Role of Credit Rating Agencies in Financial Stability and Development
Credit Rating Agencies—or External Credit Assessment Institutions, as referred to in the New Basel Capital Accord—provide independent, forward-looking “opinions” to investors on the credit worthiness—or ability and willingness to service debt in full and in time—of an obligor (debt issuer) with respect to a specific financial obligation, or a class of financial obligations, or a specific financial program such as a commercial paper issuance. Those opinions are expressed in the form of (a) a credit rating for various financial instruments and transactions such as corporate bonds (both financial and non-financial institutions); (b) obligations issued by sovereign (central governments) and sub-sovereign (state and local governments) borrowers, other public institutions, and supra-nationals (multilateral and regional institutions); and (c) structured finance transactions (e. g., asset-backed securities, project finance transactions, collateralized debt obligations).
The ratings are based on current information obtained from the obligors and other sources that the rating agencies consider reliable. Judging credit quality involves analyzing a broad scope of relevant risk factors, often subjective, which are unique to particular industries, issuers, and countries. For a discussion of what methodologies are used in assessing country credit ratings, what the sources of possible biases are in those assessments, and how the rating methodology has evolved in recent years, see Bhatia (2002). Credit ratings may be of long-term or short-term duration, depending on the maturity of the instrument. Rating agencies differentiate the ability to service foreign and local currency debt in their analysis and issue separate ratings by currency. They may be subject to downgrade or upgrade should a rating agency consider that material changes in the financial condition of an issuing entity warrant a rating review.14