Issues Around Credit Rating Agencies

Credit Rating Agency is an organization that gives rating to the debtors or the borrowers (government, companies etc) on the basis of their ability to pay back their principal loan and interest on time. Thus it gives an idea of the probability of committing a default by them on debt and other credit related instruments. It is important to note that such agencies give ratings only to the organizations and not individual customers for whom separate credit score is released.

Every country has their own credit rating agencies and besides them there are international credit agencies. The most important among them are Standard and Poor’s, Moody’s and Fitch.

Why ratings are given?

These credit rating agencies help investors, customers etc to get an overall idea of the strength and stability of an organization. On the basis of these ratings, investors can make informed and value based decisions since it’s a third party rating and an unbiased one. Thus these agencies help build trust between the financial players and the companies or the governments. For example-Sovereign credit ratings are given to the national governments which highlight a country’s economic and political environment. Thus it helps investors to know the level of risk associated with investing in a particular country. It is important that a country has a good credit rating as it will help in attracting more foreign direct investment and funding in international bond market. Therefore, many countries generally seek ratings from the largest credit rating agencies like standard and Poor’s, Moody’s and Fitch.

What factors decide these ratings?

There are several criteria behind rating a government’s creditworthiness. Among them are political risks, taxation, currency value and labour laws. Another is sovereign risk where a country’s central bank can change its foreign exchange regulations. These risks are taken into account and ratings assigned accordingly.

Credit rating agencies in India

Currently there are six credit rating agencies in India which are registered under SEBI namely-CRISIL, ICRA, CARE, SMERA, Fitch India, ONICRA.

CRISIL

It stands for Credit Rating information Services of India ltd and is the first credit rating agency set up in India in 1987.Currently headquartered in Mumbai, it not provides ratings to the agencies but also provides policy advisory services to the clients. Majority of its shareholders held by Standard’s and Poor’s, which is one of the biggest credit rating agencies of the world. Besides India, it has expanded its operations to US, Poland, Argentina, Hongkong, China, Singapore etc

ICRA

It was set up in 1991 as Investment Information and Credit Rating Agency. However, it was renamed as ICRA ltd and was listed in the Bombay Stock Exchange and National Stock Exchange in 2007.Currently its headquarters are in Gurugram, Haryana. It caters to domestic organizations only with a prime focus on ratings of MSMEs and does not have any global presence.

CARE

It was established in 1993 as Credit Analysis and Research ltd. Headquartered in Mumbai, it is the second largest credit rating agency of India. It gives rating to debt instruments, claim paying ability of insurance companies, corporate governance etc.

SMERA
Founded in 2005, SMERA stands for Small and medium enterprises rating agency of India. It works exclusively for the Micro, Small and Medium Enterprises and has more than 350000 enterprises under it.

ONICRA

Onicra credit rating agency of India ltd is a private rating agency headquartered in Gurugram, Haryana. It was established in 1993 and provides credit ratings, risk assessment and other support services to corporate, MSMEs etc.

Fitch India

Headquartered in Mumbai, it is a major financial information service provider and rating agency having a global presence in more than 30 countries. It is 100% owned subsidiary of Fitch India.

International rating agencies

Below three are American financial services companies. Today these three are called as ‘Big Three Credit Rating Agency’ and control more than 90% of the credit ratings market.

Standard & Poor’s

It is the oldest credit rating agency of the world which started its operations in 1860 by Henry Poor. The ‘standard’ part was set up in 1906 and both the organizations were merged in 1940s and came to be called as Standard & Poor. Today it stands as the biggest rating agency with headquarters at New York. It rates borrowers on a scale from AAA to D, with AAA being the highest rating and D being the lowest.

Moody’s

It was founded in 1909 by John Moody to produce manual of statistics related to bonds and stocks. It is only in 1975 that it was identified as Nationally Recognized Statistical Rating Organization by US. It rates debt securities which includes government or corporate bonds and does research in risk management. The securities are assigned the rating from Aaa to C, with Aaa being the highest quality and C of the lowest quality.

Fitch

It was founded by John Knowles Fitch in 1914 as the Fitch Publishing company. It got identified as Nationally Recognized Statistical Rating Organization in 1975 by US. It has dual headquarters at New York as well as UK (London).It is the smallest among big three credit rating agencies and covers more limited market.

Problems

  • One of the major limitations is that methods employed by them are not universal. Each rating agency employs its own methods, thus, different agencies coming out with different conclusions.
  • Sometimes companies themselves employ the rating agencies, thereby, manipulating the agencies to obtain a better credit rating.
  • In last decade these agencies have not been able to predict the risks associated with many debt related instruments and organizations. For example-Credit rating agencies gave highest ratings to the Mortgaged backed securities which was ultimately responsible for the subprime crisis of US.
  • There is monopoly in the market by three rating agencies titled as Big 3(Standard & Poor, Moody and Fitch).Also there is no transparency in their operations which has led to decreased confidence in them.

Should Credit rating Agencies be regulated?

Rating agencies can distort the market and shift the flow of investment from one country to another leading to currency fluctuations, shutdown and unemployment. For example-It is argued that unduly negative evaluations accelerated the European sovereign debt crisis which spread through Greece, Spain, and Italy etc. In 2010 S & P downgraded Greece debt to junk status which weakened investor’s confidence, increased the cost of borrowing and overall exacerbated the crisis. Further, they also tend to influence fiscal and monetary policies across the world. Hence there is a need for their regulation.  But there are high chances that the increasing regulation of government may lead to compromise on their autonomy and their independence. Hence rather than external regulation, there is a need for internal regulation by the rating agencies by coming open on their tools and mechanisms adopted in rating. For instance-These credit rating agencies should declare on their website the methods employed so that there is no opaqueness.

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