Rating Agencies and Commercial Banks

Rating Agencies and Commercial Banks

Different players have joined the financial market sector to fill the deficit that exists in the supply of financial services. Different financial services providers all over the world have joined the market to suffice the demand. This review takes into account the market players and specifically the commercial banks. The performance of commercial banks is evaluated according to the ratings given by the rating agencies. A comparison is given on the various services provided by commercial banks in specific states and that of the general market.

General Review

In the year 1990 to 2000, security markets were noted to be an essential external funding source for emerging markets. The emerging markets consider the security market as the major driver in the financial sector performance. Attention has been given to the security market by various financial services providers in a bid to achieve their objectives. Capital flows in terms of composition and scale are vital determinants in the performance of financial sector in the emerging markets. The various agencies of credit rating such as the Moody’s Investors Service and Standards and Poor’s (S&P) have a significant impact on the performance of markets. They influence the willingness of investors to invest in the various financial instruments that exists (Augustine, 2012).

There have been adjustments in the credit ratings termed as severe in the economies of most of the emerging markets. The financial crisis in Asia during year 1997 to 1998 caused a stir in the process of credit rating. The usefulness of credit rating was laid to doubt. There was an improvement in credit ratings at the beginning of 1990s and the collapsing of markets during the Asian financial crisis. This caused a global cyclical capital flows due to the presence of accelerated capital flows period and reduced ratings on the capital flows. The investor’s confidence in the market is high on the credit ratings in the financial sector. The ratings are indicators of the performance of the financial sector. High ratings imply better performance of the financial institution and the investor will have confidence in this kind of market. Developed markets are rated high and investors flock the markets in these economies (A, 2007). The scenario is different in the developing economies that have to struggle with the odds of financial crisis.

In these economies, the policymakers in the financial sector develop strategies and policies to curb these odds. The implementation of these policies determines the performance of a given market (Abdelaziz & Lateef, 2010). The agencies involved in are essential in the performance of the international markets both in the developed and the developing markets. The credit rating agencies provide information regarding the performance of markets. There exists asymmetric information in the financial market sector. Investors lack sufficient information necessary to make a judgment regarding the market to exploit. The credit rating agencies, thus, grant information that provides a platform for decision making by the investors. The investors have information at their disposal regarding the riskiness of various financial securities. This information aids in the decision-making regarding the financial investment to exploit (Abdelkader & Neila, 2009). Investors in the international arena prefer to engage in markets where they have certainty of performance. The ratings, thus, provide a consolidated confidence regarding the kind of investment to make. The same assessment is done on the commercial banks both in the developed and the developing markets. Commercial banks are financial service providers and therefore, operate in the financial sector. In this regard, they provide services extending to financial instruments. The ratings on commercial banks consequently indicate the performance of the given institution. Investors will use this information as the basis of decision making. Assessments in terms of risk are also a critical factor in the decision making process (Abdul-Rashid & Ahmed-Usman, 2010).

Credit rating agency is one of the rating agencies that exist in the financial sector. They provide vital information regarding the creditworthiness. Evaluation of risks and returns that are likely to arise from given investments is also provided. The information given regards default probabilities and issues pertinent to hedging and pricing of risky securities with fixed income. The choice as to the investment decision lies barely on the investor (Abul, 2009). The judgment given by the credit rating agencies is broadly used due to its wide dissemination. The prospective investors get a wide range of information and can make a decision on which market to engage globally.

The ratings on commercial banks provide a basis for accessing credit internationally. Commercial banks trades with other financial agencies and in most cases are used as economic drivers in the various economies (Pham & Walter, 2011). To access credit from the international arena, ratings form an essential base. In the year, 1970 to 1980 commercial banks were used as the channel of international financing. This is because commercial banks were in able assess and evaluate creditworthiness of the borrowers. The assessment ensures that the commercial banks undertake to perform riskless activities. The transactions carried out by the commercial banks ensured that they do not engage with risky investors. This ensured their continued survival in the market. The existence of commercial banks poses a threat to the functionality of the credit rating agencies. This is possible due to the relationship developed between the commercial banks and their clients (Alexa, 2007). The operations of the commercial banks in evaluating the creditworthiness of their clients led to the emergence of the credit rating agencies. Rating is an essential factor in the evaluation and assessment of performance by the various financial institutions including the commercial banks (Alhasan & Ibrahim, 2001).

