Analyzing the Impact of Credit Ratings on Borrowing Costs and Investment Decisions

Abstract

This internship explores the critical role of credit ratings in financial markets, emphasizing their influence on borrowing costs and investment decisions. Credit ratings, issued by agencies such as Moody's, Standard & Poor’s, and Fitch, are essential indicators of creditworthiness, shaping investor perception, risk assessment, and capital allocation. The research highlights that higher credit ratings significantly lower borrowing costs for corporations and sovereign entities, while downgrades lead to higher yields and restricted market access. It also examines the evolution of global capital adequacy standards. Since Basel I (1988), increasing financial globalization and innovation have demanded more flexible frameworks. Basel II (2004) introduced a dynamic, risk-sensitive approach, allowing institutions to assess their own risks under strict regulatory supervision and disclosure requirements. This shift represents a transformation toward "standardization with flexibility." In Bangladesh, the transition from Basel I to Basel II began in 2009-10. The Bangladesh Bank raised the minimum capital requirement to 10% of risk-weighted assets, up from 8%. Analysis of 25 listed private commercial banks shows that higher capital requirements positively influence bank profitability, countering the traditional view that capital and profitability are negatively correlated. Additionally, the study examines how institutional and retail investors rely on credit ratings for portfolio construction, risk management, and regulatory compliance. It acknowledges the limitations and conflicts of interest within the credit rating industry, stressing the need for transparency, regulatory oversight, and methodological rigor. By combining quantitative analysis with case studies, this research deepens the understanding of credit ratings as a central mechanism in global finance, offering valuable insights for policymakers, investors, and corporate managers navigating the interplay between ratings, risk, and returns.