Centre for Economic Policy Research

4.3
Beneficiaries of an effective rating mechanism
Credit-rating agencies have always been viewed as an important instrument in the
hands of investors to help guide their investment decisions. Ratings have also
long been used as a means for wealth owners to constrain the actions of fiduciary
agents (e.g., trustees). High quality borrowers are, however, also potential benefi-
ciaries of a well-functioning credit-rating process. In the presence of asymmetric
information, high quality borrowers will find it difficult to ‘certify’ the quality of
their liabilities, and will thus have to pay a premium to lenders to compensate for
their uncertainty about the quality of an issue. The existence of credible 
independent credit assessment permits the quality of an issue to be certified more
easily than by any other means, securing access to funding on better terms than
would be possible in the absence of credit-rating agencies. 
It might seem that issuers of debt of below average quality would have less
interest in ratings. Once the quality of above-average debt has been certified, 
however, investors will revise down their estimate of the average quality of 
non-certified debt.
38
Those issuers whose debt quality is above the average of this
remaining debt would then have an interest in being rated. By this process, all
except the lowest quality of debt issuers will have an interest in a credible 
certification mechanism. 
More recently, regulators too have come to place increased reliance on credit
ratings as part of their ongoing supervision of financial intermediaries. Regulators
want to monitor risk-taking by financial intermediaries to ensure that risks are
properly managed, disclosed and priced, as well as supported by sufficient capital
to protect certain classes of claims holders, including depositors and policy-
holders. Ratings have the advantage of being a readily available and independent
source of assessment of credit risk. They thus avoid the substantial resource costs
that would be involved in a regulatory agency undertaking its own credit 
assessment, to say nothing of the need regulators would then face to justify their
judgements.
All of these potential benefits depend on ratings providing the financial 
market-place with information that is additional and credible. If rating agencies
merely duplicated information that was available elsewhere; or if their 
Rating Agencies: Conflicts of Interest in Credit Assessment and Consulting 43

---

assessments were biased; or if the reliance placed on such assessments were due
mainly to a special status conferred by regulation, then their economic function
would be open to question.