There is an emerging trend in the convergence of credit ratings in both the developed and emerging economies. This has been termed as financial markets seismic shift. Economies with emerging markets have been rated to possess dismal performance lower than the investment grade. Developed economies, on the other hand, enjoy high ratings on the investment grade. The economic downturn caused by the financial crisis has changed the perspective of risky and safe assets in investment (Alha, Suzanne, Christine, & Lorna). The investors in the international arena are attracted by valuable bonds in the emerging markets. This has been fueled by the increasing returns and the improving creditworthiness of financial instruments in these markets as compared to the developed markets. The improving value of financial assets and instruments creates an opportunity for new investors in the international arena. There existed a large gap in the average ratings between the emerging and the rich economies. According to Bart Oosterveld of Moody’s, significant convergence ratings are in progress. This is due to the observed, continued downgrading of the developed economies. The emerging economies have continuously being upgraded. This serves to change the trend in the preference of investment destinations by the foreign investors. According to Moody’s, developed economies like the United States and the United Kingdom risk downgrading. Developed economies with emerging markets like China, Turkey, and Brazil are continuously being upgraded. The changing trend in ratings poses eminent danger to the developed economies, and they risk being overtaken by the emerging economies if the trend continues (Ana & Helena, 2012).

Marie Cavanaugh of Standards and Poor’s and who also sits in the Sovereign Ratings Committee expects upgrading of emerging markets to continue. This is specifically the case in the emerging markets of the growing economies. The positive trends observed in the current economies never existed  a decade ago. Countries that are highly rated, but face fiscal challenges, run a risk of downgrading. Strategists and fund managers are of late learning of the risks that persist in the markets that have been assumed to be risk free (Andreas, 2007). The developed world, in this sense, has been assumed to possess the risk free market, which is contrary to the reality. Investors realize the fact that the developed world possesses a lot of risk within their markets. The ratings given by the rating agencies are enlightening the investors to perform in various markets.

In the year 2007 to 2009, there was a massive financial crisis globally. The debt crisis in the Euro zone was also prevalent, and the financial institutions were highly exposed to risk. The big institutions in the developed economies suffered excessive risks. These risks were not exposed to the public and even the regulators were never made aware (Andrew, 2009). The downfall of these large financial institutions triggered the fall in the financial system globally. Financial institutions all over the world suffered massive losses in their welfare. This led to the development of regulatory reforms in the financial markets in most economies globally. United States established the Dodd-Frank Act to shield the financial system from collapsing. The performance of financial institutions depends on the behavior of risk taking with the quest to maximize profits. Therefore, the reforms undertaken should not negatively constrain the behavior of risk taking. Constraining this behavior may lead to dismal performance of these financial institutions. The banking sector is vital in the performance of economic growth in any given country (Andrew, 2010). In this sense, these institutions are essential in ensuring effective performance of the economy. Most of the large financial institutions have undergone several reforms, including privatization with the objective of becoming competitively fit (Andy, 2007).

There has been worldwide instability in the financial sector as a result of the currency crises. The 2001 currency crisis in Turkey triggered the policymakers and strategists to develop and implement policies that shield financial crisis (B, 2010). The changes in the bond and stock market have also impacted the performance of global financial institutions. The ratings provided by the rating agencies may affect the prices. The changes in ratings in terms of downgrading and upgrading affect the pool of investors. The changes in the ratings communicate certain information regarding a given economy. The information indicates whether a country is performing well or has a dismal performance (Jones & Tsutsumi, 2009). Countries will be triggered to develop strategies that will help absorb the shock in the financial crisis as indicated by the ratings. The ratings have significant effects on the performance of financial instruments and thus an aspect that governments should consider (Reisen, 2003).

The banking sector is a vital economic driver. The performance of this sector is critical for the overall performance of the economy. The developed economies have laid much emphasis in safeguarding this sector. They have developed models to assist in reviving their economies and ensuring that they perform according to their expectations. A well-known Basel Committee was established by the developed economies to assist in monitoring the performance of the banking institutions. The emergence of the Basel Committee was after the Herstatt bank in Cologne was liquidated in year 1974. Harmonization of the banking standards was considered necessary and hence the formation of the council. The Basel 1 strategy ensured harmonized standards both in the financial and in the capital markets. These considerations were only made within and between the member states. The performance of the banking sector in less developed economies was never considered in this strategy (Ailola, 1998).

