Economics
Credit Ratings
Credit ratings are assessments of the creditworthiness of individuals, companies, or governments. They are assigned by credit rating agencies based on the entity's ability to meet its financial obligations. Ratings typically range from AAA (highest) to D (default), with higher ratings indicating lower credit risk. These ratings are important for investors and lenders in evaluating the risk associated with providing credit or investing in a particular entity.
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eBook - PDFFINANCIAL SYSTEM, FINANCIAL DEVELOPMENT AND FIRM SURVIVAL:
PERSPECTIVES FROM TURKISH FINANCIAL SYSTEM AND GLOBALIZATION
- Adnan Kara, Ramazan SAYAR(Authors)
- 2020(Publication Date)
- Peter Lang Group(Publisher)
While developing countries finance their development, they need international funds due to insufficiencies in their own resources. Accurate determination of the credibility of borrowing institutions is of great importance in the international markets in which coun- tries, public institutions, private sector organizations, financial institutions, and investors come together. Therefore, Credit Ratings have become a more widely used indicator in regulation and risk management process (Gür & Öztürk, 2011: 71). The fact that Credit Ratings contain explanatory information about country risk undoubtedly affects the economies of the country to a great extent. The effects of ratings on the country's economy and markets are summarized as follows (Yazıcı, 2009: 4): ➢ Rating builds confidence in the economy and brings stability in developing financial markets ➢ Rating ensures integration of markets with international markets ➢ Rating limits the overall risk level in the economy and increases the efficiency of financial transactions. Credit Ratings and Credit Rating Agencies 67 2 Credit Rating Agencies Credit rating with the shortest and clearest definition means assessment of the capacity of the debtor to pay the principal and interest on time and in full. This assessment is carried out by CRAs within the framework of a certain method. Although there are many local and national rating agencies around the world, the study focuses on S&P’s, Fitch, and Moody’s, which hold almost the entire market. When examining the types of ratings, we mentioned that the rating is classi- fied into subcategories according to maturity, currency, rating agency, and rated asset. In this part of the study, the sovereign ratings among the mentioned types are emphasized and the long-term foreign currency ratings determined by these big three international CRAs are examined.
eBook - ePub- Giulia Mennillo(Author)
- 2022(Publication Date)
- Agenda Publishing(Publisher)
2 What do credit rating agencies do? The authors of the common language of credit riskA credit rating agency rates the creditworthiness of a bond issuer. But what does this actually mean? Common knowledge in the context of financial markets suggests that rating involves an assessment of creditworthiness, which relies on figures and data conventionally deemed relevant for this purpose. Generally speaking, the verb “to rate” signifies the assignment of “a standard or value to (something) according to a particular scale”.1 In the case of credit rating, the object of the assessment refers to any entity seeking access to capital markets by issuing bonds to satisfy its funding needs, ranging from companies, banks, municipalities and sovereigns to supranationals.2 In the case of public entities, the refinancing through capital markets is not as apolitical as it sounds. When a state or municipality resorts to capital markets, it exposes itself to the CRAs’ judgement, becoming subject to the logics and interpretive frameworks of the financial market community. Unlike politically unpopular taxation, a public entity implicitly consents to the rules of the game of the financial market’s sphere. Apart from creating a financial dependence, the borrower tacitly accepts that norms, worldviews and ideas preponderant in financial markets transcend and diffuse into the political sphere.Considering the definition of the verb “to rate” – assigning a standard or value to a particular scale – the specificity of the credit rating scale is that it is created by the CRAs themselves. The same applies to the assigned value – that is, the rating content; scale and value do not exist independently from each other. The scale constitutes the rating content, mirroring how creditworthiness has come to mean “credit rating”. Instead of amounting to a quasi-metric that is fungible and transferable to other units of measurement, Credit Ratings have gained power of definition over creditworthiness: A bond issuer is deemed creditworthy because
eBook - PDFPrivate Ratings, Public Regulations
Credit Rating Agencies and Global Financial Governance
- A. Kruck(Author)
- 2011(Publication Date)
- Palgrave Macmillan(Publisher)
Credit rating agencies publish, for instance on their websites, the criteria that guide their assessment of credit risk in the rating proc- ess. ‘The standard [of credit-worthiness, A.K.] provides a set of crite- ria which defines, for a general audience, what credit quality is about and how it can be enhanced’ (Kerwer 2002: 300). Financial mar- ket actors are aware of credit rating agencies’ criteria for credit risk assessment and tend to adjust their behavior to conform to them, since – by assigning and constantly reviewing Credit Ratings – credit rating agencies do not only define a standard of creditworthiness, but also verify compliance with the standard and promote its adoption (Gras 2003: 25–6). Credit rating agencies’ standard of creditworthi- ness thus becomes a benchmark for other market actors (King and Sinclair 2001: 4–5). Even if some actors may depart from these marks, they must be aware that the marks are still the standards for the work of other actors. The letter grade assigned by credit rating agencies marks a seal of approval or a certification for the creditworthiness of a borrower and, consequently, for adopting and living up to the credit rating agencies’ standard of creditworthiness (Gras 2003: 17; see also Brunsson and Jacobsson 2002a: 5). This seal of approval is vital for borrowers’ financing conditions and their access to capital. The criteria credit rating agencies set for the assessment of creditwor- thiness are in effect ‘access rules for financial markets’ (Kerwer 2006: 91). This gives credit rating agencies considerable leverage over other financial market actors. From this perspective, credit rating agencies should be conceived as representatives of the broader category of ‘coordination service 64 Private Ratings, Public Regulations firms’ and as incumbents of private authority (Cutler et al. 1999b; Nölke 2004; Nölke and Perry 2007; Sinclair 1999, 2001).
