What is this Credit Rating business?

Tue, Jun 26. 2012

With the global financial crisis showing little sign of abating, there is more talk each day of the ‘credit rating’ of this or that country or bank being downgraded. In order to give our readers a basic understanding of what this means and why it matters, SEARCHLIGHT takes the liberty of reprinting this brief explanation from the Daily Telegraph of London.{{more}}

Why credit ratings matter

Q: What is a credit rating?

Credit ratings are scores given to countries and companies to give an indication of how likely they are to pay back their debts. The ratings are given by the big ratings agencies – Moody’s, Standard and Poor and Fitch, to help investors decide how to lend their money.

Q: How are countries rated?

Like a school report, debt issued by companies and countries is graded with letters, so a score of AAA is the highest. A rating of BB and below is considered ‘junk’ – with a much bigger risk of lenders not getting their money back. Debt rated D is in default.

Q: Why does a rating matter?

Ratings matter because they determine how cheaply countries and companies can borrow money. Investors find it more risky to lend money to organisations with low ratings, so they charge higher interest rates.

Q: How significant is a downgrade?

Companies or countries are always desperate to keep high ratings so that they can borrow money at more favourable rates and keep up their reputation for being creditworthy. However, credit rating agencies do not always get their assessments right. Some of the agencies rated the debt of Lehman Brothers, the collapsed US bank, at AAA, until days before it failed.

Q: What does a downgrade mean for the banks?

A move to downgrade the banks is likely to mean that they will find it more expensive to borrow money on the international markets. The higher cost of credit can be passed on to consumers. Banks in Europe have all been downgraded recently, adding to funding difficulties.