With the emergence of financial crisis of 1990, the Basel Committee decided to come up with a more comprehensive strategy to cover the financial sector. The criticisms leveled against the Basel 1 strategy led to the development of Basel II. Basel I only covered the ten member states and was, thus, seen to be less inclusive. The Basel II was an improvement to the Basel I to cover a wider scope. The incorporation of regulation and surveillance in the market based operations were one of the vital factors addressed in the Basel II. All these strategies set aims to curb risk in the financial market both within the member countries and in the international arena. This is due to the fact that the performance of financial institution in one economy affects other economies. The latest global financial crisis had its route from the western countries, but it spread into the international arena.

Specific literature

Having expounded the mind into the performance of financial institution in the international arena, we now constrain ourselves to specific regions. The impacts by the various rating agencies have been analyzed in the international markets. The ratings have a significant impact on the performance of the financial institutions, including commercial banks globally. The global financial crises that have occurred have resulted in severe implications on the banking sector all over the world. Banking sector is a key driver of the economy and, thus, measures should be taken to safeguard the sector (Asante-Odame & D, 1990). The ratings given by the various rating agencies gives and insight on the performance of the various financial institutions including the commercial banks. These ratings serve as the platform for developing measures and strategies to curb the crisis in this sector. This section on specific literature analyzes the performance of financial institutions in the banking sector for specific regions. The analysis is done in line with the rating agencies findings (Nyong, 1989).

Middle East

The rating agencies findings have a considerable effect on the performance of Middle East financial institutions. Certain issues increased risk of emerging markets over the past years. Middle East being concentrated with the emerging markets is working to avoid these issues. According to the executives in the corporate institutions and the policymakers, the rating gap between the economies in the Middle East and that of the developed economies is large. The indebtedness to the west countries gives the relatively sharp contrast between the Middle East countries and the developed economies. Philippines are considered to be at par with Spain in terms of accessing funds. However, according to Moody’s and the Standards & Poor’s, the Asian country rates below Spain. The two rating agencies have placed the Philippines despite having the same capability as a country from the West. The ratings of these economies highly influence the banking sector performance in these regions. Since the ratings serve as the basis for acquiring loans, commercial banks in the Middle East economies fall at a relatively lower creditworthiness, compared to their West counterparts. The investors agree that according to the performance of the Philippines and the guidelines given by Moody’s, the country should be rated three notches higher. Their bond yields and effort to safeguard the commercial banks from bankruptcy should imply higher rating according to the rating model by Moody’s on the market performance (Seetanah & Seeboruth, 2011).

Investors and bankers in the Middle East claim that there is a bias in the credit rating. The developed economies are favored when it comes to the ratings at the expense of emerging markets. According to bankers in Asia, the rating agencies in the West seem not to understand this fact and they end up giving faulty findings on the ratings. The executives of the rating agencies have a contrary opinion. They portend that Government Debt to Gross Domestic Product ratio is not always the best indicator in the evaluation of the creditworthiness of a given sector (Marcellina & Robert, 2005).

The financial sector in Middle East is growing at a high rate in the banking sector. The rating of this financial sector is compared to the growth of other financial services providers in this industry all over the world. The sector is, however, undergoing rapid reforms and transformations. The structuring of banks in this region enables the institutions to be profitable and possess efficient operations as compared to banking in other regions. There is an increased number of banks in the public sector in this region, and they cover the largest market compared to other banks. There is government intervention in the operations of these banks in regard to liquidity and credit issues (Glen, 2011). There is a high concentration of financial institutions in the Middle East. The number of banks in this region is high and serves a low number of people. The population has the opportunity to make the judgment regarding the financial institution in which to make viable investments. The population in South Africa is approximately 54 million, and it is served by the presence of five banking institutions that are regarded to be major. In the United Arab Emirates, however, the number of banking institutions is approximated to be thirty, serving a population of around 5.3 million citizens. There exists a vast difference between these states in the banking sector.

The growth in the banking sector is attributable to the demand for the expansion project in the infrastructure sector and the interest rates in the region that are considered to be generally low. This results in higher income in the net interest and, hence, better performance of the banking sector. The main drivers in transforming services in the banking sector are considered to be the educated young population in the Middle East. This population has vast knowledge regarding the products and services offered by the commercial banks. In comparison to the whole world, Middle East offers the largest market for Islamic banking (Yellen, 2008). Technology is also another driver for the performance of the Middle East banking sector. The banks in this region have concentrated fully on the infrastructural development and the use of technology in their operations. The efficiency and effectiveness of these banking institutions is improved as it can serve a larger number of population when using technology (Perko & Bobek, 2008).

