Significantly, rating agencies are firms that assesses the financial strength of governments, government entities and institutions on their ability to borrow and repay loans or alternatively their ability to meet principal and interest payments on their debts.

Today, they’ve become so important and somehow powerful because majority of investors depend on them for information to make investment decisions.

Importantly, the ratings they assign to governments, government entities or institutions demonstrate the capacity of the borrower to honour its debt obligations as agreed.

Though there are other rating agencies, the global credit rating industry is highly concentrated, with the three agencies - Moody's, Standard & Poor's, and Fitch.

Together they control nearly the entire market (95%). They also provide the much-needed service for both borrowers and lenders.

The top firms include Moody’s Investor Services, Standard and Poor’s (S&P), and Fitch Group. Moody’s and S&P are located in the United States, and they dominate 80% of the international market. Fitch is located in the United States and United Kingdom and controls approximately 15% of the global market.

Indeed, it is not surprising that the Finance Ministry is unhappy with Moody’s rating of Ghana's credit to Caa1, alternatively a junk status. One, it is based in the USA where a chunk of the global investors reside and also because the USA boast of a greater number of the world’s richest investors who are active on the capital market.

Operations of credit ratings  

Each ratings agency uses unique letter-based grades to indicate if a debt has a low, high default risk or financial stability with respect to the issuer.

Usually, the debt issuers may be sovereign nations, local and state governments, special purpose institutions, companies, or non-profit organizations.

Whilst S&P and Fitch have similar mode of assigning their ratings, Moody’s ratings differ a bit.

The credit rating agencies received lots of criticism during the global financial crisis in 2008 for failing to assign the appropriate ratings on institutions that led to collapse and subsequently the subprime mortgage crisis. Due to this they’ve become very careful and alert with their ratings.

They were slammed for failing to identify risks that would have warned investors against investing in certain types of debts such as mortgage-backed securities.

Classifications of credit ratings

Ratings are classified as investment grade and speculative grade.

Investment grade ratings indicate that the investment is considered solid by the rating agency, and the issuer is likely to honour the terms of repayment.

Credit rating agencies typically assign letter grades to indicate ratings.

For instance, S&P, has a credit rating scale ranging from AAA (excellent) to D (default), whilst Fitch uses AAA (prime or excellent) to D (default). Moody’s uses credit rating scale of Aaa to C (default).

Below is the rating scales of the rating agencies:

Moody’s	S&P	Fitch
Long-term	Long-term	Long-term
Aaa	AAA	AAA	Prime
Aa1	AA+	AA+	High grade
Aa2	AA	AA	High grade
Aa3	AA-	AA-	High grade
A1	A+	A+	Upper median grade
A2	A	A	Upper median grade
A3	A-	A-	Upper median grade
Baa1	BBB+	BBB+	Lower medium grade
Baa2	BBB	BBB	Lower medium grade
Baa3	BBB-	BBB-	Lower medium grade
Ba1	BB+	BB+	Non-investment grade  speculative
Ba2	BB	BB	Non-investment grade  speculative
Ba3	BB-	BB-	Non-investment grade  speculative
B1	B+	B+	Highly speculative
B2	B	B	Highly speculative
B3	B-	B-	High speculative
Caa1	CCC+	CCC	Substantial risk
Caa2	CC	CCC	Extremely speculative
Caa3	CC-	CCC	In default with little prospect for recovery
Ca	CC	CCC	In default with little prospect for recovery
C	C	DDD	Default
	D	DD	Default
		D	Default

Parameters of credit rating

The credit rating agencies take into consideration several factors like the financial statements, level and type of debt, lending and borrowing history, ability to repay the debt, and past debts of the entity before rating them.

Be it a sovereign or an institution that is being assessed, the key factors generally considered are

Business Analysis or Company Analysis

Economic Analysis

Financial Analysis

Management Evaluation

Geographical Analysis

Fundamental Analysis

Importance of credit rating agencies

The credit rating agencies have become a benchmark for regulation of financial markets.

Legal policies require certain institutions to hold investment graded bonds. Bonds are therefore classified to be investment graded based on their ratings by these agencies.

Credit rating agencies are so important that they provide risk measures for various entities and make it easier for financial market participants to assess and understand the credit risk of the parties involved in the investing process.

Significantly, their information indicates whether a borrower does or does not receive a loan. Good credit ratings allow people, companies, and governments to easily borrow from financial institutions or public debt markets. 

The rating agencies also assess the credit risk of specific debt securities and the borrowing entities.

In the bond market, a rating agency provides an independent evaluation of the creditworthiness of debt securities issued by governments and corporations.

Ratings are used in structured finance transactions such as asset-backed securities, mortgage-backed securities, and collateralised debt obligations. The rating agencies as a result focus on the type of pool underlying the securities and the proposed capital structure to restructured financial products.

Ultimately, rating agencies also give ratings to sovereign borrowers, who are the largest borrowers in most financial markets. Sovereign borrowers include national governments, state governments, municipalities, and other sovereign-supported institutions.