Africa’s New Credit Rating Agency: Transforming Financial Evaluation

For governments, a credit rating is not merely a financial metric; it embodies a verdict that can influence borrowing expenses, market accessibility, and ultimately, the ability to support their populations.

Rating decisions are conducted away from public view in a process that lacks transparency and accountability. This obscurity can be particularly harmful to African countries.

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When rating decisions are not transparent, it becomes challenging to challenge possible biases or inconsistencies in the methodologies that disadvantage developing economies. As a result, this leads to higher borrowing costs that divert funds away from healthcare, education, and infrastructure development.

Africa’s emerging credit rating agency has the potential to reshape this environment. The African Credit Rating Agency is being established by the African Union and its partners.

This initiative signifies more than just a new contender in the field; it seeks to reimagine how financial authority is obtained, exercised, and scrutinized.

The new agency aims to implement transparent governance frameworks that could transform rating methodologies.

As a researcher who has extensively examined the operations of rating agencies, I believe this opportunity to enhance transparency in financial governance extends beyond merely refining ratings; it marks a step towards economic independence.

The effectiveness of the African Credit Rating Agency shouldn’t only be evaluated based on its capacity to rival the “big three” rating agencies (Standard & Poor’s, Moody’s, and Fitch). The pivotal question is not whether an African agency can compete but if it can introduce a new way to assess credit ratings globally.

An Imperfect Process

The three major agencies do provide their methodologies—criteria and risk models—which creates an illusion of transparency. However, the final judgments stem from committee meetings that leave no public record, accountability, or genuine right of appeal.

These rating committees typically consist of five to ten analysts who meet privately to determine each sovereign rating. S&P, Moody’s, and Fitch have internal rating committees for every sovereign assessment. Deliberations, dissenting opinions, and the reasons behind final votes remain confidential. Only a brief summary is provided with any rating decision.

Research indicates that credit rating agencies are more proficient at assessing the creditworthiness of advanced economies than that of developing nations. Studies have also investigated discrepancies between the expected outcomes from public methodologies and the actual ratings assigned. While such research has been conducted in places like Hong Kong and China, no parallel examinations have been performed for African sovereigns.

This gap highlights an accountability shortfall. When expectations based on methodology fail, we must scrutinize the activities within these committee rooms, especially when African countries are evaluated by analysts located thousands of miles away, often lacking a thorough understanding of local economic and political conditions.

The African Credit Rating Agency could implement three significant changes to the rating process:

• Conducting public deliberations
• Forming hybrid committees
• Utilizing technological advancements

Firstly, it could release committee transcripts within 30 days of each decision, granting markets and governments unprecedented insight into rating rationales. This approach is not radical—central banks already issue meeting minutes, and courts provide opinions including dissenting views.

Secondly, it could create panels that involve not just rating analysts, but also regional economists, sector specialists, and even civil society representatives, all taking recorded votes. This diversity of expertise would challenge “group think” while shedding light on the complexities of African economies often overlooked by traditional agencies.

I have explored this idea from the perspective of integrating climate and sustainability-related expertise into credit rating committees, a crucial advance for evolving the structure of the credit rating committee.

Thirdly, the agency could employ artificial intelligence to analyze patterns within committee discussions, identifying possible regional biases or inconsistent application of methodologies. It could also utilize secure digital ledgers to create immutable records of decisions.

Why the Big Three Maintain Secrecy

The industry relies heavily on confidentiality, safeguarding proprietary methodologies and shielding decisions from external scrutiny. This natural oligopoly (a market dominated by a few major players due to high entry barriers, supported by a market preference for predictability) helps maintain the status quo.

The sovereign credit ratings from the three leading agencies are based on both quantitative and qualitative factors. Yet research shows that these sovereign ratings are heavily affected by qualitative judgments, disadvantaging developing economies when agencies display pro-Western biases arising from a lack of data or expertise.

The consequences of a credit rating downgrade for a sovereign borrower can be complex. Studies reveal that a single-notch downgrade can raise borrowing costs by over 100 basis points, resulting in an additional US$100 million annually on a US$10 billion bond.

Investors prefer fewer, stronger signals over multiple competing perspectives.

Thus, there is little incentive for established players to embrace change. The African Credit Rating Agency, as a newcomer, can provide governance innovations that benefit both markets and nations.

Radical transparency may initially unsettle markets. Committee members might encounter political pressures. Yet, transparency alone does not ensure equitable outcomes.

However, the world demands transparency from central banks and constitutional courts. Why should we accept anything less from institutions that dictate sovereign fates?

Future Directions

By 2050, one in four people on Earth will be African. The financial frameworks serving them must evolve to acknowledge the continent’s unique strengths.

Opening the rating committee for scrutiny represents more than just a procedural change; it’s about reshaping who holds power in global finance. If it achieves this, the African agency will not only deliver better ratings but also exemplify how global finance can be governed more equitably.

Daniel Cash, Reader in Law, Aston University

This article is republished from The Conversation under a Creative Commons licence. Read the original article.