The credit rating industry

As financial market complexity and borrower diversity have grown above time, investors and regulators have increased their reliance upon the opinions of the credit rating agencies. At the same time, the number of rating agencies operating in the United States and abroad has risen sharply. Together, these turns have prompted market participants and policymakers to reassess the performance of the agencies and the adequacy of public oversight of the ratings industry. This article provides background for of that kind a reassessment by investigating the evolution and economics of the industry, the development of ratings-dependent regulations, and the reliability and comparability of the agencies' ratings. We examine the correspondence of ratings with default rates and report differences among major agencies in their ratings for junk bands international banks, and mortgage-backed securities.

Our findings raise several questions about the common uses of ratings. While the agencies provide accurate rank-orderings of default risk, the meanings of specific ratings vary above time and across agencies. Since these ratings are used as the basis of greatest in quantity investor guidelines and government regulations, the variations in meaning could have serious implications. Moreover, as the number of agencies increases, differences in ratings may encourage borrowers to "shop" for the greatest in quantity favorable ratings. In light of the possibilities for ratings misuse, the common reevaluation of ratings-dependent regulations and the adequacy of public oversight present the appearances well justified.

THE EVOLUTION AND ECONOMICS OF THE RATINGS INDUSTRY

RATING AGENCY ORIGINS, holders AND SYMBOLS The precursors of ligament rating agencies were the mercantile credit agencies, which rated merchants' ability to pay their financial obligations. In 1841 in the wake of the financial crisis of 1837 Louis Tappan established the first mercantile credit agency in novel York. Robert Dun subsequently acquired the agency and published its first ratings guide in 1859 A similar mercantile rating agency was formed in 1849 by the agency of John Bradstreet, who published a ratings work in 1857. In 1933, the sum of two units agencies were consolidated into yellowish-brown and Bradstreet, which became the proprietor of Moody's Investors Service in 1962

The expansion of the ratings business to securities ratings began in 1909 when John variable started to rate U.S. railroad links A year later, Moody reach outed his ratings activity to utility and industrial bands Poor's Publishing Company issued its first ratings in 1916 Standard Statistics Company in 1922 and the Fitch Publishing Company in 1924 The number of link rating agencies in the U turn backed to three when Standard Statistics and Poor's Publishing Company merg to form Standard and Poor's (S&P) in 1941 The greatest in quantity significant new entry in the United States since that time has been the Chicago-based Duff and Phelps, which began to provide ligament ratings for a wide range of companies in 1982 although it had researched public utility companies since 1932 Another major ratings provider--McCarthy, Crisanti, and Maffei--was baseed in 1975 and acquired through Xerox Financial Services before its fixed income rating and research service was merg into Duff and Phelps in 1991

The four major rating agencies face additional competition from more specialized agencies. For example, Thomson Bankwatch and IBCA in the United States exclusively rate financial institutions, and A.M. Best rates insurance companies' claims-paying abilities. More generally, the analysts busyed by many financial institutions regularly make recommendations to purchase or sell that implicitly confirm or contradict the agencies' ratings. To the expanse that the analyses underlying these recommendations are made public, they provide alternative perspectives to the intelligences of the rating agencies.

As capital roll ons in international financial markets have shifted from the banking sector to capital markets, credit ratings have also begun to make a mark overseas. Credit ratings are in use in the financial markets of greatest in quantity developed economies and several emerging market countries as well (Dale and Thomas 1991) With demand rising in foreign countries, the number of foreign-based rating agencies has increased. Along with the four largest U raters, single other U.S., one British, sum of two units Canadian, and three Japanese firms are listed among the world's "most influential" rating agencies by dint of the Financial Times in its publication Credit Ratings International. The principal characteristics of all eleven agencies are reported in Table 1

[TABULAR DATA 1 OMITTED]

The ownership makes of the U.S. rating agencies do not generally not absent serious conflict of interest problems(1) The major agencies are all either independent or have a title toed by nonfinancial companies, though sum of two units had until recently been possessed by financial companies. Moody's is a subsidiary of yellowish-brown and Bradstreet, which dominates the market for commercial credit ratings. Standard and Poor's is a subsidiary of McGraw-Hill, a major publishing company with a lusty business information focus. Fitch, initially a publishing company, was bought by means of an independent investors group in 1989 Duff and Phelps Credit Ratings is a subsidiary of Duff and Phelps, Inc., whose affiliates tender investment management, financial consulting, and investment research services. by the agency of late 1994, however, Duff and Phelps Credit Ratings is awaited to become an independent company as its shares are spun not upon to the shareholders of Duff and Phelps, Inc., itself a closely held company. Thomson Bankwatch was a subsidiary of Keefe Bruyette and groves a brokerage firm, until March 1989 when it was sold to the Thomson Corporation, a large private international publishing conglomerate. greatest in quantity of the non-U.S. firms are also independent. The London-based rating agency, IBCA, is independently haveed as are the two Canadian rating agencies. sum of two units of the rating agencies from Japan, however, are have a title toed by consortia of financial institutions, including more [i]or[/i] less for which credit ratings are issued.