Media Home
UN Web TV
UN Audiovisual Library
UN PhotoIMF / CREDIT RATINGS
Download
There is no media available to download.
Share
STORY: IMF / CREDIT RATINGS
TRT: 3:54
SOURCE: IMF
RESTRICTIONS: NONE
LANGUAGE: ENGLISH / NATS
DATELINE: RECENT, WASHINGTON, DC / FILE
1. Wide shot, exterior IMF headquarters
2. Med shot, John Kiff working at desk
3. SOUNDBITE (English) John Kiff, Monetary and Capital Markets Department, IMF:
“Well, on balance, credit rating agencies have done quite a good job, and they’ve been doing this back to the turn of the last century, so they have a lot of experience. We have a lot of data to see that they do a pretty good job. Where they developed their poor reputation was in the context of the sub-prime crisis and their rating of mortgage-related securities. There were about 3 trillion of those issued between 2005 and 2007 that received the coveted AAA rating. And that AAA rating is supposed to mean that the security’s very, very unlikely to default, very unlikely to be downgraded from that point. In the context of, say, the Michelin Restaurant Guide, that would be the three-star restaurant. In fact, what’s happened to those three trillion securities since is that over half of them are now rated below CCC or below or they’ve been put into default. And that CCC rating would be the equivalent of not being at all in the Michelin Guide. You wouldn’t make it in there with that kind of rating.”
4. Cutaway, IMF
5. SOUNDBITE (English) John Kiff, Monetary and Capital Markets Department, IMF:
“Credit rating agencies contribute to financial instability in an inadvertent way because they’re ratings are so embedded in very mechanistic ways in various regulations and legislation and rules. So when they downgrade a security, it often triggers forced sales on the part of investors and Central Banks that use ratings to determine what collateral they can accept on their various operations. When the ratings are dropped below that threshold the liquidity can often dry up in those markets. And so inadvertently credit rating agencies and their downgrades can lead to spillovers and knock-on effects in markets.”
6. Cutaway, IMF
7. SOUNDBITE (English) John Kiff, Monetary and Capital Markets Department, IMF:
“In order to mitigate this instability the key is to reduce the mechanistic reliance of various legislation and regulations and so on on credit ratings. And, in fact, the authorities are working very vigorously towards doing just that. The challenge really is you’ve got to find a replacement for ratings. They’re so embedded in procedures, rules, and so on, including the private sector with private sector contracts and so, they’re so embedded you can’t just remove them and say now you’re all on your own, particularly for smaller investors who don’t have massive credit departments to do their own credit analysis. There’s no easy solution for them and they will probably continue to use credit ratings, which also means that we have to tighten the regulation of credit ratings to make sure that the world is safe is for everybody.”
8. Wide shot, exterior IMF headquarters
Credit ratings, which measure the relative risk that an entity such as a government or a company will fail to meet its financial commitments, play a significant role in certifying the quality of investments in fixed-income markets.
Regulators, for example, rely on ratings in setting standards for securities that financial institutions hold. Institutions must hold less capital to buffer against losses on higher-rated assets than on lower-rated ones. Central banks often rely on credit ratings to determine what securities they will accept as collateral on loans to bank or other financial institutions. Ratings play similar roles in private financial dealings when securities are posted as collateral and private financial contracts often contain ratings triggers that end credit availability or accelerate a borrower’s credit obligation if a downgrade occurs.
A new IMF analysis says that ratings have inadvertently contributed to financial instability in financial markets during the recent global crisis and more recently with regard to sovereign debt. The analysis recommends that regulators reduce their reliance on credit ratings as much as possible and increase their oversight of the agencies that assign the ratings the ratings used in regulations.
In the case of sovereign debt, the IMF said in the report released September 29, the problem does not lie entirely with the ratings themselves, but with over reliance on ratings by market participants, coupled with deleterious sell offs of securities when they abruptly downgraded, called “cliff effects.” The IMF says, however, that credit rating agencies (CRAs) have to shoulder some of the blame for these cliff effects, because they may pay insufficient attention to sovereign debt composition and contingent liabilities.
The IMF report, which is part of the main Global Financial Stability Report to be released October 5, also emphasized that despite these issues, ratings serve a useful purpose. They aggregate information about the credit quality of various types of borrowers and their financial obligations, allowing such borrowers access to global and domestic markets, and enabling them to attract investment funds. The ratings add liquidity to markets that would otherwise be highly illiquid.
Although CRAs have most recently been scrutinized because of their downgrades of sovereign debts, due to weakened government balance sheets, the IMF report noted other destabilizing knock-on and spillover effect of rating downgrades. For example, sudden sharp and frequent downgrades of structured credit products in 2007 and 2008 triggered large sell offs and dealt a crippling blow to financial markets. That caused many policymakers and market participants to question the CRAs and their methodologies.
The major CRAs, Fitch, Moody’s, and Standard & Poor’s, do not target their ratings to the specific probability that an issuer will default. Instead they seek to provide only relative rankings of credit risk that issuers in a grade are more likely to default than those in a higher grade and less likely than those below it. The IMF report finds that the CRAs do a pretty good job meeting that goal. For example, all of the sovereign debt that has defaulted since 1975 had received speculative-grade ratings one year ahead of their default. In other words the defaulting debt was concentrated in the lowest credit ratings.
The rating agencies also aim to ensure that ratings do not change frequently, because users prefer to avoid the costs associated with frequent policy changes and investment decisions linked to ratings. The CRAs minimize ratings changes by judging an entity’s ability to survive a cyclical economic trough (that is, “through the cycle”) and by applying various rating change smoothing rules.
But the IMF report says that smoothing techniques instead often have an opposite effect from what was intended. Typical smoothing rules sometimes merely delay inevitable downgrades that become more abrupt and cliff-like if the situation has continued to deteriorate.
