Credit rating involves evaluating the risk that a company or an individual is taking with their debtor by analyzing and predicting their ability to pay the debt and in the required time or their likelihood of failure to pay. Credit rating agencies are the companies that are responsible for the evaluation and give the ratings for different companies and individuals as per their established standards. Depending on the credit scores that the individual or the company has, the agency advises the creditor whether or not lending the money is a good idea. The regulatory environment for the Chinese credit rating history differs from that of other large bond marketers such as the United States. A unique factor about the Chinese credit rating industry is that there are no Credit rating agencies within China who have unsolicited rating policy and all public bonds have just one rating. Although there is only a small number of research which has been conducted on the Chinese credit rating industry and bonds, higher yields are usually gotten from lower rated bonds though such a generalization can be hard since only a few studies have been conducted on this area. China having a different rating system as compared to other global rating agencies which have a similar rating system thus are international companies which have perfected their rating skills make the Chinese rating agencies less accurate. Therefore, China would also have more accuracy if they adopted the same rating system as other companies.
A good credit rating system is proportional to the growth of a bond market thus China and every other country around the globe needs to ensure that the credit rating system is accurate enough. Ratings from different agencies affect the economy of a country significantly since they also affect the attitude of the investors. Investors are more likely to work with a company that has a good credit rating as opposed to one without since then they are promised that they will make profits with the company. Unlike China whose credit rating industry is still developing, the US industry has a few agencies which are very reliable since they give accurate results. Issuers and investors in the United States have to pay close attention to the credit rating systems but this is not the case for Chinese agencies since they do not have the same level of reliability (Dhawan& Yu, 2015). Instead, the rating agencies in China have to fight for relevance mainly because they also do not have a conducive regulatory environment. Chinese credit rating agencies were only allowed to issue bonds since 1984 thus the agencies have been rendered powerless for long and have only started to become relevant in the recent years seeing the major role that they play in the Chinese economy. Despite the benefits that are associated with the agencies, there is still the issue of corruption since some of the agencies give more credit rating even if the company or do not deserve it. There is need to ensure that the Chinese credit rating agencies can be trusted so that they could also get to an international level which will in turn reduce the default risk and also improve the Chinese stock market.
The Chinese corporate market has come a long way and the Credit rating agencies (CRAs) have helped improve the bond market even though it is still young and immature when compared with that of developed nations such as Japan, Europe and the United States. The mature bond markets, unlike that of China are usually extremely skewed towards the top and China should aim to reach to such levels given that this will help improve its economy significantly (Dhawan & Yu, 2015). Once China reaches the same level of mature bonds as the United States or Europe, investors are also going to benefit since they will have a more reliable means of gauging where to invest and where not to invest. Credit rating agencies need to prove that they are reliable enough so that bond issuers and investors can be able to gauge which companies to give money without the fear that they will go through unnecessary losses that would have otherwise been avoided if the rating was through a more reliable credit rating agency.
According to Akdemi and Karsh, credit ratings are necessary since good credit ratings are beneficial to the debtors since they make it easier for them to borrow money from public debt marketers and financial institutions. Credit rating agencies affect many dynamics such as government and politics thus they play such an important role in the farewell of a nation and not just the debtors. Credit ratings not only affect a particular company but also the country where the company is located thus it is an important tool to use when assessing a borrower’s creditworthiness (Akdemir & Karsh, 2012). Different credit rating agencies have developed their own systems of rating corporate and sovereign borrowers and most of the systems are designed to not only consider the likelihood that an individual will pay the debt but also the severity of the loss incase there is one. This is important for the borrower since it prepares them for the loss that they will go through thus measures to deal with this can be put into place hence preventing the company from have economic challenges because the company or individual who took a loan is unable to pay it back. It is crucial that all borrowers have good credit ratings so that it can be easier for them to access loans from financial institutions since a good credit rating reflects the ability of the company or the individual to pay up the money within the agreed time.
