Rating Agency

Rating Agency is an organization engaged in assessing the creditworthiness of issuers and the investment quality of issued securities, based on which issuers are assigned credit ratings.

There are about 100 rating agencies all over the world performing their activities that are divided into international and national rating agencies. There are three most reputable agencies, called the Big Three: Fitch Ratings, S&P Global Ratings, Moody’s Investors Service.

Features:

• It assigns ratings to issuers of liabilities or securities: sovereign states, local authorities, special-purpose entities, profit-making and non-profit organizations;
• It does not assess the creditworthiness of individuals;
• It assigns ratings to securities: bonds, deposit and saving certificates, commercial securities, preferred shares and structured finance instruments;
• It assigns a rating in the form of an alphabetic score that reflects the probability that the borrower will be able to repay the principal and accrued interest;
• In addition to the borrower rating, it also publishes a forecast:

• Positive: when there is a probability of positive changes and possibility of the rating upgrade;
• Stable: the rating is expected to remain unchanged;
• Negative: when there is a probability of negative changes and a possibility of the rating downgrade.

Advantages:

• Rating agencies assign risk levels to various organizations, which allows investors to obtain an independent opinion on the credit risk of each borrower, who, in turn, can access the loan-based funding without the need for evaluation by each lender;
• Investors have access to up-to-date information on the reliability of their investments, since the borrower’s solvency is assessed by the agency throughout the entire period of cooperation;
• Agency ratings are used by banks to determine the risk premium they charge for loans and bonds. A low credit rating leads to an increase in the interest rate on debt obligations;
• A high credit rating allows for access to large investors;
• At the country level, a favorable rating can help attract direct foreign investment into the country.

Disadvantages:

• Lack of competition in the credit rating market: a large share is occupied by the Big Three companies;
• Availability of an international and a national scale, not limited to the sovereign rating of the country;
• Low reaction to events and incorrect assessments by rating agencies can provoke crisis phenomena. For example, assigning a high credit rating to mortgage-backed securities, which turned out to be investments with a high risk, was one of the reasons for the financial crisis in 2008;
• Discrepancy of results of different rating agencies;
• Conflict of interest between rating agencies and issuers of securities that pay for rating services and are interested in positive evaluation;
• Political commitment.