Most of us will be familiar of the ratings like A+, B, B+ on a school report card. What puzzles the investors are that such school grade like ratings of AA+, BBB are provided by Credit rating agencies to investments in private companies, even to countries and economies. Let us see the significance behind such ratings being assigned to corporations and countries.

Credit rating agencies are private firms that assign certain grades called credit ratings to companies and entities who are issuers of debt in general. Many corporations, companies and even governments frequently issue bonds and debentures to raise money from the public investors. The credit rating agencies are like guardians of the financial markets that rate these entities who borrow from the public so that the average public investor is aware of the risks of buying these debt instruments.

The most important aspect here is that credit ratings provided to investments or debts issued by a company rate only the investment and not the company itself. The credit rating agencies perform an in-depth analysis of the debt issuer’s ability to pay back the loan to their investors on the promised terms. The credit rates like AAA, AAA+, BBB, BB+ and AA+ are the ratings provided by these rating agencies based on their objective analysis. Some of the most reputable and leading global credit agencies are Moody, Fitch and Standard & Poor (S&P).

Now, these credit rates can be provided to investments, companies, even governments and economies. A highest credit rating of AAA signals that the debt-issuer has excellent credit quality and so a very low credit default risk. While other ratings like AA, AA+ represent high credit quality with BBB, BB+ represent good credit quality with medium credit risk. Whereas, the ratings like BB signal high credit risk with CCC, CC, C and D representing  highest risk to default which are only assigned to junk bonds and investments.

The ratings provided by Credit rating agencies have a profound impact on the markets. Based on the credit ratings of rating agencies institutions and companies will accordingly increase or lower the interest rates for their debt investments. If the rating is poor it will attract poor response for the investment and hence the interest rates will be high making it costly for the entities to borrow. A good to high quality credit rating will make it easier for the debt-issuers to borrow from the public as the interest rates will be relatively less on these debts.

During the recent recession, the leading credit rating agencies like Fitch and S&P even downgraded the U.S economy as a whole to a mere AA from its highest credit rating of AAA. Likewise the credit rating agencies periodically review their ratings and may upgrade or downgrade as per their evaluation. Thus, rating agencies help the investors by providing the credit risks of an investment, while they also help the borrowers by providing credibility and reputation for their debt issues.

However, rating agencies only rate those investments and companies which approach them to rate it. This creates a conflict of interest as these credit rating agencies get paid by these companies to rate them. Though the rating agencies are supposed to be reputable and have objective evaluations, the recent financial crisis seems to prove otherwise.

Many leading credit rating agencies like S&P, Fitch and Moody’s have been accused of wrongly rating certain high risk mortgage backed assets with AAA and AAA+. Many pension funds that invested in such high risk junk bonds based on these rating lost their investment rescuing in many employees completely losing their retirement benefits.

Therefore, as guardians of the financial market, these credit rating agencies have a huge responsibility and moral obligation towards the investors to provide highly objective and most accurate credit ratings. One has to wait and watch whether these credit rating agencies will regain their lost reputation!