Question

In view of mixed results by credit rating agencies in recent years (with both business and government entities), what measures do you think are important bench marks in assessing credit worthiness? Explain the basis for your reasoning. You may also offer your reasons why you believe credit agencies appear to have been less effective in recent years.

Answer 1

Credit rating agencies has been accused of mismanagement of their ability of rating of varrious entities and securities. I think important benchmarks in assessment of the creditworthiness are as following-

A. Analysing of various securities in their specific capacity and not try to mix the characteristic of one security with the another.

B. Analysing the nature of the security into a much larger macro perspective which will be helpful in order to analyse the security with respect to to the economy.

C. Analysing the creditworthiness of the borrower by looking at their future district earning capability rather than looking at the past performance of these borrowers because past performance does not guarantee the future repayments.

D. Ascertainment of proper inflation and interest rate for the cash flows which will be earned by various borrowers so that the proper credit worthiness of these borrowers can be assessed in a proper way.

E. Assessment of credit worthiness should also undertake factors like trends in the industry and trends in the economy so it will be helpful in order to synchronise the performance of the company with the industry.

I think credit rating agencies has been less effective because credit rating agencies also suffers due to conflict of their interest because they are paid by the entity whom they are going to review so there is a very high conflict of interest on the part of the credit rating agencies and credit rating agencies are also reliable on the information which are provided by the entity itself about its securities to credit rating agencies and these credit rating agencies are also relying upon the past performance to analyse the future repayment ability.