LIMITATIONS OF CREDIT RATING
1) Rating Changes – Ratings given to instruments can change over a period of time. They have to be kept under rating watch. Downgrading of an instrument may not be timely enough to keep investors educated over such matters.
2) Industry Specific rather than Company Specific – Downgrades are linked to industry rather than company performance. Agencies give importance to macro aspects and not to micro ones and over-react to existing conditions which come from optimistic/pessimistic views arising out of up/down turns.
3) Cost Benefit Analysis – Rating being mandatory, it becomes a must for entities rather than carrying out Cost Benefit Analysis. Rating should be left optional and the corporate should be free to decide that in the event of self rating, nothing has been left out.
4) Conflict of Interest – The rating agency collects fees from the entity it rates leading to a conflict of interest. Rating market being competitive there is a distant possibility of such conflict entering into the rating system.
5) Corporate Governance Issues – Special attention is paid to
a) Rating agencies getting more of its revenues from a single service or group.
b) Rating agencies enjoying a dominant market position engaging in aggressive competitive practices by refusing to rate a collateralized/securitized instrument or compelling an issuer to pay for services rendered.
c) Greater transparency in the rating process viz. in the disclosure of assumptions leading to a specific public rating.
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