 | The examples and perspective in this article deal primarily with the United States and do not represent a worldwide view of the subject. (December 2022) |
A credit rating agency (CRA, also called a ratings service) is a company that assigns credit ratings, which rate a debtor's ability to pay back debt by making timely principal and interest payments and the likelihood of default. An agency may rate the creditworthiness of issuers of debt obligations, of debt instruments,[1] and in some cases, of the servicers of the underlying debt,[2] but not of individual consumers.
Other forms of a rating agency include environmental, social and corporate governance (ESG) rating agencies and the Chinese Social Credit System.
The debt instruments rated by CRAs include government bonds, corporate bonds, CDs, municipal bonds, preferred stock, and collateralized securities, such as mortgage-backed securities and collateralized debt obligations.[3]
The issuers of the obligations or securities may be companies, special purpose entities, state or local governments, non-profit organizations, or sovereign nations.[3] A credit rating facilitates the trading of securities on international markets. It affects the interest rate that a security pays out, with higher ratings leading to lower interest rates. Individual consumers are rated for creditworthiness not by credit rating agencies but by credit bureaus (also called consumer reporting agencies or credit reference agencies), which issue credit scores.
The value of credit ratings for securities has been widely questioned. Hundreds of billions of securities that were given the agencies' highest ratings were downgraded to junk during the financial crisis of 2007–08.[4][5][6] Rating downgrades during the European sovereign debt crisis of 2010–12 were blamed by EU officials for accelerating the crisis.[3]
Credit rating is a highly concentrated industry, with the "Big Three" credit rating agencies controlling approximately 95% of the ratings business.[3] Moody's Investors Service and Standard & Poor's (S&P) together control 80% of the global market, and Fitch Ratings controls a further 15%. They are externalized sell-side functions for the marketing of securities.
- ^ A debt instrument is any type of documented financial obligation. A debt instrument makes it possible to transfer the ownership of debt so it can be traded. (source: wisegeek.com)
- ^ For example, in the US, a state government which shares the credit responsibility for a Municipal bond issued by a municipal government entities but under the control of that state government entity. (source: Campbell R. Harvey's Hypertextual Finance Glossary)
- ^ a b c d Alessi, Christopher. "The Credit Rating Controversy. Campaign 2012". Council on Foreign Relations. Archived from the original on 27 July 2013. Retrieved 29 May 2013.
- ^ $300 billion collateralized debt obligations (CDOs) issued in 2005-2007 (over half of the CDOs by value during time period) that rating agencies gave their highest "triple-A" rating to, were written down to "junk" by the end of 2009. (source: The Financial Crisis Inquiry Report (PDF). National Commission on the Causes of the Financial and Economic Crisis in the United States. 2011. pp. 228–9.)
- ^ McLean, Bethany and Joe Nocera. All the Devils Are Here: The Hidden History of the Financial Crisis, Portfolio, Penguin, 2010 (p.111)
- ^ Barnett-Hart, Anna Katherine. "The Story of the CDO Market Meltdown: An Empirical Analysis" (PDF). March 19, 2009. Harvard Kennedy School. Retrieved 28 May 2013.
Overall, my findings suggest that the problems in the CDO market were caused by a combination of poorly constructed CDOs, irresponsible underwriting practices, and flawed credit rating procedures.