Why Do We Need Credit Rating Agencies

Published: 2021-06-29 06:56:23
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                              AG912 International Financial Markets and BankingAssignment 2Name: SHREYANS JAIN                                                                Student number: 201768529Part ATask answered: 1Word count: 2320Part A – task [1]A credit rating agency is an entity which assesses the ability and willingness of the issuer company for timely payment of interest and principal on a debt instrument. Each rating symbol is an alphanumeric representation of the probability of degree of repayment risk associated with debt instruments. Rating is denoted by a simple alphanumeric symbol, for e.g. AA+, A-, etc. Rating only provides an additional input to the investor and the investor is required to make his own independent and objective analysis before arriving at an investment decision. According to Partnoy, the essence of the reputational capital view is that credit rating agencies fill an important need arising from the information asymmetry between issuers and investors. Credit rating agencies are reputational intermediaries that bridge the information gap, not unlike restaurant or movie reviewers, except that they use letters (such as AAA) instead of stars or tomatoes. (Partnoy.2017).According to Benmelech, Credit rating agencies are of central importance in credit markets and credit ratings play a key role in corporate financial policies. However, the influence of credit rating agencies is not confined only to corporate bond but also rate government such as sovereign ratings-municipal bonds and structured finance products. In world’s financial markets the rating agencies have been described as “superpowers” because they provide useful information to participants in credit markets and potential investors on the bonds that they rate, and thus are highly significant as they produce information that would be otherwise inexistent. (Benmelech,2017).According to benmelech, the usefulness of credit rating agencies according to benmelech is that Credit rating agencies are of central importance in credit markets and credit ratings play a key role in corporate financial policies. However, the influence of credit rating agencies is not confined only to corporate bonds. For example, on September 24, 2007, the U.S. Securities and Exchange Commission granted the registration of S&P as a nationally recognized statistical rating organization (“NRSRO”) under the U.S. Credit Rating Agency Reform Act of 2006. The registration applies to five classes of credit ratings for which an NRSRO may be registered under the Act. Those are: financial institutions, brokers, or dealers;  insurance companies;  corporate issuers;  issuers of asset-backed securities;  issuers of government securities, municipal securities, or securities issued by a foreign government.  He also evaluated the quantitative content of rating decisions made by S&P and assess its development over time. His results suggest that S&P rating decisions moved from being quantitative to being qualitative and then being highly quantitative again in the last few years, and can be predicted using firm characteristics with a high degree of accuracy. In addition to analysing the quantitative content of credit ratings over time, he also analyses the evolution of credit rating standards and find that conservatism in credit ratings exists and continues through 2015. The results suggested that rating standards were kept more lenient during the global financial crisis, and it is possible that ratings were artificially held up to avoid even further downgrades.

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