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The Mystery of Credit Rating Agencies: How Do They Assess Borrowers' Creditworthiness?
Credit rating agency (CRA) refers to a type of company that specializes in providing credit rating services. These ratings are mainly used to evaluate borrowers' ability to repay debts and the possibility of default. Whether it is countries, companies, or different types of financial instruments, these institutions can provide ratings for market reference. Over the past few decades, however, the role and value of credit rating agencies have been widely questioned, sparking discussions about their functions and how they operate.
Credit rating agencies have reduced information asymmetry to some extent, but do their ratings really reflect the true state of the market?
The history and development of credit rating agencies
The history of credit rating agencies can be traced back to the early 19th century, when the scope of business activities became wider as the United States expanded. Merchants' concerns about extending credit when dealing with unfamiliar customers led to the creation of the credit reporting industry. These commercial credit agencies provide companies with credit assessments to help them make more informed lending decisions.
As market demand grew, credit rating agencies began to focus on rating related securities, especially in the booming railroad bond market. For example, in 1909, John Moody published a rating report specifically for railroad bonds, one of the first instances of seeking independent market information.
The evolution of the role of credit ratings
After the Great Recession, the credit rating business in the United States grew rapidly and came under tighter regulation. According to the 1936 law, only those bonds deemed "investment grade" by a "recognized rating manual" can be purchased by banks and other financial institutions to prevent the expansion of investment risks.
Although changes in the political structure have brought about the expansion of rating agencies, trust in the industry is facing increasing challenges.
The impact and controversy of ratings
Credit ratings not only affect a single company's access to funds, but also have a key impact on the operating model of the overall capital market. For example, during the financial crisis, many bonds that were originally rated "AAA" were eventually downgraded to "junk bonds," causing huge losses to investors and triggering a credibility crisis.
Questions against credit rating agencies mainly focus on the accuracy and timeliness of their ratings. For example, some critics point out that the responses of credit rating agencies have often lagged behind actual market conditions in many important financial events, including the financial crisis of the past decade and the collapse of energy giant Enron.
Transparency of the rating process
How does the credit rating process work? Generally speaking, credit rating agencies will predict the likelihood of default by analyzing the financial statements, legal contracts and other relevant information of the issuing company. These ratings are usually presented in a letter combination, such as AAA or AA. However, these ratings reflect the agency's opinion and not definite facts.
In the United States, credit rating agencies are able to proactively "monitor" securities, which means that they will continue to review the credit status of the relevant securities after they are rated and make adjustments if necessary. However, for some institutions, such "monitoring" may not be efficient or timely, leading to instability in the financial market.
Perspectives for the future
As the capital market evolves, the influence of credit rating agencies will continue to exist for a long time. Many investors still rely on the ratings provided by these institutions as an important basis for investment decisions. However, growing criticism has also prompted the industry to think about how to improve the transparency and accuracy of credit ratings.
In an ever-changing market, can credit rating agencies keep pace with the times and truly ensure the healthy operation of the market?
From a historical perspective, credit rating agencies play an indispensable role in the capital market, but how to solve the challenges and problems that come with it to enhance their credibility and reliability is also a norm. and important issues that regulators need to face urgently. In the future financial ecosystem, can these institutions rebuild trust and improve the transparency of their rating processes, which will directly affect investor confidence and market stability?
