Wednesday, 5 October 2011

Introduction to Credit Rating Agencies

There has been a lot of press over the last fee months about countries being downgraded by credit rating agencies. The US made the headlines over the summer and more recently Italy has had it's economy both formally downgraded and generally ridiculed. Despite this many still aren't too sure what credit rating agencies really are, what they do and what the implications are of these downgrades.

What are credit rating agencies? The big 3 agencies are Standard & Poor's, Moody's and Fitch and they are widely regarded as credible and independent in assessing credit worthiness of large-scale borrowers. These borrowers being large corporations, banks and countries who typically borrow by issuing bonds. The agencies assign credit scores to enable investors (lenders) to quickly assess the risk of purchasing various bonds.

Why does it matter if a country is downgraded? As with consumer credit the lower tour credit rating the more costly your borrowing and the more difficult it is to raise money. The implications for countries, particularly certain ones in Europe, are potentially very damaging. Rating downgrades mean the government bonds have to carry a higher yield to attract investors and are therefore more expensive to repay. Countries like Italy, who already have significant debts and little or no economic growth to help manage repayments, could experience long term economic problems as a result.

Are credit ratings agencies ever wrong? The short answer is yes - most recently the subprime mortgage crisis was in part blamed on the agencies for giving financial products far too high a rating when the underlying security was actually very high risk and carried a high chance of default. Bankers took the brunt of the wrath from the press but the credit rating agencies were equally at fault.

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