Credit rating agencies Free Essay Example

Credit ratings, bond ratings also referred to debt ratings are issued to financial institutions as regards preferred stock, corporate bonds and government bonds. The duration of the obligation affects the rating levels. Moreover issuers take credit ratings as an independent verification and validation of their credit-worthiness and the accuracy and efficiency of the instruments they issue.

However, there has been widespread criticism as regards the regulation of credit rating agencies, in that existences of weak regulations have given credit agencies much freedom, there are several criticisms which are bound to affect any decision made in regards to regulating credit rating companies, in the present and in future, these criticisms include:- Credit rating agencies are reluctant and take time to downgrade companies punctually.

Banks which have been declared bankrupt, have at times enjoyed favourable credit ratings up to the collapse stage, which whereas credit agencies have sufficient information pertaining the company’s financial woes. Past research has revealed that the market leads a downgrade, therefore invalidating the need for rating since it is a product of the market.

Regulatory measures have been proposed for the financial regulators to adopt and rely on credit spreads, when calculating the risk in the portfolio of banks.

Moreover, credit rating agencies been accused of undue influence by relating closely with the rated company’s management, personal interests if feared to supersede the independence of rating. It is not lost that the corporations being rated are the ones who pay the credit agencies, conflicts of interests are therefore bound to occur, which may result to biased rating positions and the rating companies may not provide honest ratings.

In addition, credit agencies usually offer what they belief to be the best alternative to positively affect credit score, in case companies desire to take actions. This is seen as serving and limiting the rated companies to achieving a better score, which may be in conflict or may not be in agreement with the company’s goals, vision and objectives and strategic actions. The fact that companies operate in an interdependent manner, creates a major challenge for credit scoring.

An action taken by one company is bound to have adverse or otherwise effects in collaborating companies such as creditors and debtors. Any action, which may affect the credit score by a CRA can have a net result of creating a vicious cycle, to the rated company and affect the interest rate, this affects the existing contracts with collaborating institutions, this results to addition in expenses hence lowering credit worthiness, causing an increase in expenses and ensuing decrease in credit worthiness.

The collapse of Enron due to rating triggers has it has been pointed out by Salter (220), is an exemplar, of resonating effects of reducing in CRA score reduction. When a rating falls below a trigger rating, some creditors demand to be paid in full, since the rated company may not be in position to honour the debt, creditors may seek to acquire the company’s assets, this results to collapse of the firm. This should therefore be considered by the regulating authorities, since CRA ratings are influential accelerant in a downfall of a weak firm.