This week, an article in the Financial Times drew my attention for its critical perspective on the potentially problematic role of credit rating agencies in assessing private credit risk. The piece raises fundamental questions that reach far beyond the mechanics of credit scoring; it touches on an essential pillar of modern market economies: trust.
Trust is a cornerstone of capitalist activity. Commercial exchanges – whether simple transactions or complex multi-party deals – can only take place when all sides believe in the reliability, capability, and integrity of their counterparties. For entrepreneurs, the absence of trust dramatically increases friction. If you cannot rely on a supplier to deliver the agreed quantity or quality of goods, or if you doubt a customer’s willingness or ability to pay on time, even the most compelling business model becomes difficult, if not impossible, to scale. Trust ensures predictability – and predictability is the oxygen of economic activity.
This principle applies equally to financing decisions. When an individual applies for a mortgage, the lending institution must gain comfort regarding repayment capacity and, in the event of default, the recoverability of the outstanding balance – typically achieved by repossessing and selling the property. These data points shape not only the loan decision but also the pricing structure. The stronger the borrower’s profile, the more competitive the interest rate. Remove trust from this equation and the entire mortgage market grinds to a halt, taking with it a substantial portion of private real estate transactions.
In the corporate world, and particularly in private markets, the same dynamic holds. For example, when a private equity fund seeks to acquire a company, leverage plays a central role in structuring the transaction. Debt providers, whether banks, pension funds, insurers, or specialized credit funds, assess the risk-return profile using the same basic logic: the more resilient the target company, the more manageable the debt load, and the more robust the transaction appears. This directly influences the pricing and terms extended to the acquirer. A substantial part of LBO financial engineering consists precisely of optimizing leverage levels to maximize equity returns without compromising the long-term viability of the underlying business.
As financial products grow more complex, issuers of debt (those seeking to raise capital) turn to supposedly independent credit rating agencies to evaluate the risk embedded in the underlying assets. This practice provides efficiency: potential lenders are spared the burden of independently dissecting, for example, every asset in a securitized portfolio. Well-known agencies such as Moody’s, Fitch, and S&P have long shaped global perceptions of sovereign and corporate creditworthiness. In recent years, new entrants, including Egan-Jones, JBRA, and HR Ratings, have emerged, seeking to capture a share of a rapidly expanding market.
However, in the race to attract clients, rating agencies can compete not only on price and service quality, but also (more problematically) on the generosity of the ratings they assign. This competitive tension, as highlighted by the Financial Times, introduces a structural conflict of interest: issuers pay for the very ratings that investors rely on to guide capital allocation. When agencies become “accommodating,” the reliability of their assessments becomes compromised.
Compounding this concern are questions surrounding the relentless pursuit of profitability in a sector where analytical precision should remain paramount. The FT article underlines, for instance, the remarkably high output of analysts at Egan-Jones, who reportedly produce an average of 250 ratings per year, compared with fewer than 40 at Moody’s or Fitch. Such extraordinary productivity raises legitimate concerns: speed, in this context, may very well come at the expense of rigor. Insufficient due diligence does not merely distort individual transactions: it introduces systemic risk.
When the compass used by rating agencies begins to deviate, the integrity of the entire financial system is jeopardized. An overly generous rating leads lenders to underestimate the true risk of the instruments they finance. As a result, they may allocate insufficient capital buffers to absorb potential losses. Because lenders often borrow themselves to fund their positions, a mispricing at one point in the chain can cascade across the system. The repercussions extend far beyond financial institutions.
Take pension funds as an example. These long-term stewards of retirement capital rely heavily on rating agencies to evaluate whether an asset is appropriate for portfolios that must preserve capital and ensure stable returns. If instruments considered “ultra-safe” are, in reality, riskier than advertised, the impact on future retirees could be substantial. A misjudgment at the rating level thus transforms into a social issue with long-lasting consequences.
These risks are not unprecedented. Roughly twenty years ago, the U.S. financial sector suffered deeply from widespread misjudgments of risk in the real estate market. Market participants, overwhelmed by the complexity of structured products and seduced by illusory promises of high yet “safe” returns, funneled billions into a towering edifice of debt that ultimately collapsed. The resulting subprime mortgage crisis ranks among the most severe economic shocks of the modern era, with global spillovers that took years to unwind.
Against this backdrop, the concerns raised today about private credit should not be taken lightly. Behind what may initially appear as an esoteric discussion lies a genuine threat to the opaque but booming private credit market, now estimated at roughly USD 3 trillion. Weaknesses in rating practices could carry significant implications for financial stability, investor protection, and broader economic resilience.
Regulators around the world have begun to acknowledge these vulnerabilities and are increasingly vocal about the need for enhanced oversight. Yet the question remains: are these warnings arriving early enough to prevent emerging risks from materializing, or are we once again reacting to structural tensions only after they have taken root?