A Critical Analysis of the Roles & Importance of Credit Rating Agencies

A Critical Analysis of the Roles & Importance of

Credit Rating Agencies

TABLE OF CONTENTS:

Introduction Page 2 - 3

The Roles and Methods of Credit Rating Agencies Page 3 - 4

The Significance & Origin of Recent Credit Rating Agency Criticism Page 4

The Accuracy of Credit Rating Agency Ratings Page 4 - 5

The Independence of Credit Rating Agency Ratings Page 5 - 6

The Speed of Credit Rating Agency Reactions to New Information Page 6

Conclusion Page 6 - 8

Reference List Page 9 - 11

A Critical Analysis of the Roles & Importance of

Credit Rating Agencies

Introduction:

The Australian Securities Exchange website explains that a credit rating can be seen as an estimate made by a Credit Rating Agency (CRA) “of the general worthiness of the company or entity that has issued…debt” (Australian Securities Exchange 2012) or of the creditworthiness of a specific “debt-like financial product” (Australian Securities and Investment Commission 2008). A credit rating signals “the likelihood that the debt will be repaid” in a timely manner (Rom 2009). CRAs openly advertise their use of independent and expert opinion in deriving each credit rating (Moody's Investors Service 2012) and there is certainly argument that CRAs are important in modern financial systems (Australian Securities and Investment Commission 2008). The recent global financial crisis (GFC) has turned the spotlight around and many are questioning the creditworthiness of CRAs themselves. Indeed it is now widely accepted that CRAs, particularly Moody’s Investor Services Pty Limited (Moody’s), Standard & Poor’s Pty Ltd (Standard & Poor’s) and Fitch Pty Limited (Fitch), or the “Big Three” (White 2010), were largely responsible for the “recent market turmoil” (Australian Securities and Investment Commission 2008). Subsequent to this, questions have arisen over the accuracy of CRA credit ratings and the independence of these ratings as well as the speed with which CRAs react to new information. As an educated and informed tertiary level finance student, I can identify with both the importance of, and criticisms