 pandemic poses a challenge for SME financing. Historically, in crisis situations, banks have been forced to be extremely cautious in approving loans and to tighten financing conditions. However, the financial market now has a tool for objectifying credit risk that can help facilitate the flow of credit: credit ratings. Let’s see how a credit rating helps banks to keep the financing tap open:
- It helps in the funding decision: Credit ratings give banks a better understanding of SME credit risk and can serve as a guide for screening companies applying for financing, especially for those institutions that do not have an advanced risk model. Large banks, which do have powerful statistical models, can use the credit rating as a specialized, independent and objective second opinion, which reinforces their own evaluation mechanisms.
- Interest rate guidance: Banks can take a company’s credit ratings as a benchmark for setting the interest rate applicable to its debt. The price of the financing will then depend on the credit quality expressed in the rating, so that between a BB and a B rating there may be a substantial increase in the interest rate.
- Regulatory capital calculation: Credit ratings are accepted for the computation of equity that banks have to allocate to absorb losses that may arise as a result of their risks. Thanks to this mechanism, banks that lend funds to companies with a better credit rating are rewarded with a lower equity requirement.
- Securitization of bank assets: SME credit ratings can be used in the securitization of loans granted to SMEs by banks. Securitization programs, guaranteed by the State, can be a good formula for financing SMEs in the long term.