Credibility of S&P and Moody's Ratings Before and After the US Financial Crisis - Literature review Example

? Comparison of Credibility (Accuracy) Of S&P and Moody's Ratings Before and After the US Financial Crisis Lecturer: Comparison of Credibility (Accuracy) Of S&P and Moody's Ratings Before and After the US Financial Crisis S&P and Moody's Rating Influence on the US Financial Market S&P and Moody influence the U.S financial markets by reflecting difference indicators of the financial health of the banks. These ratings tend to be sensitive depending on the economic climate; thus, many rating agencies have nowadays changed their rating model in response to the latest financial crisis that impacted the US financial markets. The rating process increases the bank capacity; thus, the discretion level tends to be higher especially where Moody’s ratings are employed (Laere, Vantieghem and Baesens 2012, P.4). These rating systems have also influenced the U.S capital markets by enabling the U.S financial markets to examine the credit risks. S&P and Moody’s ratings play significant roles in the capital markets; thus, the rating agencies employ them in measuring the expected financial losses (Langohr and Langohr, 2008). This is crucial because they enable the financial market to respond to financial insecurity or risks. This is through establishing regulatory approaches that protect the financial markets from incurring losses. S&P and Moody frequently provide financial analysis to the analysts and issues standard public financial statement of the U.S banks on credit conditions. They also carry out credit ratings in order to offer investors with adequate information; hence enabling them to overcome credit crisis. Moreover, they have influenced the US financial market by enabling them to make financial analysis in order to determine the strength of banking institutions. They have enabled them to split bonds and rate the financial institutions against each other in order to determine their performance level. Hampton (2009) argues that strong financial ratings offer financial institutions greater access to capital markets; thus directly influences the operational and performance of US financial institutions. The rating activities also are effective for financial regulators, depositors and many others in analyzing the financial strength of banking institutions. Thus, through S&P and Moody rating services, the U.S financial institutions have enabled to improve their business performance level. Literature Review on the Methodology Changes of S&P and Moody's After All the Criticism It Has Faced On Their In Credibility and Accuracy of Their Published Ratings Varied literature have attempted to reveal the methodology changes of S&P and Moody’s after they faced varied criticism on their credibility and accuracy issues. They have made great efforts of becoming more cautious in order to recover their reputations after the criticism during the recent financial crisis. The S&P and Moody's, as well as, other credit rating agencies have been a subject of controversy; thus, they have been criticized for not being accurate and credible. These agencies faced severe criticism especially during the recent rise of gasoline in the U.S that contributed to a global financial crisis (Eccleston, 2013. However, the credit rating agencies have made significant attempts of making changes in rating system; thus, they have focused on creditworthiness, which has become the key aspects in the financial markets. S &P have attempted to implement varied methodologies and this has changed drastically after the 2007 to 2008 global financial crisis. Before the crisis Moody's employed RiskCalc model for estimating private industries default risks. However, the current regulatory approach, which is characterized by capital ratios, stress tests among other methodologies makes it necessary in rating activities. Anand and Subramanian (2013) reveal that S&P and Moody's have made significant efforts of responding to criticism by increasing the regulatory use of ratings in order to reduce financial risks. This regulatory approach is an effective methodology that calls for risk management because any error might occur in the credit rating process; hence creating a severe consequence to credit sellers and buyers. This can impact the overall performance of the financial markets; thus, implementation of regulatory approaches toward risk management is crucial. Ellis (2012) asserts that imposing liability on CRAs is a good idea because it will enable the agencies to be accountable for any financial risks or problems, which may arise during the financial rating process. S&P and Moody's have been cautious; thus, they have implemented regulatory frameworks including self-regulation and legislations that aim to reduce any potential risks, which may impact the financial markets. Commercial and agency rating methodologies are among the recent models employed in rating activities. S&P and Moody’s major aim was to offer credit opinions on financial tasks for investors. These methodologies have moved from traditional AAA rating to B.C and bond credit rating, which are currently contributed to efficiency in rating services (Kiff, Nowak, Schumacher and International Monetary Fund (2012) argue that while credit rating