Whither the Credit Ratings Industry?

23 Pages Posted: 22 Apr 2011

See all articles by Pragyan Deb

Pragyan Deb

International Monetary Fund (IMF); London School of Economics & Political Science (LSE) - Financial Markets Group

Mark J. Manning

Bank of England

Gareth Murphy

Bank of England

Adrian Penalver

Bank of England

Aron Toth

University of Warwick - Department of Economics

Date Written: March 28, 2011

Abstract

Credit rating agencies originally emerged as private companies offering investors considered opinions on the credit quality of borrowers. But while they continue to perform this function, their role has expanded over time. Credit ratings are now heavily hardwired into financial contracts, investment processes, and the regulatory framework. Rating agency decisions therefore have potentially systemic consequences. Many policymakers and commentators have argued that the crisis was exacerbated by a combination of faulty ratings methodologies, conflicts of interest, and overreliance on ratings by banks, investors and regulators. Credit rating agencies have therefore come under close scrutiny in recent years and new legislation has been passed in both the United States and Europe that brings them further within the regulatory perimeter. This paper describes the current role of rating agencies, examines the failures observed during the crisis, and considers the public policy response. It argues that rating agencies perform a valuable role, but that the common and often mechanistic reliance on ratings for information, certification and regulatory purposes lies beneath many of the problems observed during the crisis. The policy priority should therefore be to reduce the scope of such reliance, but to the extent that CRAs nevertheless retain a strong influence in financial markets there may also be a case to consider structural measures to directly tackle potential conflicts of interest in the way in which ratings are produced.

Suggested Citation

Deb, Pragyan and Manning, Mark J. and Murphy, Gareth and Penalver, Adrian and Toth, Aron, Whither the Credit Ratings Industry? (March 28, 2011). Bank of England Financial Stability Paper No. 9, Available at SSRN: https://ssrn.com/abstract=1814999

Pragyan Deb

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

London School of Economics & Political Science (LSE) - Financial Markets Group ( email )

Houghton Street
London WC2A 2AE
United Kingdom

Mark J. Manning (Contact Author)

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Gareth Murphy

Bank of England

Threadneedle Street
London, EC2R 8AH
United Kingdom

Adrian Penalver

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

Aron Toth

University of Warwick - Department of Economics ( email )

Coventry CV4 7AL
United Kingdom

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