More other factors affect the performance of commercial banks within the Middle East economies. This is attributed to the fact that there is a competitive environment in the banking sector. The low government intervention and regulations that assist in the monitoring of financial institutions improve efficiency in the banking sector. The young generation that is educated and demanding the services of financial institutions increases the concentration of banks in this region. The Middle East region has competitive advantage that enables it to improve financial sector performance. States like Qatar and the United Arab Emirates possess the opportunity for future expansion (Wu & Chen, 2010).

From 1990 various structural changes in the banking sector have affected operations in the banking industry. The increased globalization and technological advancement enhances effective delivery of services by commercial banks. These aspects increase competition in the banking sector worldwide. The banking institutions that do not develop strategies to cope with competition face the risk of collapsing.

Economic indicator is another factor that influences the performance of commercial banks in the Middle East. When there are favorable economic conditions within the states, the performance of the commercial banks is noted to be favorable. The recent financial crisis in the world hit the performance of commercial banks. The commercial banks in the United Arab Emirates incurred losses in their performance. The risk that is posed by the country also influences the performance of the commercial banks. The risk posed by the country may be in terms of political stability. The stability in terms of governance is critical for the performance of any given financial institution. The presence of political stability in the state is an indicator of positive performance by the commercial banks. These factors are critical for the performance of financial institution in the Middle East. The presence of different cultures in the Middle East poses an immense risk of operational factors.

Lebanese Economy

Lebanon is a country in the Middle East situated in the Western Asia. The country borders Israel, Mediterranean Sea, and Syria. The economy of Lebanon is resilient due to its capability of withstanding invasions and wars with Israel. There has also been sectarian crisis in the internal operations with Syrian dominating influence. The resilience assisted Lebanon in achieving a growth of 9% during the financial crisis that hit the world. This growth was triggered by the regulations that existed in the banking sector. The restrictions on credit assisted in nurturing this growth and have a significant impact in the recession.

Entrepreneurial enterprise is prevalent among the urban population in Lebanon. Tourism as a sector is a significant contributor towards the growth of the economy in Lebanon. Lebanese economy has survived severe recession. The reconstruction effort that was put in rebuilding the economy of Lebanon after the war between Israel and Hezbollah assisted to a large extent in the performance of the economy. In the year 2010, the economy of Lebanon grew by 8% making the country’s economy the 18th fastest in terms of growth. The growth in the Lebanese economy has been relatively higher compared to the economic performance of other states in the Middle East. Lebanon is singled out as a major hub for economic growth within the region with well organization of the banking structure that assists in the growth of the economy. The increasing gross domestic product and the capability to withstand financial crisis are outstanding aspects of the Lebanese economy (Economy Watch, 2012).

The credit ratings in the international sphere have had much weight on the Lebanese economy. Most of the economies in the world continue to rely on Moody’s, Standard & Poor’s and Fitch in the grading of their investment risks. This has been so even after these rating agencies have recorded certain errors in their findings. The downgrading of three banks in Lebanon by Moody’s did not have any impact on the performance of the Lebanese economy. The downgrading never had any perceptible impact on the market.

According to the governor of Banque du Liban, the central bank in Lebanon, the ratings by these agencies had insignificant impact on the performance of the economy. According to him, the valuations do not purport any fundamental weaknesses regarding the performance of banks in Lebanon. The participants of the Lebanese markets have complete information and clear knowledge regarding the situation of banks in the economy. In this regard, they don’t depend on any ratings given by the international agencies in making their investment decisions. Salameh notes that, downgrading in Lebanon does not affect the operations of the banks. In comparison to the Western countries, the impact of credit rating in Lebanon is smaller. This is attributable to certain aspects possessed by the Lebanese banks. The trust that the population has in the banking sector is one of the factors that have kept the banking sector in a competitive position. The international investor base in Lebanon is small and, therefore, the international rating agencies do not have much impact on the commercial bank performance in Lebanon. There is also an increased sustained deposit in the banks that have helped them survive in harsh economic situations. Approximately 88% of funding in the Lebanese banking sector relies on the deposits by private sectors. In case the panic arises, banks rush to ensure their vast depositors of the market conditions. Thus, the relevance of bank ratings on Lebanon is nil (Tannous, 2012).

