Thursday, December 29, 2011

All about Rating Agencies

The role of some of the major rating agencies has been under immense scrutiny since the global meltdown of 2008. In this blog I wish to make clear what these rating agencies are all about. That is, Who are they? What is their job? How they do it? How do they earn money etc.

Who are they?

There are a number of them but the major ones are Standard and Poor's (S&P), Moody's and Fitch. These are all from the USA. The first 2 control approximately 80% of the ratings market. One of the reasons that their word is taken for granted is that they are recognised by the Securities and Exchange Commission (SEC) of the USA. In fact, SEC requires some investment agencies/funds to get their investments rated by these agencies.

What is their job?

Their main job is to rate a borrower, be it an organisation or a government. This rating signifies the risk a lender takes while lending the funds to the borrower. For e.g., if a company is rated AAA (which is the highest rating), its borrowing costs would be comparatively lower.

How they do it?

They rate an entity based on various parameters that they consider important. For eg., while rating a country they might take into consideration the economic, geo-political environment of the country.

How do they earn money?

It is infact the borrowers who pay money to get themselves rated.

Whats the controversy?

Before the 2008 meltdown, the mortagage backed securities were given very high ratings which infact caused the meltdown. Thus there is this question of accountability. Most goverrnments esp in Europe feel that these agencies have immense power to dictate the borrowing costs of a country. The market is dominated by these US firms. Europe feels it needs to have its own rating agency.

Thus most analysts believe that there is a need to enforce accountability on the part of these agencies.

8 comments:

Anonymous said...

1. How often do these agencies rate a particular a corporation or a government?

2. Why don't they rate some countries (and) in some cases why do they withdraw the ratings?

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