Akdemi and Karsh point out that countries that have good credit ratings benefit significantly from them since it means that they can easily access funds from another country and this also attracts different types of investors into the country thus benefitting the country. For a country that gives a lot of loans especially to African countries such as Kenya, Ethiopia, Angola, Zambia and Cameroon amongst others which are not even African, the Chinese credit ratings are very relevant since they assure the government of the capability of these countries to repay the loans thus avoiding losses to the government (Akdemir & Karsli, 2012). Countries that have good credit ratings have also benefitted from China since this has attracted a lot of investors to their countries thus benefitting the nations. However, there are some countries which are unable to repay their debts and this means that the Chinese government will either suffer losses or look for ways through which they can be able to recover the money from them. Therefore, as discussed by Akdemi and Karsh, credit ratings are relevant and not just in China but for all the nations since they have a load of benefits especially in helping to avoid losses that might negatively affect the financial institution that lend the money or the government if it lent money to a certain country.
According to Zhou et al., the Chinese bond market has significantly grown over the past few years from almost non-existent to $5.4 trillion as of 2015 making it the third largest bond marketer globally. The research by Zhou et al., was aimed at studying determinants of bond rating and the Chinese credit rating industry and how it affects the government and borrowers. An analysis of the default risk that a financial institution is taking before giving out a loan is necessary so as to prevent losses that would have otherwise been avoided if a credit rating of borrower had been conducted thus showing their ability to pay up the loan and in the agreed time (Zhao et al., 2018). The Chinese bond market is usually controlled by the government though there are types of non-governmental public bonds. Credit ratings for companies within China were only issued by local companies and the government forbade foreign companies from giving credit ratings for the domestic companies that only operate within the country until recently.
There are several factors which determine the Chinese bond ratings. To begin with, market-based variables and accounting ratios are among the major determinants excluding financials in the sample since one cannot compare the accounting ratios for financial and non-financial firms. This is also another factor that reduces the sample size thus Zhou et al., point out the importance of conducting more research on the Chinese bond market so as to increase the data present on the issue thus making it easier to come to some conclusions. The analysis that Zhou et al., conduct on Chinese bond ratings comes to a conclusion that indeed the bond ratings are useful in that they provide important information on the default risk that a financial institution is taking with a borrower thus being able to distinguish between individuals and companies with whom it is safe to lend money and those who the financial institution is likely to experience a loss if they have a bad credit rating history (Zhou et al., 2018). It is also important that foreign investors in China realize that the Chinese credit ratings differ from other international ratings and the Chinese ratings are very coarse. Therefore, a one notch difference with the Chinese ratings in the international ratings is equal to one letter difference. However, this is not conducive for development of the bond market since the bond ratings are less informative thus making it hard to clearly see the default risks. However, the government allowed credit rating agencies from US into Chinese domestic bond in 2019 and the presence of a more established CRAs has helped better the credit rating industry significantly.
China has had problems with developing its credit rating industry since the 1980s and most of the individuals who can easily access loans are privileged state owners (SOE) that have political connections thus forcing private companies to opt for informal channels when they need a loan. The Chinese credit rating agencies are responsible for rating the financial health insurance companies, banks, stocks and domestic corporate bonds thus they are very relevant to the Chinese economy as they help financial institutions understand the risk that they are getting into when they lend certain companies or individuals money depending on the credit rating (Lopatta et al., 2019). A good credit rating means that it is safe for the financial institution to give money to a certain company since they are more likely to pay it and in the agreed time as opposed to a company that has a bad credit rating. Credit ratings are not based on how a company has been performing over the past few years but on the likelihood that they will meet certain obligations within a few years thus make enough profits that will allow them to be able to pay up the money that they had borrowed to develop their company. Therefore, Scott points out that it is not easy to establish a credit rating for a company and this requires a lot of expertise which can only be reflected through consistently being accurate in credit ratings. Therefore, credit rating agencies need to be independent from the government because politicizing CRAs makes it hard to obtain the right ratings thus individuals with a bad rating might be given a good one thus increasing the risk of a financial institution if they borrow them money. Additionally, this would mean that deserving companies and individuals who actually have a good credit rating might be denied loans to develop their companies yet they are more promising on paying up the debt than some companies. The government should only develop measures to ensure that the CRAs within the country are effective enough and not politicized since the overall goal is to provide a conducive environment for entrepreneurs to be able to develop their companies which directly benefits the economy of a nation.
