We often hear about rating agencies in global finance: what are they and what do these institutions do that is so important?
Rating agencies are key players in the global economic and financial scene. Knowing what they do and how they operate is essential, especially to orient oneself in the choice of investments.
The judgments of these agencies are able to influence stock exchanges and financial markets, as well as offering a picture of the credit stability of companies and states. The most famous, feared and anticipated pronouncements of these companies concern, in fact, the ability of individual countries to repay their credit. When an agency must publish the evaluation (the rating, precisely) and the future prospect of state solvency (the outlook), governments and markets are on maximum alert.
For example, Italy ended 2024 with these judgments from the three main global agencies on its ability to repay debts: Moody’s rating Baa3 with a stable outlook; S&P rating BBB with a stable outlook; Fitch rating BBB with a positive outlook; Dbrs Morningstar rating BBB and a positive outlook.
But what do these acronyms and ratings mean specifically? They are nothing more than the result of the analysis activity of rating agencies on the sustainability of a State’s debt, on which its reliability from the perspective of investors depends.
To learn more about the role played by rating agencies in global finance, below is a guide on what they are and how they work.
What are rating agencies?
A rating agency means:
an independent body that assesses the repayment capacity and reliability of financial issuers, such as companies or governments, and their financial instruments, such as bonds or stocks.
The main objective of this institution, in essence, is to provide an impartial and objective assessment of the solvency of an entity, based on detailed financial analyses and statistical models.
This evaluation is the result of detailed financial analysis and the study of statistical models, with the ultimate goal of providing an objective and impartial judgment on the credit of the issuer or the security in question.
The outcome of this evaluation is translated into the so-called “rating”, an alphanumeric score that represents the issuer’s ability to honor its commitments within the established timeframes. In practice, these agencies try to understand what the value of a government bond or bank is.
What do rating agencies do
Rating agencies operate through a rigorous and well-defined process.
To establish their judgment, analysts from rating agencies collect the financial data and operations of a state or company, analyzing key indicators such as income, debt, cash flows and other relevant factors.
This information is then compared with the evaluation criteria established by the agency, which may vary depending on the sector or type of entity being rated.
This assessment determines the “credit capacity” which is then classified on a standardized evaluation scale, namely the rating.
Types of ratings
Rating agencies offer different types of ratings depending on the entity being analyzed. Among the most common are credit ratings, which evaluate the financial solvency of a company, and sovereign ratings, which evaluate the ability of a government to honor its financial commitments.
How the rating is issued
The rating issued by an agency is usually expressed through a combination of letters and symbols, or in some cases, through a numerical scale.
For example, a AAA rating represents the highest degree of reliability, while a rating of C or lower indicates a critical financial situation.
Securities that have a very low rating are also called "junk bonds" (junk bonds), since they have no value whatsoever.
Rating agency rating scales
Each rating agency has its own rating scales, which indicate the quality of the credit rated. However, there are some similarities between the scales of the different agencies, allowing a relative comparison between the ratings issued by different entities.
| Rating | Meaning |
|---|---|
| AAA | Excellent quality of the entity, maximum stability and reliability |
| AA | Stable entity, but potentially exposed (can do more, but does not commit) |
| A | Entity whose financial capacity is in adverse economic conditions |
| BBB | Entity whose finances are temporarily satisfactory |
| B | Entity with variable economic situation |
| CCC | Entity with vulnerable finances |
| CC | Entity with Highly Vulnerable Finances |
| C | Entity that has filed for bankruptcy |
| RD | The entity does not pay some commitments, but continues to pay other obligations |
| D | The entity is in a state of bankruptcy, therefore, it is insolvent |
Rating Agencies: Why Are They Important?
Rating agencies provide financial market participants with essential information for making investment decisions.
Investors, for example, use the agencies’ assessments to assess the risk associated with a potential investment.
The judgment of the rating agencies is followed closely especially by the States, because the publication of the assessment says a lot about the financial state of the country, the credibility of the government’s economic policies, and the ability to develop and prosper.
The rating also determines the performance of the stock market and government bonds; any investor before buying a bond (which is like a credit, which the investor buys) needs an accurate analysis of the economic, financial and equity stability conditions of the entity whose securities he is buying.
Rating agencies essentially set out to do this: analyze, study and evaluate the financial conditions of an entity and provide investors with a tool to weigh their investment choices and understand when an investment is safe.
What are the most famous rating agencies?
The most well-known rating agencies are three and all have their main headquarters in New York:
- Standard & Poor’s
- Moody’s
- Fitch
These agencies enjoy a consolidated reputation in the financial sector and their ratings significantly influence international markets.
Moody’s Corporation began its operations around 1900, when John Moody and his associates published “Moody’s Manual of Industrial and Miscellaneous Securities”, which contained basic information on a wide range of securities. Today, Moody’s Investor Service not only provides information, but also research reports, risk analysis and credit ratings for over 106,000 structured finance obligations.
Fitch Ratings was founded by John Knowls Fitch in 1913, when he used to publish statistical analyses in his “The Fitch Stock and Bond Manual”. In 1924, Fitch Publishing Company pioneered the AAA to D rating scale, which is still in use today. Today, Fitch Ratings provides services from its two offices in New York and London, as well as offices around the world.
Standard & Poor’s was formed in 1941 by the merger of Standard Statistics with Henry Varnum Poor, publisher of the “History of the Railroads and Canals of the United States,” one of the first attempts to uncover the financial background of U.S. railroads. Today, S&P is not only known for issuing its ratings, but is also highly regarded for its market indices, such as the S&P 500 and the S&P Case-Shiller home price index.
Other notable rating agencies include RDBS Morningstar, Dagong Global Credit Rating (China), and Scope Ratings (German and the only European one).
Original article published on Money.it Italy. Original title: Cosa sono le agenzie di rating e cosa fanno
