Credit Rating Agency is an organization which specialises in the task of alloting a credit rating to companies, governments and non-profit organizations who issue debt instruments. Sometimes the rating is given to the instrument itself. The rating is based on the creditworthiness of the issuer and this rating will have an impact on the price or interest rate of that particular debt instrument or security. Credit bureaus differ from credit rating agencies, as the former only provides a credit report and credit rating on an individual from the data which is reported to it.
A credit agency rating is very useful to investors as it gives them a basis to form a decision on investing among different options available. As the rating is independent it gives the investor a measuring tool to gauge the credit risk involved in an investment. The credit agency rating can also boost the confidence of the investors in a falling market and revive the economy. An increased confidence tends to lower the cost for both the lenders and borrowers, and increases the availability of risk capital in a market, which can form the main factor behind sustainable growth. Credit agency rating also gives a chance to companies who are just starting to find a good investor base and also for certain universities, hospitals and small governments to have a share of the capital market.
Although there are many advantages, still many people have questioned the efficacy of a credit agency rating, particularly after the present financial crisis. There is a general opinion that many of these agencies cannot give an impartial ratings as they have vested interests and due to the conflict of interests the rating always suffers. One classic example is the sub-prime crisis, where it was felt that certain credit rating agencies had colluded with lenders of sub-prime mortgage and given excellent ratings which were not actually deserved. Basically the credit rating agencies did not warn the public of certain malpractices and there was no unprejudiced assessment of the debt instruments.
Another glaring example is the case of Enron which was given an investment grade rating by Standard & Poor's and Moody's the two best credit rating agencies. Just three days after the rating was awarded, Enron went bankrupt.
These debacles and unfair practises have eroded the confidence of many investors in credit agency ratings and this has caused much damage in the market. Investing and capital markets can suffer a huge blow if steps are not taken to restore the confidence of the public in Credit Rating Agencies.