Future Regulation of Credit Rating Companies
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.
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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.
Oligopoly market behaviours is also observable in credit rating companies, in the rating market there is a domination of a few companies that deal with the rating business, the principal rating companies are recognized and entry of a new player is very restrictive. The existing credit rating firms therefore enjoy huge percentages of the market as can be attested of the very insignificant number of new rating firms, the fact that most credit rating companies rarely disclose their financial earnings, while ensuring that restrictive conditions offer a disadvantage to potential entrants.
The need for regulation of Credit Rating Agencies has been further catapulted by apparent misjudgements made by the rating companies, this is more apparent in cases were the rating companies have awarded high scores to structured products such as structured debt, which fail to reveal their true status, till a later time when the rating is reversed downwards. The rating of Goldman Sachs Abacus CBOs is an example of such a case, where the true value of Abacus could not be ascertained by the investors, since it had been rated highly by a respectable firm, Moody’s.
According to Carmichael et al (155 – 65), very limited legislations and regulations exist to address such shortcomings. Quality and inconsistence in rating standards is also apparent when different firms rate the same organization. In addition, there is no clear distinctive clear difference of corporate or government bonds and structured finance by the rating agencies. In addition, banks which have overly relied on the credit ratings and failed to do complementary internal risk assessment, have suffered from insufficient capital reserves.
Some rating agencies have been given a preferential treatment by the government as they play a quasi-regulatory role; these are Moody’s, Fitch, and Standard and Poors. However, the fact that they profit seeking entities is bound to generate conflict of interest. The rating agencies are supposed to be impartial and neutral in their ratings without being compromised, however, the fact that they are paid by the companies issuing securities means that they may work for the benefit of the hand that feeds them, hence being insensitive to the concerns of the investors.
This has resulted to market stakeholders using credit rating scores it as regulatory requirement of the Federal Reserve, but use Treasuries and index to benchmark. Credit rating agencies share a symbiosis relationship with the government in terms of regulation. Whereas governments are expected to regulation all organizations operating within its area of jurisdiction, Credit rating agencies assign credit scores to the government.
The score is very important for the government, the government may therefore fail to acutely apply regulatory procedures on the rating agencies, on a political perspective, the rating agencies may manipulate the government score ratings, to win government confidence and avoid regulatory measures. Credit Risk Management definition Credit risk is defined as the extent of value fluctuations in debt instruments and derivatives due to alteration in the fundamental credit quality of borrowers and counterparties.