eBook - PDF- P. Molyneux(Author)
- 2011(Publication Date)
- Palgrave Macmillan(Publisher)
109 6.1 Introduction A rating is an indicator, normally drawn up by a specialized agency, which measures the solvency of an entity or issue of assets by means of a categorical scale. The ultimate purpose of ratings is to inform other mar- ket agents (investors and regulators) regarding the solvency of the entities evaluated and/or of the assets issued. The rating reduces one of the main problems of markets: the asymmetry of information between issuers and other agents, since the latter do not have access to all the information relating to the solvency of the entity that is being rated (Losada, 2009). What elements are taken into account in awarding ratings depends on the type of issuer or issue that is to be rated. In general terms, the most important factors, according to the rating agency Fitch, are the integrity of the balance sheet, profitability and risk management, although other factors are also considered, such as the quality and strategy of the man- agement team, the future outlook for the business and the environment in which the issuer operates (sovereign risk, sector risk and support in the event of difficulties) (Verona, 2002). The use of ratings as indicators of entities’ credit quality, or as indi- cators of the quality of the assets issued, has experienced significant growth in recent years due fundamentally to the changes in the chan- nels of financing. Thus, financing needs are increasingly channelled through the financial markets, which thus come to substitute for tradi- tional bank loans. Furthermore, the emergence of new financial prod- ucts in these markets, and the complexity of these products, have helped to increase demand for this type of indicator. Another factor explaining 6 Are the Ratings Good Indicators of the Creditworthiness of the Entities that Qualify? Carlos Salvador Muñoz, José Manuel Pastor and Juan Francisco Fernández de Guevara
eBook - PDFPolitical Economy Perspectives on the Greek Crisis
Debt, Austerity and Unemployment
- Ioannis Bournakis, Christopher Tsoukis, Dimitris K. Christopoulos, Theodore Palivos, Ioannis Bournakis, Christopher Tsoukis, Dimitris K. Christopoulos, Theodore Palivos(Authors)
- 2017(Publication Date)
- Palgrave Macmillan(Publisher)
8.1 Introduction Over the past few years, the debate for sovereign Credit Ratings has increased, as a result of their significance in the recent financial and Eurozone debt crisis. Sovereign Credit Ratings are forward-looking estimates of the prob- ability of default put forward by rating agencies. In other words, they are a qualitative measure of a government’s ability and willingness to repay both 8 On the Role of the Credit Rating Agencies in the Euro Zone Crisis Periklis Boumparis, Costas Milas and Theodore Panagiotidis © The Author(s) 2017 I. Bournakis et al. (eds.), Political Economy Perspectives on the Greek Crisis, DOI 10.1007/978-3-319-63706-8_8 177 P. Boumparis · C. Milas University of Liverpool, Liverpool, UK e-mail: [email protected] C. Milas · T. Panagiotidis Rimini Centre for Economic Analysis (RCEA), Rimini, Italy C. Milas e-mail: [email protected] T. Panagiotidis (*) Department of Economics, University of Macedonia, Thessaloniki, Greece e-mail: [email protected] 178 P. Boumparis et al. the debt and the corresponding interest on full and on time. In many cases, a government’s willingness to pay could be as significant as its ability to pay. For instance, Argentina in 2013 refused to compensate an American that rejected participating in a haircut. Sovereign Credit Ratings are pri- marily determined by the three main credit rating agencies (CRAs), Fitch, Standard and Poor’s (S&P) and Moody’s that control more than 90% of the market. Sovereign ratings are considered to be a credible qualitative measure of a country’s general performance. As a result, they represent a key factor of sovereign spreads a country faces in the international financial markets and consequently of its borrowing cost. Greece could be one characteristic example. Between the months of April and May 2010, the three leading rating agencies (S&P, Moody’s, and Fitch) downgraded Greece a cumula- tive total of six notches.
