The Credit Rating Agencies and Their Role in the Financial System

Abstract

Despite extensive criticism, the major credit rating agencies (CRAs) – Moody’s, Standard & Poor’s, and Fitch – remain as central entities in the financial markets of the U.S. and Europe, especially with respect to bonds and similar financial instruments. This chapter provides a discussion of the role that the CRAs continue to play in the financial system and how and why they play that role. After a brief overview of the CRAs as providers of information that lessens the problems of asymmetric information in lending/borrowing markets, the chapter discusses the expanded use of the CRAs’ ratings in the prudential regulation of financial institutions and the problems that contributed to the financial crisis of 2008. The chapter concludes with a discussion of the likely direction of the CRAs and their regulation.

Keywords: credit rating agency (CRA), nationally recognized statistical rating organization (NRSRO), asymmetric information, creditworthiness, bond markets, financial regulation, Moody’s, Standard & Poor’s, Fitch, prudential regulation

JEL Classification: G24, G28