Instructions

1. Use Times New Roman as font, and 12 as font size. 2. Use 1.5 line spacing. 3. Justify the paragraphs, i.e., blocked left and right. 4. Word count: minimum 1,000 words and maximum 3,000 words.

Case study : A Credit rating agency is a company that assesses the financial strength of companies and government entities, especially their ability to meet principal and interest payments on their debts. The rating assigned to a given debt shows an agencys level of confidence that the borrower will honor its debt obligations as agreed. Each agency uses unique letter-based scores to indicate if a debt has a low or high default risk ranking and the financial stability of its issuer. The debt issuers may be sovereign nations, local and state governments, special purpose institutions, companies, or non-profit organizations. Thus, Rating agencies 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. Large bond issuers receive ratings from one or two of the big three rating agencies. In the United States, the agencies are held responsible for losses resulting from inaccurate and false ratings. The ratings are used in structured finance transactions such as asset-backed securities, mortgage-backed securities, and collateralized debt obligations. Rating agencies focus on the type of pool underlying the security and the proposed capital structure to rate structured financial products. The issuers of the structured products pay rating agencies to not only rate them, but also to advise them on how to structure the tranches. 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. The sovereign ratings given by a rating agency shows a sovereigns ability to repay its debt. However, following the Global Financial Crisis of 2008, Credit Agencies drew criticisms for giving a high credit rating to debts that later turned out to be high-risk investments. They failed to identify risks that would have warned investors against investing in certain types of debts such as mortgage-backed securities. The credit rating industry is dominated by three big agencies, which control 95% of the rating business. The top firms include Moodys Investor Services, Standard and Poors (S&P), and Fitch Group. Moodys 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 London and controls approximately 15% of the global market. The big three agencies came under heavy criticism after the global financial crisis when institutions such as Lehman Brothers filed for bankruptcy. They were also blamed for having contributed to the collapse of the real estate market in the United States and more especially in relation to the security-backed mortgages. In a report titled Financial Crisis Inquiry Report, the big three rating agencies were accused of being the enablers of the 2008 financial meltdown. In a bid to tame the market dominance of the big three, Eurozone countries have encouraged financial firms and other companies to do their own credit assessments, instead of relying on the big three rating agencies.

Required; Using a standard report format:

Critically analyse the role played by the Credit Rating Agencies in addressing the information asymmetries inherent in the lending decision. How do the Credit Agencies contribute to the moral hazard problem faced by the lending bankers that rely on their ratings. Explain how the Credit Rating Agencies contributed to the moral hazard problem which led to the Global Financial Crises of 2007-2008. What lessons were learnt about the role of Credit Ratings Agencies in the financial crisis and what reforms were passed to avoid a repeat of the failures identified during the crisis.