Ratings agencies must be tightly supervised, says IMF

Sovereign credit ratings have inadvertently contributed to financial instability,according to the IM

By New Statesman Published 30 September 2010

Credit ratings agencies must be more tightly supervised as they can influence financial stability, says the IMF in its half-yearly Financial Stability Report to be released next week.

According to the BBC, ratings agencies have been foregrounded due to the downgrades they imposed on weakened sovereign balance sheets such as that of Greece and Ireland.

Sovereign credit ratings have inadvertently contributed to financial instability, said the IMF, noting that downgrades can result in destabilising "knock-on and spillover effects" in financial markets.

Ratings agencies have been found to exercise influence on fund managers on the question of which bonds to hold, with a downgrade pushing them to selling government bonds or refusing to buy newly issued ones. This causes a fall in the price of bonds and increases borrowing costs, thereby making further downgrades theoretically possible.

The IMF report particularly singled out Moody's, Fitch and Standard and Poor's as those agencies with global scope.

The report recommends that policymakers reduce dependence on credit ratings as much as possible.

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1 comment

Thu, 2010-09-30 14:55 — Per Kurowski (not verified)

To reform financial regulations we need to reform in depth the Basel Committee.

In May 2003, as an Executive Director of the World Bank, I told those many present at a risk management workshop for regulators the following with respect to the role of the Credit Rating Agencies. “I simply cannot understand how a world that preaches the value of the invisible hand of millions of market agents can then go out and delegate so much regulatory power to a limited number of human and very fallible credit-rating agencies. This sure must be setting us up for the mother of all systemic errors.” And this I repeated over and over again, even in the press.

Now the IMF is finally admitting “Policy makers should continue their efforts to reduce their own reliance on credit ratings, and wherever possible remove or replace references to ratings in laws and regulations, and in central bank collateral policies”

That is good, better late than never. But the real question has to be why on earth it had to take a financial crisis of monstrous proportions to reach a conclusion that should have been apparent to any regulator from the very beginning.

I saw it happen and I know why it happened. As I wrote in a letter published in the Financial Times in November 2004, it was the result of the whole debate about bank regulations being sequestered by the members of a small mutual admiration club.

If there is now something even more important than rectifying the faulty financial regulations, that is to break up the Basel Committee and make absolutely sure it represents a much more diversified group of thinkers. That would have at least guaranteed that the basic question of what the purpose of the banks should be would have been put in the forefront before regulating them. Current regulations do not contain one word about that.

Besides me there were not too many but still plenty of experts who raised the question of whether the credit rating agencies should have such a prominent role. These persons should participate in designing and putting in place the needed reforms. It is simply unacceptable that these reforms with huge global implications are implemented exclusively by Monday morning quarterbacks.

Per Kurowski
A former Executive Director at the World Bank (2002-2004)
http://subprimeregulations.blogspot.com/