The Power and Importance of Credit Rating Agencies

           The importance of CRAs cannot be undermined. The growth of the international financial markets over the last twenty years would have been unthinkable without CRAs. Only because of the availability of clear, internationally accepted indicators of the risk of default were investors willing to invest in international securities—whether corporate or government bonds—whose credit quality they would have been virtually unable to assess on their own. The CRAs worked for decades on designing a simple and readily understandable system that would allow any investor to invest in international securities with which they were not directly familiar. Where corporate and government bonds are concerned, this system has proved reliable and enabled investors to diversify their portfolios.

The power of CRAs should not be underestimated. Where they can give very high ratings, they can also give very poor ratings. The format of the ratings varies from agency to agency, but broadly speaking, at the top of the scale you have AAA-rated debt which means that the issuer is very unlikely to default, all the way down to junk bonds, where there's a high risk of losing some or all of your money. Clearly, if you get an AAA stamp, then you can borrow money cheaply. But if you're told you're junk, then you'll have to pay a pretty big interest rate to get credit.

Today, Greece has become the world's least creditworthy country after Standard & Poor's has cut its rating from B to CCC. This means that in the event of adverse business, financial, or economic conditions, Greece is not likely to have the capacity to meet its financial commitment on the obligation. S&P says that Greece will probably default on its debts at least once by 2013. People in Greece are losing their jobs; the unemployment level is at 16% in March. With Greece’s credit rating in junk status, it really needs to be bailed out by the European Union (EU) and International Monetary Fund (IMF).

The foregoing proves that CRAs really wielded power in international financial markets. An international bank, for instance, would want to determine the capacity of a country to pay before it grants a loan to that country. It will rely then on the ratings given by CRAs. It will assess whether there is a low or high risk of default on the part of the borrower. A country, like the Philippines, wants a high credit standing so that it may obtain loans to cover budget deficits at low interest rates. To be able to obtain a good credit standing, the country has to show that it has the ability to pay. And that can be shown by implementing sound monetary and fiscal policies.