eBook - PDFThe Rating Agencies and Their Credit Ratings
What They Are, How They Work, and Why They are Relevant
- Herwig Langohr, Patricia Langohr(Authors)
- 2010(Publication Date)
- Wiley(Publisher)
The agencies provide the market with an independent heuristic of creditworthiness, based on company fundamentals, that indicates gradations of creditworthiness, making it easy for credit investors to compare different potential investments without undertaking their own credit analysis. True Ratings Measure Credit Risk and Should Not Price It There is no paradigm shift from fundamental ordinal ratings to market-implied cardinal ratings. These two are complementary. Cardinal estimated default probabilities are mapped in fundamental ordinal ratings and add additional insight when interpreting ratings, but the ratings themselves retain the characteristics of fundamental ratings. 135 Katiforis, G., 2004, Report on role and methods of rating agencies, European Parliament, January 29, Session document A5-0040/2004, 1–11, page 6. 3 The Raison d’ ˆ Etre of Credit Ratings and their Market Why do Credit Ratings exist? Who needs them? What is the scale and scope of their appli- cations? Credit Ratings are an information good at the intersection between borrowers and investors, respectively the demand and supply for capital. Providers and users of ratings all agree that they are an opinion on the relative ability of an entity to meet a finan- cial commitment. This chapter explains in sequence the different needs that Credit Ratings satisfy – each actually corresponding to a somewhat distinct function of Credit Ratings, the original economic function of Credit Ratings, and the current rated universe in terms of issuers, products, and regions. More specifically, we distinguish in Section 3.1 the three dif- ferent functions of ratings and follow through on how issuers, investors, and prescribers use them. After this description, we provide in Section 3.2.3 a more formal economic analysis of a credit rating as a solution to information asymmetry, what we refer to as the original and fundamental function of Credit Ratings.
eBook - ePub- D. Tennant, M. Tracey(Authors)
- 2017(Publication Date)
- Palgrave Pivot(Publisher)
These questions are of concern not only to the borrowers, but naturally to the creditors as well. Investors face the complex task of assessing the creditworthiness of sovereign debt issues in an environment characterized by increased uncertainty in the post-global crisis era. Even without the heightened uncertainty, the complexity of assessing the creditworthiness of sovereign debt should not be underestimated. This is because a country’s ability and willingness to repay debt is affected not only by its economic, social and political dynamics, but also by increasingly commonplace internal and external shocks.How do creditors make their decisions as to a country’s creditworthiness? Increasingly they have come to rely on the assessments provided by credit rating agencies (CRAs). CRAs garner information on borrowers from a variety of sources and assess the default risk of the financial products being offered. The default risk is computed and condensed into a single relative measure—a credit rating in the form of a letter grade (Kruck 2011). This rating is a judgment on the “future ability and willingness of an issuer to make timely payments of principal and interest on a security over the life of the instrument.”2 This judgment forms the basis of the important but often uneasy relationship between countries which rely on funds from international capital markets, and the CRAs which influence the countries’ ability to access such funds.Gatekeepers to the international capital marketsThe CRAs’ outputs are used to guide the investment choices of government agencies and key institutional investors in the capital markets (pension funds, investment banks and other financial institutions). At the start of the millennium, the two major CRAs (Moody’s and S&P) passed judgment on approximately US$30 trillion worth of securities each year. According to their own estimates, at that time Moody’s had 4,000 clients for its publications and approximately 30,000 regular readers of its print output, and both Moody’s and S&P regularly issued press statements about credit conditions (Sinclair 2005). Output produced for dissemination through the Internet was just then gaining popularity. By the end of the 2007–2009 global crisis, however, CRAs have become known to even the casual newspaper reader. This is not only because of the plethora of articles that have blamed the CRAs for several failures leading up to and exacerbating the crisis, but also because of the demonstration of the critical role that the CRAs play in global investment decisions (Kruck 2011).