Commercial Banks in Lebanon

Lebanon enjoys a wide range of commercial bank services. This is attributable to the stability of the banking sector in the economy of Lebanon. The banks in Lebanon face competition from other established banks in the region. However, the stability of the Lebanese economy serves as the major driver for the better performance of commercial banks in the country and the region at large. Efficient resource allocation may be achieved if these banks increase their lending to the private sector that serves as the backbone in the existence of these institutions. The stability of the bank depends on various factors both internal and external. These factors also act as the major drivers in the performance of the banks in Lebanon. The banking industry in Lebanon is the most profitable institution countrywide. The report released by the central bank of Lebanon had this information (Finger & Hesse, 2009). The research was undertaken by the central bank and the banks within the region.

The countries that pose a threat to the performance of the banks in the country include its neighbors. The political unrests and the war in Israel and Syria are crucial hick ups in the performance of the banks in Lebanon. This is one of the factors affecting the performance of the banks in Lebanon. Economic conditions have a significant effect on commercial banks performance in this region. Lebanon enjoys a stable economy that is able to absorb shocks arising from financial crisis. Lebanon was in a position to improve its economic growth in the period of serious financial crisis. It was noted to be among the best in terms of increasing gross domestic product. This aspect of stability in the economy has facilitated the performance of the banking sector within the country ( Inderscience Enterprises Ltd, 2008).

Middle East is a mixed up economic zone. There exist different common cultures and beliefs within this region. There are various religions ranging from Christians to Muslims among others. The different religions and cultures possess different beliefs and ways of performing duties. They possess varied beliefs in terms of investor and, thus, tend to have varied investment sectors. The region has a wide concentration of Islamic banks. This region has the largest number of Islamic banking in the world. Recent trend indicate that the performance of Islamic banking sector is improving. There is increased number of Islamic banks being opened in the region. The growth of these banks poses competition to the growth of the Lebanese banking sector if it were to increase its operations across the borders. Competition arises as another factor that affects the performance of the commercial banks within the country of Lebanon. Its capability to survive in the competitive market is attributable to the policies and strategies employed by these banks.

The commercial banks in Lebanon had to overcome a lot of hurdles before eventually flourishing. In the year 1975 to 1990, there was a civil war in Lebanon. This had a devastating impact on the economy of Lebanon. There was a killing of labor force in the economy, while the other part fled for their safety. The system of free exchange rate kept the banking sector in the economy thrilling. The application of the strict secrecy law in the operations of the banking sector in the economy ensured that the banks remained on top in their performance record. The stringent laws worked well with the commercial banks (Shaher, Kasawneh, & Salem, 2011).

Foreign banks such as the bank of America and the Citibank withdrew their operations from Lebanon during the civil war. Commercial banks in Lebanon were able to survive this strife by employing several strategies that enhanced their survival. The economy was dollarized during this period of civil war and the banking customers preferred to keep their deposits in dollars. The support given to the commercial banks by the customers ensured their continued survival (Petersa, Raadb, & Sinkey, 2004).

The existence of banking institutions like the HSBC in the Middle East poses a formidable challenge to the performance of the commercial banks in Lebanon within the region. HSBC is a private bank in the Middle East and has been cited to be the best banking institution in Asia. The use of technological innovation by the HSBC bank enables it to have a wide reach in its operations. It has extended its operations to countries like Kuwait and Lebanon among others. The bank has also effected the automation of funds for easier accessibility by the customers. This institution is the only one dealing in United States Dollar-Settlement scheme in the United Arab Emirates. The competition posed by such institution within the region to the performance of commercial banks in Lebanon is significant (Global Finance, 2010).

Several factors affect the performance of commercial banks in the world. The existence of international rating agencies is a key aspect in influencing the performance of the economy and consequently that of the banking sector. The ratings serve to instill confidence among the investors. When the performance of a given institution is rated well, investors gain confidence in that institution and they make their investments with such institutions. The effect of ratings is not equally proportional in all countries. Ratings in countries like Lebanon do not have a significant effect in the performance of the banking sector. Other factors like the economic condition and the level of competition also have significant influence on the performance of banks alongside technology and political stability. This overview presents an insight regarding the performance of institution in the banking sector.