Why we should beware of the use of credit rating agencies even if they are superb
Sir, by now you must know that I am one of those who have been most sceptical about the growing role that has been assigned to the credit rating agencies in channelling the financial flows of the world, which is why I commend the financial team of FT for their Failing Grades?, May 17. But, having said that let me briefly give you an example why I think we are on the wrong track even if these agencies were superbly and almost inhuman efficient in their work.
As my MBA, though not that rusty, is from 1974, pre Black-Scholes-Merton model days, I am currently trying to update it by taking the exams for a Certified Financial Advisor (CFA) in the USA, surrounded by thousands of much younger candidates. It is not easy and so that you can better understand how hard it really is, just look at the following question that appears in a CFA mock exam:
Explain whether you agree or disagree with the following statement: “The credit risk of a bond is the risk that the issuer will fail to meet its obligation to make timely payments of interest and principle”
If I had answered the above with a YES, as anyone would have intuitively done, had they not peeked in on the updates, I would have distanced myself further from my CFA certification since the right answer indicated is a “NO”, among others because the (modern) credit risk now includes a “Downgrade risk, which is the risk that an issue will be downgraded by a rating agency”
And so now, instead of having to focus on the true object of the credit risk, we must also focus on the side issue of the opinions of the credit rating agencies, and that Sir, though we might feel all cosily comforted by more knowledge, does not really seem to put the world on a wiser financial track.
I do not mind credit rating agencies but, if we are forced by financial regulators to go by their criteria, then they should be forced to be equally responsible for them. Alternatively, let them hang around, giving their First Amendment protected opinions, but do not force anyone to have to follow them.
As my MBA, though not that rusty, is from 1974, pre Black-Scholes-Merton model days, I am currently trying to update it by taking the exams for a Certified Financial Advisor (CFA) in the USA, surrounded by thousands of much younger candidates. It is not easy and so that you can better understand how hard it really is, just look at the following question that appears in a CFA mock exam:
Explain whether you agree or disagree with the following statement: “The credit risk of a bond is the risk that the issuer will fail to meet its obligation to make timely payments of interest and principle”
If I had answered the above with a YES, as anyone would have intuitively done, had they not peeked in on the updates, I would have distanced myself further from my CFA certification since the right answer indicated is a “NO”, among others because the (modern) credit risk now includes a “Downgrade risk, which is the risk that an issue will be downgraded by a rating agency”
And so now, instead of having to focus on the true object of the credit risk, we must also focus on the side issue of the opinions of the credit rating agencies, and that Sir, though we might feel all cosily comforted by more knowledge, does not really seem to put the world on a wiser financial track.
I do not mind credit rating agencies but, if we are forced by financial regulators to go by their criteria, then they should be forced to be equally responsible for them. Alternatively, let them hang around, giving their First Amendment protected opinions, but do not force anyone to have to follow them.
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