Credit rating agencies - Are they useful?
Credit rating agencies – Are they useful?
Once we land in a crisis the blame game starts. The subprime crisis of 2007 plunged the world in deep recession. One such entity to blame is the Credit Ratings Agencies (CRAs). The CRAs rate creditworthiness, which is a measure of the ability and willingness of debtor to pay a debt. A credit rating is not a measure of the value or profitability of a financial instrument or of the debtor. Credit ratings are useful because they serve as a widely accepted, standardized scale of creditworthiness across industries, financial instruments and even time. CRAs are considered gatekeepers, because they issue ratings that help determine whether a company is worth lending to, and at what cost. However looking at their role in the crisis a question arises on their usefulness?
Yes they are useful –
1. It was a major yet just a single incident and the agencies have proven their worth till now.
2. Highly rated instrument of a company gives an assurance to the investors of safety of instrument and minimum risk of bankruptcy.
3. Rating symbol can be understood by an investor which needs no analytical knowledge on his part. This helps in quick decision making.
4. The rating agency is quite independent and absence of business links between the rater and the rated firm establishes ground for credibility and attract investors.
5. Investors rely upon credit rating. This relieves investors from investigating about the company themselves. An independent evaluation is thus much more valuable.
6. Ratings from different agencies help the investors to understand the difference of opinion prevailing in the market about a company.
7. Since CRAs provide ratings to variety of instruments, an investor has choice of choosing from variety of alternatives by looking at the risks.
8. It is also beneficial to the company as it acts as a marketing tool.
9. It is good for non popular companies. It lowers the cost of borrowing, helps in growth and expansion and also improves corporate image.
No they are not useful –
1. Biased rating - There is a bias towards companies wherein interest of the CRAs lie. Also human bias for unavoidable personal weakness of the staff might affect the rating.
2. Misrepresentations - The companies having lower grade rating do not advertise or use the rating while raising funds from the public. The CRAs do nothing regarding this.
3. Rating is done on the present and the past data. Anything can happen after assignment of rating symbols to the company. Thus risk of the rating is not taken into the consideration.
4. Company might conceal material information from the investigating team of the credit rating company rendering the rating unreliable.
5. Rating is done for a particular instrument to assess the credit risk but the rating is no guarantee for soundness of a company.
6. A company might be temporarily in adverse condition but it is given a low rating. This adversely affects the company’s interest.
7. Downgrading the rating results into marring the image of the company; making it more difficult for the company to come back on top.
8. Rating done by the two different credit rating agencies for the same instrument of the same issuer company in many cases would not be identical. This can again give misleading information.
9. There is lack of competition as Standard and Poor's and Moody's dominate the financial ratings industry.
10. CRAs wield enormous power as gatekeepers but lack accountability.
We see that they are enormously useful however they need serious regulatory authorities to hold them accountable. There is a need to strengthen the accuracy of their ratings. Their independence should be given prime importance. Biased ratings will only lead us to another crisis, maybe worst this time.
Discussion
- RE: Credit rating agencies – Are they useful? -Deepa Kaushik (09/24/15)
- Credit rating is a financial tool that aids in the judgement of the financial stability of an individual or an organization. But, we Indians hardly know the importance of credit rating. Credit rating is a very beneficial tool in not only the assessment of the organization in concern, but it is also a major aid in stabilizing the economy of the nation. The number and intensity of the fraudulent play can be checked much efficiently with the credit rating.
People in our country are unaware of the credit ratings. The reason behind this ignorance is the lack of importance given to credit rating by our government. The way the initiative of assigning a Aadhar Number to every citizen started, gave a little hope of linking all the assets and accounts of every individual and tracking their database which could have paved way to value their ceedit rating. But, tge initiative didn't stand up to the mark with a new concern coming up every now and then to hamper its progress.
People abroad do give importance to credit rating. Defaulting even a single payment anywhere in their life greatly affects their credit rating and they tend to lose their benefits. If a similar condition is created in our country, people would make sure to be specific and punctual in their transactions. This could also help to curb corruption to a good extent.
Credit rating should be done by a single unit for the entire nation. This unit should be free of government holdings and should be given authority for free access. Such a standard laid for the entire nation would be much beneficial to access every individual or the organization in a much better way - RE: Credit rating agencies – Are they useful? -Pintu (09/24/15)
- Genuine rating is good for both customers and companies. Any biased rating would harm the society adversely. A company is undergoing a tough time and a bad rating during that period can destroy its image. It has it negative and positive aspect. The agency who releases such rating should consider various aspects.