agencies (CRA’s) have an impact in the cost of funding the sovereign issuers; thus rating on financial stability should be the major concerning issue. S&P and Moody's have been criticized for failure to maintain financial stability in rating process, but the CRAs have attempted to perform reasonably well especially in the rank ordering default risk in varied sovereign nations ( Wague, 2011). According to Nowak, Schumacher and International Monetary Fund (2012, p. 1), the empirical research evidence supports significant reform initiatives in order to reduce the impact of CRAs; thus enabling them to improve their rating performance level. They also argue that more transparency in regard to other methodologies employed such as quantitative parameters used in the financial rating process should be more transparent and accurate. According to Moschella (2010), ABS CDOs rating methodologies were commonly used for rating services, but this changed after the criticism that the CRAs lack competition, the agencies have now realized the significant need for increasing competition level among the concerning industries. For instance, in July 2011, the financial minister of Germany demanded the CRAs to break the oligopoly of the financial ratings; the ratings were also made publicly even though the insurers wanted a rating or not. The ratings were done on the basis of offering information to the public in order to create transparency. Godlewski (2007) argues that implementing legislation that can hinder new entrants into the market can curb the excessive powers of the agencies; thus influencing financial markets (Choi, 2009). Encouraging higher level of competition for the S&P and Moody's agencies will increase transparency on the way ratings are assessed. The recent rating activities by S&P and Moody's in the U.S financial banks have fueled some questions as to whether the ratings correspond to accurate financial risks assessments and the way the agencies are influential to U.S financial market. The disputation that ratings was subjected to accurate default risks was brought into the discussion table by the sheer volume and intensity of diverse downgrades to the U.S mortgage-related planned securities in the awake of financial crisis (Kiff, Nowak, Schumacher and International Monetary Fund 2012, p.3). There have been also arguments about these rating agencies due to contemporary relegates of European sovereigns, which contributed to uncertainty in the financial markets. The critics are not new but even during the Asian crisis, the CRAs were blamed for downgrading the Asian and the entire European markets (Chernobai, Jorion and Yu, 2011). These crisis worsened the economic growth of many countries; thus intensifying the cost of borrowing. However, many capital markets started making varied changes through employing effective methodologies and made publicly the financial information, which was used by financial market to value fixed revenue securities. Cameron and Green (2009) argues that despite the increased global financial crisis that contribute to criticism towards the CRAs agencies, S&P and Moody's have attempted to respond to the criticisms. This is through implementing varied legal system that enables the capital markets to maintain creditworthiness. The agencies have also issued accurate regulations that demands rating agencies to comply with the financial and reputational requirements; thus avoiding financial risks. Andersen and Schroder (2010) argue that the implementation of the detailed regulatory that took place in the recent global market contributed to corporate scandals, which led to financial market issues; thus some of them created defaults to the public companies. However, S&P and Moody's agencies responded to these scandals by implementing a new regulation that based on the CRAs Reform Act of 2006; thus, rules were issued basing on this act. This enabled many financial markets to perform their business successfully; thus created the CRAs a very profitable agency. Helleiner, Pagliari and Zimmermann (2010) also attempt to reveal the politics behind the international regulatory changes with an aim of reducing global financial risks. S&P and Moody's offer a separate model that analyzes the rating determinants for financial markets. The ratings results from varied methodologies that makes the stable and tactless to temporary credit risks fluctuations. However, the political debate that contributed to varied criticism over these rating agencies, consequently led to varied changes in the financial capital markets. They also led to the implementation of laws regarding bank-rating methodologies with an aim of improving security for financial capital markets. Saunders, Allen and Saunders (2010) offer new approaches for value at risk and also provide some paradigms for managing credit risks; thus contributing to successful business performance in the financial markets. References Andersen, T., & Schroder, P. (2010). Strategic Risk Management Practice : How to Deal Effectively with Major Corporate Exposures. Cambridge University Press. Adekola, A., & Sergi, B. S. (2007). 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(2011). Credit And Credibility: Triple-A Failure And The Subprime Mortgage Crisis. Review Of Business Research, 11(4), 1-12. Read More