The credit rating industry in China is heavily politicized thus making it hard for companies to obtain approval for issuing shares thus it is still hard for companies to obtain capital even though there are stock companies such as Shenzhen and Shanghai which are ready to help companies and have helped approximately 1400 companies to obtain capital. Credit rating agencies are very powerful especially in capitalist countries. Lower bond ratings issued by financial institutions and government mean that there is a higher probability of the issuer defaulting. Higher interest rates reflect a greater risk since it usually is a penalty to the issuers even though it aids in attracting potential buyers. Politicizing the credit rating industry has made the credit rating industry very powerful since the investment industry is forced to act in accordance with the ratings (Kennedy, 2008). Scott points out that even though the CRAs were originally a mimicry of the United States and transplantation has not been an easy process, they are beneficial to China as a country thus very relevant. However, if the agencies are less politicized, they are more promising that they are at the moment and they will have more benefits on the Chinese economy. States play a major role in constructing markets and the government ensuring that the credit rating agencies in China are effective enough is a duty thus they need to be more private.
According to Zhuang and Wu, the credit and bond industry in China has not been effective and the number of defaulted debts has been significantly increasing over the past few years. In 2014, there was a total of 1.34 billion yuan which was defaulted and the number has surged to about 122.898 billion yuan as of 2020, which is quite alarming. Additionally, the types of bond defaulters now range to state owned enterprises, central government enterprises and privately owned companies thus posing a great risk to the stability of the Chinese financial market (Zhuang & Wu, 2021). These bond defaults are an indication that the credit rating industry in China is not effective enough otherwise the financial institutions would not have such losses as they would be able to distinguish between individuals with a good credit rating and those with a bad one thus reducing the risk of default debts. Therefore, to wrestle this bond defaults and ensure that financial institutions are well aware of the risk they are taking by loaning certain companies and individuals, there is need to have a good credit rating system. This means that companies will be well evaluated thus informing the financial institution on the probability of defaults hence more stability on the capital market.
Credit rating industries are a very important sector of any country thus the need to have accurate and efficient CRAs otherwise a country could be at the risk of an economic downturn. The Chinese credit rating industry only emerged in 1988 and it has progressively improved over the past four decades hence keeping pace with the development of the bond market. When the Chinese credit rating industry first begun, it was not as effective as it is today and regardless of the various issues affecting it thus making it less efficient today, there has been a significant progress especially as of 2005 which has also benefitted the Chinese bond market. CRAs can be gauged on their expertise depending on how accurate they have been with giving companies either good or bad credit ratings (Livingstone et al., 2017). One of the major debates in China concerning the issue of CRAs is liability since some of the them have misled financial institutions to give loans to companies that do not have good credit rating thus resulting into losses that would have otherwise been avoided. The argument is to have a negligence liability on the CRAs so that they can account for the losses that they make companies go through. This will mean that they will be more careful in their evaluation so as to ensure that they do not subject the financial institutions to financial risks that would have otherwise been avoided. However, there are also arguments against fraud liabilities for CRAs. The argument is that they are predictive opinions and it is not all the time that that these opinions could be right thus the agencies should not be liable.
Some of the major legal issues facing the CRAs in China include market access, independence of CRAs, avoidance from conflicts of interest and Inflated ratings which make the agencies less efficient in their work. Independence of CRAs is especially an issue since they have been politicized thus suffer from issues such as corruption by powerful individuals in the government thus making it hard for private companies to benefit from the capital. China, unlike countries such as the United States has a very short history of CRAs thus one cannot mainly rely on reputation to identify the most efficient agencies since most of them can be said to be on the same level of success (Lopatta et al., 2019). However, China has seen an increase in competition of late since the government has allowed reputable companies from countries such as the US to evaluate domestic companies and Chinese CRAs are also growing at a very fast rate. Prior to 2019, market access for reputable international CRAs was a major challenge since the companies had to work with a Chinese CRA but this has been eliminated as a challenge thus there are now more accurate CRAs. Credit rating is very important and the Chinese government needs to work towards eliminating any challenges that might be facing the industry so as to eliminate defaulted debts and also reduce financial risks.
The number of domestically issued bonds has been dramatically increasing over the past few decades but it is unfortunate that the number of defaults has also been increasing. Chinese borrowers present the financial industry with a higher risk of defaults as compared to other countries such as the United States where the borrowers are more likely to repay their loans than the Chinese borrowers (Sheng, 2019). Therefore, there is need for the credit rating agencies in China to identify the main problem so that they could reach the same level as other credit rating agencies and avoid putting banks and other financial institutions under financial risks. When internationally recognized credit rating agencies rate Chinese companies there is a low likelihood of losses thus the Chinese CRAs need to learn from them so that they could also get chances to issue bonds in international markets which is not the case at the moment. Although China has a different rating scale with other rating companies, the CRAs in China usually rate the domestic companies at a higher rate and this could be associated with the higher rate of defaults.
