Credit risk and ratings

Chapter 6 was about the risk that affects every bond at once. This chapter is about the risk that affects one bond and can take all of it.

What a rating is

SEBI's definition, read on 1 October 2026:

A credit rating represents the rating agency's opinion on the likelihood of a rated debt obligation being repaid in full and on time. Credit rating is therefore an assessment of the probability of default on payment of interest and principal on a debt instrument.

An opinion about the probability of default. Not a measurement, not a guarantee, and — importantly — about default, not about whether the price will hold up.

The scale is standardised across agencies, so AAA means the same thing wherever you see it:

Symbol	SEBI's definition
AAA	Highest degree of safety; lowest credit risk
AA	High degree of safety; very low credit risk
A	Adequate degree of safety; low credit risk
BBB	Moderate degree of safety; moderate credit risk
BB	Moderate risk of default
B	High risk of default
C	Very high risk of default
D	"in default or are expected to be in default soon"

Note where the language turns. Down to BBB the agency talks about safety. From BB it talks about risk of default. That is the investment-grade boundary, and it is a change of subject rather than a change of degree.

Modifiers of "+" and "−" apply from AA to C, and SEBI adds a clarification worth repeating because it trips people up:

The minus symbol associated with ratings has no negative connotations. In fact, ratings in a higher rating category such as "AA-" are stronger than ratings in a lower rating category such as "A+".

What a rating is not

SEBI devotes a whole question to this, and it is the most useful paragraph in the subject:

Credit ratings are not a recommendation to buy, hold or sell a debt instrument. Further, a credit rating merely provides an additional input to the investor and the investor is required to make her or his own independent and objective analysis before arriving at an investment decision.

And then the list of what a rating explicitly does not measure:

liquidity risk, pre-payment risk, interest rate risk, risk of secondary market loss, or exchange loss risk

Read that against the previous chapters. Interest rate risk is the whole of chapters 3 and 6 — the rating says nothing about it. Liquidity risk and secondary market loss are chapter 2's warning about thin trading — also not in the rating.

So a AAA bond can lose you money in three ways the rating never addressed: rates rise, you need to sell and nobody is buying, or you sell into a wide spread. The rating was right the whole time; it was answering a narrower question than you asked.

Who pays

SEBI states it without euphemism:

In India, the debt issuing entity pays for the credit rating. The practice is termed as "issuer-pays" model.

The borrower pays the agency that grades the borrower. This is the global norm and it has an obvious tension in it, which is why agencies are regulated, why the symbols are standardised, and why SEBI mandates continuous monitoring rather than a one-off grade.

It is not a reason to ignore ratings. It is a reason to treat a rating as one input assembled by someone the issuer paid — exactly the weight SEBI's own language gives it.

Two more things SEBI says plainly:

SEBI does not play any role in the assessment made by the rating agency.

and, on what happens if a rating proves wrong:

such opinions may prove wrong in the context of subsequent events. There is no contract between an investor and a rating agency. The investor is free to accept or reject the opinion of the agency.

No contract. If you buy a AAA bond and it defaults, you have no claim on the agency. That sentence should settle how much weight the rating carries on its own.

Ratings move

A rating is not a one-time exercise. SEBI requires an agency to "continuously monitor the rating of such securities and carry out periodic reviews of all published ratings."

Two habits follow.

Watch the direction, not just the level. A bond downgraded from AAA to AA+ is still excellent and something changed. A sequence of downgrades is a trajectory, and trajectories in credit tend to continue.

A downgrade hits the price immediately. Buyers demand a higher yield for the new risk, so by chapter 3's seesaw the price falls — and in a debt fund the NAV falls with it. The loss arrives on the downgrade, long before any actual default.

The forward-looking bit

SEBI draws a distinction that explains what an agency is for:

A credit rating agency provides an opinion relating to future debt repayments by borrowers. A credit bureau provides information on past debt repayments by borrowers.

Future, not past. Which is both the value of a rating and the reason it is sometimes wrong — it is a forecast, and forecasts of rare events are hard.

Reading credit as an investor

Three practical rules, in order.

A yield well above the government's is a credit opinion you are being paid to accept. Chapter 2's rule, now with a name. Whether to accept it is a real decision; pretending the extra is free is not.

Diversify credit or do not take it. One default in a concentrated portfolio removes years of extra yield. Taking credit risk through a fund that holds dozens of issuers is a different proposition from buying three bonds yourself.

Match the rating to the job. For money that must be there — an emergency fund, a deposit due next year — the extra yield from credit is not worth the tail. That is money for government securities and deposits, and chapter 12 puts it in context.

The point

A rating is a paid-for opinion on the probability of default, standardised from AAA to D, continuously reviewed, and explicitly not a recommendation and not a statement about interest rate or liquidity risk. The issuer pays for it, and you have no contract with the agency if it is wrong.