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CREDIT RATINGS: Methodology and Reality

Monday 22, 05 2017
The article refers to the Credit Rating; Rating Methodologies and the ways that Credit Rating Agencies make their own money. The article also mentions Vietnam Banks Reports 2009 prepared by VietnamCredit, their current development and future's plan
CREDIT RATINGS: Methodology and Reality

The term Credit ratings is formed by two words - “credit” and “ratings”, which makes it much more confusing for Vietnamese people to understand. “Credit” is understood as “Tin nhiem” and “Tin dung” in Vietnamese. 

Whereas the former meaning refers to the quality that somebody/something has that makes people believe them, the latter one is, in narrower scale, about the status of being trusted to pay back money to the person who lends it. Therefore, Credit ratings is “Danh gia tin nhiem” if broadly understood and “Xep hang tin dung” in a narrower sense.

Methodology and Source of income of CRAs

Different perspectives lead to different descriptions of the operations of CRAs. In general, however, most of Credit Rating Agencies operate under either business model: Subscription model (non-consultative ratings) and Issuer-pays model (consultative ratings).

“Subscription model” means that the agency will conduct research and “pass their own opinions” independently and objectively without the consultancy of any rated subjects. The products will be furnished to investors, distributors, governments or anyone who may concern for their reference while making decisions. This model is normally adapted by small agencies as their opinions are not prestigious enough to have great impacts on the large scale.

On the contrary, the Issuer-pays model (consultative ratings) is conducted on demands of the rated subjects. It is the loan/security issuers that will pay for the credit ratings of their loans. Therefore, no matter how objective it is, there may exist conflict of interest as the agency is paid by the issuers for the credit ratings.

Critics argue that the issuer-pays model creates a potential conflict of interest because the agencies are paid by the organizations whose debt they rate. It is the conflict of interest that has led to the erroneous ratings by the “Bigs”, causing financial crisis or collapse of many economies so far.

Will “children” or “adults” be in charge of credit ratings?

Credit ratings calls for not only great insights but also objectivity. The ways of thinking of a child and an adult can be used as a metaphor for this. A child can give honest and sincere comments. However, honesty and sincerity are not enough for “thoughtful opinion” as visions and insights in national policies, development of the industry and businesses are also needed.

Nevertheless, human beings are egoistic, and easily affected by money. Therefore, “a child’s opinion” will be underestimated with such question as “What do you know?”. Yet with skills and knowledge, an adult will be doubted about their motivation and purposes. In general, the older and the more knowledgable one gets, the more easily they are affected, leading to biased results.

There have been erroneous credit ratings by the Big Three, Lehman Brothers’ case for example. This company had been rated A just couple days before it filed bankruptcy. With extremely erroneous ratings, the Big Three made global investors feel they were in safety zone right before the market melted.

However, the subscription model is also seen to have disadvantages, as it restricts the ratings' availability to paying investors. Issuer-pays CRAs have argued that subscription-models can also be subject to conflicts of interest due to pressures from investors with strong preferences on product ratings. This will result in the fact that the agencies will not have enough money to prosper.

Business model and ratings of VietnamCredit

It should be the investors, instead of the issuers, that have to pay the CRAs for credit rating result.

In another aspect, credit ratings is for future purposes, therefore, time is essentially needed for careful information selection. Time will decide the efficiency of credit rating acitvities, which explains why most of major CRAs are more than 100 years old.

Like what John Moody, who pioneered the rating of bonds, did to establish his carreer, it can be seen that CRAs have to endure challenges for trustworthiness. In 1909, Moody released Moody's Manual of Railroads and Corporation Securities. 20 years later, none of the securities which were highly-rated by him suffered from significant fall. Investors then placed their trust on Moody and were willing to spend money on his analysis.

Similarly, in 2009, VietnamCredit released for the first time a bank ratings report and met with negative reactions from some banks. It has been 8 years and most of low-rated banks have become zero-dong banks, been merged or performed badly. 

In fact, it remains to be seen whether prestige of a CRA is gained. Despite being a young and small company, VietnamCredit always conceives that time alone will tell – Enduring Challenges For Trustworthy Insights.
VietnamCredit always bears in mind that challenges come just to make things better. VietnamCreidit will integritously and devotingly continue its job of delivering the most objective and honest ratings possible.

Written by: Quyet Le – Vietnam Credit 

Categories:
Financial News

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