Chapter 3: Description of the credit rating industry
CRAs are business institutions dealing with information relevant to the financial markets. The three leading CRAs worldwide are Moody’s, Standard & Poor’s and Fitch and they are commonly called the Big Three. Broadly speaking, their business activities concentrate on two key aspects. First and foremost, CRAs typically provide investors with external credit ratings, ie, they help them make investment decisions. Second, they may also engage in offering ancillary services to issuers. Ratings are a fact of life in modern society where non-specialists want com- plex information distilled by experts into easy-to-use symbols and rankings. The traditional CRA activity consists of selling external credit ratings. Through their ratings CRAs assess the creditworthiness of borrowers and debt instruments. This activity allows for the transfer of information from borrowers to investors. Ratings reflect a CRA’s opinion of how likely it is that an issuer will repay a particular debt or financial obligation, or its debts generally. Two elements are at the core of every rating decision. First, the credit information is based on the probability of default of a borrower or a debt instrument. Second, CRAs assess the expected recovery in the event of default. Besides, for investments with multiple assets, CRAs also determine the correlation of defaults. The resulting ratings give a single ranking that accounts for these relevant assumptions. The rating scale developed by Standard & Poor’s is the best known and the most widely used by CRAs: AAA; AA; A; BBB; BB; B, and so on.
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