Posted in Finance, Accounting and Economics Terms, Total Reads: 285
Definition: Keepwell Agreement
It refers to an agreement between the holding company and its subsidiary to maintain solvency of the subsidiary for the term decided in the agreement. It is one of the ways a subsidiary company enhances its creditworthiness, which in turn boosts its borrowing capabilities.
Let us discuss the terms we encountered one by one.
Holding company: It refers to a company that owns some other companies’ stock, thus making it the holding company of that other company. The other company is known as subsidiary of the holding company.
Credit worthiness: It is a measure of a firm’s ability to repay its debt obligations. The lenders to a company are concerned that the company may not repay their loan and hence they refer to the credit rating of the company to decide whether they should loan out or not.
So does that mean a company with a bad credit rating will not be able to raise debt?Not at all.
For a company with a bad credit rating to raise debt, it has to offer a higher interest rate to the lenders for the higher risk they are incurring.
Hence, if by some measure a company is able to improve its credit rating, it can raise debt at relatively lower interest rates, thus reducing the cost of borrowing for the company. Thus, credit rating measures like Keepwell Agreement are extremely beneficial to the company because it highlights to the creditors that the likelihood of company failing to repay is low.