Credit Ratings Are They Reliable?

February 27, 2019
Capital Market

 

Certain events in the recent past have raised concerns over the credibility of the credit ratings. Though credit rating agencies are working from more than a decade. These agencies have faced a rough path throughout their journey and hence people have mixed reactions about credit ratings. Credit rating industry is considered as highly monopolistic as more than 90% of the ratings are controlled by three major agencies.

The three dominating credit rating agencies are Moody’s Investor Service, Fitch Rating and Standard and Poor’s. These credit rating agencies have the power to rate everyone from individuals, corporates to countries. In the globe of finance, these three companies definitely have marked their place. Recently when Moody’s announced a negative outlook on Britain’s economy it took the country by storm such as the power of these institutes.  Just like the stock market’s rough phase credit rating agencies have also had an uphill task over the last few years. 

What is the credit rating? Understanding credit rating with an example

Credit rating is basically assessing individuals, companies or countries as to whether they will be able to repay the loan in time or not. Which makes it obvious that a person who has a good credit rating score has a good track record of repaying the loan according to the loan agreement. Money lenders can make better investment decisions and borrowers can have easy access to score if the credit rating is good. 

A credit rating of Bhushan Steels was A which means it is adequately safe and poses a low risk. Just a year after its rating the company has been facing a downfall in its performance which left the investors perplexed. Later the credit rating agency degraded the rating by four steps and marked Bhushan Steels as BBB. Such ratings make it hard for people to believe in the method and criteria on which these institutes rate. Some of the credit rating agencies, however, argue that they follow a transparent matrix based on which the rating is given which includes quality of management, a track record of the company, analysis of their projects and lot more. Rating agencies argue that the rating is based on what the company is capable of currently by default and hence ratings may be adversely affected by the market scepticism. 

Type of ratings 

Generally, AAA-rated companies are deemed as the safest and more credible and the decrease in rating to AA, A, B, C and D also means that the companies are less safe and it is up to the risk factor of the investors. Developed countries like USA, France and Britain are less likely to be affected by the negative outlook of the credit rating agencies. Business analysts also suggest that credit rating should be handled by the state funded by pooling investors from the public to increase its reliability and trust amongst people. 

Final thoughts

Authenticity in the ability of the credit rating agencies to rate the right creditworthiness of the companies is still a question mark. Hence these credit rating agencies are considered instrumental in bringing about a crisis financially. But they have still managed to be in the business as the law requires the credit rating for many purposes. Credit rating agencies are also considered strict while they rate than countries than rating companies as they are not paid for doing the former. Most economists suggest that credit rating should not be considered seriously. If the investor-pays model is adopted by credit rating agencies then these ratings may be taken more seriously than it is now. 

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