Credit rating

Credit ratings are issued by a number of rating agencies that assess the quality of debt securities and the financial soundness of organisations as a whole. Credit rating agencies usually have access to unpublished and usually confidential details of company accounts, which is the main reason their ratings are more influential than those of other credit analysts. They issue ratings for sovereign debt (that of countries), local government bodies and other organisations as well as companies.

The credit rating agencies each uses a scale of ratings. These start with a top rating such as AAA (very low risk of default), with lower ratings reflecting increasing levels of risk and actual default. The highest few grades are regarded as investment grade and those below them as junk bond grades. Many funds are restricted to investing in investment grade debt instruments. The agencies use "+" and "-" modifiers on the basic ratings to provide a finely graded scale. They also indicate when they are considering changing a rating, and the direction of the likely change.

As ratings are a measure of default risk they should be roughly in line with the risk premium on the securities concerned. This is the case but the market does seem to react faster (by changing prices) to changes in risk than the rating agencies do (by changing ratings).

The credit rating agencies make their money by charging the organisations they rate. The ratings are then freely available but the agencies also charge for detailed reports. The market is dominated by a small number of agencies: Standard & Poors and Moodys are the two largest and significantly bigger than Fitch (the third largest). Other agencies are much smaller and only significant in specialist areas, such as AM Best in insurance.

The credit rating agencies have attracted considerable criticism in recent years. Concerns have included the oligopolistic nature of the market, the slow reactions of the agencies to changes in circumstances and their lack of independence from the companies they rate (their clients).