Abolishing Credit Rating Agencies is Not an Option
Despite widespread criticism for poor performance prior to the subprime mortgage crisis, the credit rating agencies remain an integral part of the financial markets, and should remain so, according to a paper from the Bank of England (not official bank policy).
Excerpts from Whither the credit ratings industry? (Complimentary)
Abolishing CRAs is not an option. Other gatekeepers would emerge to fill the void with their own ratings-like research and advice. Subsuming their role into a single public rating agency would also be fraught with difficulty: it would create false expectations, moral hazard and obstacles to innovation.
Reversing the hardwiring is challenging, but recent US legislation and the FSB’s publication of Principles for Reducing Reliance on CRA Ratings constitute an important first step. Greater transparency in issuers’ financial information and improvements in financial firms’ capacity for internal assessment are pre-requisites for reducing reliance on ratings. Since such improvements will take time, it is important that the momentum behind recent initiatives is maintained.
If reliance on ratings for the various certification and regulatory roles were reduced, CRA ratings could continue to perform their core information function without giving rise to cliff effects and incentive problems.
But even if the hardwiring of CRA ratings into regulation and certification were reduced, CRAs are sure to retain an important information role in financial markets.
Recent enhancements to regulation of CRAs, and steps to improve their governance, transparency and accountability should help to manage any adverse consequences of the influence CRAs have. But there may be a case for structural reform — at least in the structured finance segment of the market — to tackle conflicts of interest. This paper therefore also encourages deeper debate on how CRAs’ business models might be modified or replaced to meet the legitimate market demand for unbiased credit opinions.
Meanwhile the Financial Times notes that according to a recent SEC study, 97% of all credit ratings are issued by Fitch, Moody’s and Standard&Poor’s.
You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.
