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A Historical Primer on the Business of Credit Ratings

Further, in Canada, asset default factors for preferred shares, where rated, are based on the rating agency grade. For financial leases where rated, and the lease is also secured by the general credit of the lessee, the asset default factor is based on the rating agency grade. Other examples of the use of credit ratings in LRSPs governing capital requirements are found in Japan, where credit ratings issued by DRAs are used to calculate the solvency margin ratios regarding estimating credit risks for insurance companies, 19 and Australia, where prudential standards for both general insurers and life insurers use credit. | A Historical Primer on the Business of Credit Ratings Richard Sylla Department of Economics Stern School of Business 44 W. 4th St. New York NY 10012 212 998-0869 rsylla@stern.nyu.edu Prepared for conference on The Role of Credit Reporting Systems in the International Economy The World Bank Washington DC March 1-2 2001. 1 A Historical Primer on the Business of Credit Ratings Richard Sylla NYU When the business of bond credit ratings by independent rating agencies began in the United States early in the twentieth century bond markets and capital markets generally had already existed for at least three centuries. Moreover for at least two centuries these old capital markets were to an extent even global. That in itself indicates that agency credit ratings are hardly an integral part of capital market history. It also raises several questions. Why did credit rating agencies first appear when 1909 and where the United States they did in history What has been the experience of capital market participants with agency credit ratings since they did appear And what roles do agency ratings now play in those markets which in recent decades have again become global to an even greater extent than previously in history. This essay explores the historical origins of agency bond ratings and the experience the capital markets have had with them in the twentieth century. The latter is pretty much a U.S. story until the 1970s when the modern globalization of capital markets initiated a rerun of the U.S. story on a worldwide scale. Issues to be addressed include in part 1 how and why the capital markets were able to function without agency bond ratings for so much their history and why the agency rating business arose when it did. Part 2 examines the U.S. experience with agency ratings from their inception early in the century to the 1970s with reference to the markets for both corporate and state and local governmental debt. Part 3 discusses the globalization of the agency bond rating