Question

in your own words write about “credit rating agencies and the financial crisis” and support it with real life example from any financial market or institution

Answer 1

Credit rating agencies are private institutions that assign rating or a grade to financial instruments issued by companies which tell of the repayment probability and indicate the financial health of the entity. The agencies usually rate in alphabets with A regarded as high safety i.e. the repayment of the debt is assured and with D being the sign of default. Lenders, financial institutions and investors rely on the ratings issued by the agencies to make their lending and investment decisions to be assured of their money. However, these agencies issue ratings based on a gamut of factors such as financial results of the company, promoters background and expertise, economic conditions, past and present repayment history among others. The authenticity of the ratings is crucial since they are not regulated by the government and hence can be misleading. One of the major reasons for the financial crisis in 2008 was due to the inaccurate ratings issued by the agencies wherein subprime debts were given higher ratings and eventually the companies defaulted.