The changing role of sovereign credit ratings

The ongoing Eurozone crisis highlights the importance of sovereign credit ratings in determining a country’s ability to raise funds in the international capital markets. Sovereign credit ratings are published by credit rating agencies (CRAs), and the headline ratings come from the “big three” CRAs – Standard & Poors, Moody’s, and Fitch. Despite the central importance of sovereign credit ratings in the global economy, the process of determining these ratings is surprisingly subjective. As a result, central banks and regulators have criticized the role of CRAs in setting sovereign credit ratings and the effective oligopoly exercised by the big three firms. Proposals to reform the sovereign rating process range from increased regulation of CRAs on the one hand to removing their sovereign rating role altogether on the other hand. This paper examines the benefits and drawbacks of the current regime and the practical implications of changes in sovereign credit risk estimation.