Rating agencies oligopoly should be dismantled: CEA

Rating agencies oligopoly should be dismantled: CEA

Subject: Economy

Section: External Sector

Context: The oligopoly of the three global rating agencies, Moody’s, Standard & Poor, and Fitch, needs to be dismantled

Concept:

What is credit rating?

• A credit rating is a quantified assessment of the creditworthiness of a borrower in general terms or with respect to a particular debt or financial obligation.
• A credit rating can be assigned to any entity that seeks to borrow money—an individual, corporation, state or provincial authority, or sovereign government.
• A sovereign credit rating is an independent assessment of the creditworthiness of a country or sovereign entity.
• Sovereign credit ratings can give investors insights into the level of risk associated with investing in the debt of a particular country, including any political risk.
• Investors use sovereign credit ratings as a way to assess the riskiness of a particular country’s bonds.
• Obtaining good sovereign credit rating is usually essential for developing countries in order to access funding in international bond markets.

What are Rating Agencies

• A rating agency is a company that assesses the financial strength of companies and government entities, especially their ability to meet principal and interest payments on their debts.
• The rating assigned to a given debt shows an agency’s level of confidence that the borrower will honour its debt obligations as agreed.
• The Big Three Credit Rating Agencies: Fitch Ratings, Moody’s Investors Service and Standard & Poor’s (S&P) are the big three international credit rating agencies controlling approximately 95% of global ratings business.
• In India, there are six credit rating agencies registered under SEBI namely, CRISIL, ICRA, CARE, SMERA, Fitch India and Brickwork Ratings.

Role of Rating Agencies in Capital Markets

• Rating agencies assess the credit risk of specific debt securities and the borrowing entities. In the bond market, a rating agency provides an independent evaluation of the creditworthiness of debt securities issued by governments and corporations.
• Rating agencies also give ratings to sovereign borrowers, who are the largest borrowers in most financial markets.
• Sovereign borrowers include national governments, state governments, municipalities, and other sovereign-supported institutions. The sovereign ratings given by a rating agency shows a sovereign’s ability to repay its debt.
• The ratings help governments from emerging and developing countries to issue bonds to domestic and international investors.
• Governments sell bonds to obtain financing from other governments and Bretton Woods institutions such as the World Bank and the International Monetary Fund.

Issue:

According to Chief Economic Advisor V. Anantha Nageswaran there were many problems with the methodology of the rating agencies, such as “qualitative parameters” (which bring in an element of subjectivity) and the sources of information.

The rating agencies take inputs from the World Bank’s World Governance Index, which itself is “extremely problematic” because its own sources of information do not come from the countries assessed but from “think-tanks or research bodies sitting in some European countries.”

WGI is  “opaque” and does not take due note of the stage of development of a country.

As countries reach a particular stage of development, they discover the need for different institutions for governance.

For them (rating agencies) to compare the institutions of developing countries and developed countries, where such institutions took several centuries to evolve, is not a fair comparison.

World Bank’s World Governance Index

• It is released by the World Bank.
• It is based on six dimensions of governance:

1. Voice and Accountability
2. Political Stability and Absence of Violence
3. Government Effectiveness
4. Regulatory Quality
5. Rule of Law
6. Control of Corruption

• These indicators are designed to help researchers and analysts assess broad patterns in perceptions of governance across countries and over time.
• The World Bank compiles the Worldwide Governance Indicators using data from more than 30 think tanks, international organisations, non-governmental organisations, and private firms deemed credible.
• The WGI was developed in 1999 by two World Bank researchers, Daniel Kaufmann and Aart Kraay.