http://mintonsunday.livemint.com/news/the-economics-of-rating-agencies/2.4.2724521513.html
A few weeks ago, rating agency Moody’s intervention in the debate on growing polarization in the country stoked a political firestorm after its analytics arm warned that Prime Minister Narendra Modi risks losing his domestic and global credibility if he is unable to rein in colleagues making provocative statements against minorities and stoking ethnic tension. An outcry followed, but Moody’s stood by the report, saying it was the view of Moody’s Analytics, and not of its credit ratings division.
The second event involved the $121 million debt default of Amtek Auto Ltd. The default has hit the portfolios of large institutional investors such as JP Morgan Asset Management, which was left holding unsaleable assets. The event highlighted a growing risk for bond market investors; rating agencies often react late, if at all, to growing credit risks.
To put it simply, rating agencies rate borrowers—private and public—who want to raise capital in the market. Although there are exceptions to the rule, normally private players seek these ratings while sovereign ratings are unsolicited. When solicited, the fees for providing ratings can run into millions of dollars.
The first credit rating agency was founded by John Moody in the US in 1909. By the 1920s, credit rating agencies covered almost all of the US bond market. With an increase in the mobility of finance capital, they have expanded their influence across the world. But the business remains extremely concentrated and can be considered an oligopoly. Three firms—Standard and Poor’s (S&P), Moody’s and Fitch—control more than 95% of the market for credit rating agencies.
Finally, there is an inherent conflict of interest in the ratings business as these agencies depend on payments by those they are rating. Under such a business model, rating agencies may be tempted to be lenient, and more competition among rating agencies can exacerbate rather than curtail this problem.
This relates to the problem of “rating shopping”, which refers to the practice of approaching different agencies and then using the most favourable rating to raise capital.
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