Archive for August, 2012

Credit risk: what we know, what we don’t know and what we should know

Thursday, August 30th, 2012

By Mei Lin KER

With the deregulation of the financial markets, companies have progressed from traditional method of bank borrowing to the issuance of corporate bonds to seek capital from the general public. As a potential lender, how will you assess which company is a safer haven to park your money? Is there a way to allow you to gauge the default risk of each company so that you can make an informed choice? One of the solutions lies in credit rating agencies. The use of ratings is pervasive in today’s society. From movies to restaurants to even car safety, ratings are compiled to provide consumers a quick assessment and comparison of the desirability of the product or service. In the financial industry, credit risk ratings for corporate and sovereign debt instruments are provided by credit rating agencies (CRAs) with the current industry leaders being Moody’s, Standard & Poor’s (S&P), and Fitch.

The probe by the US Congress Committee uncovered the credit rating agencies as one of the main culprits fuelling the GFC calamity. Their failure in providing correct ratings to certain complex financial products led to the severity of the financial meltdown. Under Basel II, banks utilising the standardised approach to determine their regulatory capital are required to use external credit assessments to determine the weightings for calculation of the total risk-weighted assets. Elevated to the status of “nationally recognised statistical rating organisations” (NRSROs), Moody’s, S&P and Fitch provide such external credit statistics. Though more rating agencies have been added to the list as the years passed, the Big Three maintain their dominant positions, collectively representing 95% of the market. What do we actually know about such agencies to trust their competency in providing accurate and unbiased ratings? Let’s explore further.

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