Ratings Agencies - background info

September 2017

Financial markets are incredibly complicated.  Although it`s one of the later topics studied on the A` level specification, it`s well worth familiarising yourself with any specialist terminology as soon as you can.

At the weekend credit rating agency Moodys downgraded Britain`s credit rating from the highest rating Aa1 to Aa2. The Credit ratings agency is a relatively new animal on the economic landscape and increasingly influential. Their main function is to provide advice to financial investors such as banks, insurance companies and private equity companiesabout where to put their money. They fulfil a similar function to online companies like Trip Adviser or Go Compare who provide information to customers about holidays or insurance. The 3 main agencies are Moodys, Fitch and Standard and Poor.

Financial investors base their decisions on 2 factors, risk and return. Governments borrow mainly by issuing bonds which are long term securities carrying a fixed rate of interest. For example a 10 year bond of £10,000 issued by the government at 2.5% annual interest will yield £250 interest to the lender annually for the next 10 years.  Importantly the credit rating assesses the risk. When a government bond or other financial asset is given a lower credit rating, it means they are higher risk. Lenders therefore will expect a higher return and this generally puts upward pressure on interest rates.  

The lowest risk rating is Aa1 (also rated as “triple A”), while the highest risk bonds are classified as C or D. In 2010 following the financial crisis and crisis in the Eurozone, Greece`s budget deficit stood at an unsustainable 15% of GDP. Greek bonds were classified by the ratings agencies as,” junk” status. In other words any money lent to the Greek government would probably not be paid back.

In downgrading UK bonds, Moodys justify it by the uncertainty caused by Brexit and the likelihood of higher levels of public sector spending. Should the government be worried? At the start of the year Moodys was fined $864m for providing bad advice in the run up to the 2008 financial crisis. In fact all 3 of the agencies were giving AAA ratings to mortgage products, which really did turn out to be junk and precipitated the crisis!

 So perhaps we shouldn`t be too worried, after all Britain is one of the 10th largest economies in the world and the government hasn`t defaulted on its debt since 1932 during the Great Depression. However politically it is a bit of a kick in the teeth for a conservative government which prides itself in sound financial management. 

For more on this do check the BBC website: http://www.bbc.co.uk/news/busi...