eBook - ePub- (Author)
- 2021(Publication Date)
- Wiley(Publisher)
Another category of fixed-income instruments whose special features affect credit risk assessment are catastrophe and pandemic bonds. They resemble an insurance product, rather than a traditional debt instrument. For example, the World Bank issued pandemic bonds in 2017, offering investors high interest payments in return for taking on the risk of losing capital should a pandemic occur, in which case they would pay out aid to poor nations suffering from a serious outbreak of infectious disease. At the time of this writing (July 2020), nearly all the principal from those bonds has been wiped out because caseloads and deaths from COVID-19 have exceeded the bonds’ thresholds.3 . Credit Scores and Credit Ratings
- explain credit scores and Credit Ratings
- calculate the expected return on a bond given transition in its credit rating
Credit scores and ratings are used by lenders in deciding to extend credit to a borrower and in determining the terms of the contract. Credit scores are used primarily in the retail lending market for small businesses and individuals. Credit Ratings are used in the wholesale market for bonds issued by corporations and government entities, as well as for asset-backed securities (ABS).Credit scoring methodologies can vary. In some countries, only negative information, such as delinquent payments or outright default, is included. Essentially, everyone has a good credit score until proven otherwise. In other countries, a broader set of information is used to determine the score. A score reflects actual observed factors. In general, credit reporting agencies are national in scope because of differences in legal systems and privacy concerns across countries.The FICO score, which is the federally registered trademark of the Fair Isaac Corporation, is used in the United States by about 90% of lenders to retail customers. FICO scores are computed using data from consumer credit files collected by three national credit bureaus: Experian, Equifax, and TransUnion. Five primary factors are included in the proprietary algorithm used to get the score:
eBook - ePub- International Monetary Fund. Monetary and Capital Markets Department(Author)
- 2010(Publication Date)
- INTERNATIONAL MONETARY FUND(Publisher)
Country authorities have taken a two-pronged approach to mitigate these effects by seeking to reduce regulatory reliance on ratings, and by regulating the CRAs directly. In their efforts to reduce rating reliance, regulators are, however, recognizing that some smaller and less-sophisticated investors will have to continue to rely on ratings. Central banks continue to use Credit Ratings rather mechanistically in their rules that determine the securities they accept as collateral in liquidity provision and market operations, and the margin or haircut applied thereon. For example, the U.S. Federal Reserve’s Term Auction Lending Facility mandates that only asset-backed securities rated AAA/Aaa by two or more of the major nationally recognized statistical rating organizations (NRSROs) are eligible for nonrecourse loans. Similarly, the European Central Bank (ECB) requires that marketable assets meet “high credit standards” in order to be eligible as collateral, in turn requiring at least one BBB- credit rating from one of the four accepted “external credit assessment institutions” (with the exception of asset-backed securities, for which the credit rating at issuance should be AAA) (ECB 2008a, 2008b, and 2009). Joint Forum Stocktaking Confirms Extensive Use of Credit Ratings in Regulations A Joint Forum (2009) survey of the use of Credit Ratings by its member regulatory authorities in the banking, securities, and insurance sectors found that the reliance on Credit Ratings was widespread in regulations and legislation for the banking and securities sector, with more limited use in the insurance sector. 9 Credit rating references were found to be more prevalent in U.S. and Canadian legislation and regulations relative to those in Europe, Japan, and Australia
eBook - ePubBanks and Business Networks
Management, Governance and Financial Implications
- Josanco Floreani, Enrico Geretto, Maurizio Polato, Giulio Velliscig(Authors)
- 2022(Publication Date)
- Routledge(Publisher)
The elements generally taken into account for defining the ratings to be attributed to the other parties, for internal use, i.e., for current management purposes, can be identified as the following 2 : 2 No reference is made in this discussion to the provisions on the subject arising from the supervisory regulations of banks. Measurements derived from scoring systems based on the reading of particular economic-financial indicators calculated from balance-sheet figures. Assessments concerning the current and prospective conditions of the sector to which the enterprise belongs. The examination of variables of a qualitative nature, such as the governance features, the professional profile of the management, the competitive position on the markets of interest, etc. Analyses of a performance type and related to the existing relationship with the particular bank or with the entire credit system (so-called public and/or consortium central credit registers). These components are integrated, in order to determine the rating, according to different kinds of criteria ranging from statistical processing, with assignment of a particular weight to each of them, to subjective evaluation mechanisms based on judgments formulated by experts. It should be noted that in practice, intermediate solutions are sometimes used: on the basis of quantitative data alone, a first “partial” rating is derived, to be subsequently integrated with information of a qualitative nature. The measurement of credit risk, in general terms, takes place according to two distinct approaches defined as “model based” (and differentiated into structural models and in reduced form models) and as “traditional” (or “non-model based”, as they are based on historical data about insolvencies) (Cherubini et al., 2004 ; Chatteryee, 2015)
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