When conducting research on domestic and global rating agencies Xianfeng and Packer asked various CRAs some of the factors that explained the rating differences in China. Some of the agencies mentioned that rating evaluation function was one of the factors that was responsible. The researchers adjusted the global ratings so as to abstract from the rating scale impacts so that they could fall on the same level of rating but the Chinese CROs maintained the same ranks (Jiang & Packer, 2019). The researchers concluded that the domestic rating agencies sometimes gave higher credit ratings to larger companies as opposed to small privately owned companies that were looking for capital so that they could boost their businesses to become large companies. This proved that the agencies are not independent and they are influenced by factors such as political leaders and individuals who know important government officials who have influence. However, this is not the case with global agencies and they are very independent when conducting their ratings since they do not favor any company. Such differences are some of the factors which can be associated with the high defaults in China and they would be avoided by making them independent bodies that are not influenced by certain people who have influence. The research also concluded that both global and linear ratings predict spreads with regression using non-rating related variables. However, a comparison of the global and the Chinese ratings is quite hard since the Chinese credit rating industry is still young as compared to the global one that’s mature.
The main aim of this research is to identify the challenges with the credit rating system in China and measures that can be taken for improvement. Accurate and proper credit rating is important in China since it will create a steady financial and economic government as opposed to what is happening at the moment when more than 120 billion yuan are defaulted. The credit rating industry in China is just emerging and it is crucial to appreciate the steps and progress that it has made over the past few decades even though there is still much that needs to be worked on to make it effective enough to reduce the defaulted debts. To prevent financial risks and also create a more conducive financial environment, the People’s Bank of China, ministry of finance and National development issued an interim in 2019 and although not to a very large extent, it has been improving the financial environment and helped financial institutions to avoid financial risks (Guo & Wu, 2019). The major factors that make the Chinese bond and credit rating industry ineffective as compared to that of countries such as the United States is failure to have a unified regulation and politicizing the industry thus a lot of corruption and conflicts of interest. Therefore, rectifying these flaws should be a major concern to the government and this will in turn create a more accurate credit rating industry that will help financial institutions identify companies and individuals who are worthy to be loaned thus reduce the defaulted debts.
References
Akdemir, A., & Karslı, D. (2012). An assessment of strategic importance of credit rating agencies for companies and organizations. Procedia – Social and Behavioral Sciences, 58, 1628-1639
Dhawan, R., & Yu, F. (2015). Are Credit Ratings Relevant in China’s Corporate Bond Market? The Chinese Economy, 48(3), 235-250.
Guo, X., & Wu, C. (2019). Short interest, stock returns and credit ratings. Journal of Banking & Finance, 108, 105617.
Jiang, X., & Packer, F. (2019). Credit ratings of Chinese firms by domestic and global agencies: Assessing the determinants and impact. Journal of Banking & Finance, 105, 178-193
Kennedy, S. (2008). China’s emerging credit rating industry: The official foundations of private authority. The China Quarterly, 193, 65-83.
Livingston, M., Poon, W. P., & Zhou, L. (2018). Are Chinese credit ratings relevant? A study of the Chinese bond market and credit rating industry. Journal of Banking and Finance
Lopatta, K., Tchikov, M., & Körner, F. M. (2019). The impact of market sectors and rating agencies on credit ratings: Global evidence. The Journal of Risk Finance, 20(5), 389-410.
Sheng, J. (2019). The debt ratings debate and China’s emerging credit rating industry: Regulatory issues and practices. ATHENS JOURNAL OF LAW, 5(4), 375-404.
Zhao, Z., Lin, W., & Song, F. M. (2018). Rating-based restriction, credit rating inflation and bond covenants – Evidence from Chinese bond market.
Zhuang, X., & Wu, Y. (2021). Are bond defaults with the connivance of credit rating: An analysis of China’s bond market. Open Journal of Business and Management, 09(05), 2171-2182.
write