27/10 Regulators Push Banks to Limit Reliance on Credit Ratings

By JACK EWING
Published: October 27, 2010

FRANKFURT — Banks and institutional investors should break their dependency on credit rating agencies and take more responsibility for assessing the quality of the debt that they buy, a panel that is rewriting global rules on risk said Wednesday.

The Financial Stability Board, which was created by members of the G-20 to work on ways to avoid future financial crises, said in a report that overreliance on credit ratings had contributed to the financial crisis, as downgrades of certain debt issuers provoked market stampedes.

The main credit rating agencies — Standard & Poor’s, Moody’s and Fitch Ratings — have faced sharp criticism for assigning high ratings to subprime mortgages and other assets that later declined drastically in value. During Europe’s sovereign debt crisis, downgrades of debt issued by countries like Greece or Portugal helped prompt sell-offs of their government bonds and contributed to market turmoil.

Large banks should be required to supplement the work of ratings agencies by doing their own research, the F.S.B. said, and they should disclose what methodology they use. Regulators, in turn, should make sure that banks are not underestimating risks.

“Larger, more sophisticated banks within each jurisdiction should be expected to assess the credit risk of everything they hold,” the F.S.B. said.

However, the panel acknowledged that it would take institutions some time to build up the capability to better scrutinize debt, and set no deadline. “Changes in market practices cannot happen overnight,” the F.S.B. said.

Based in Basel, Switzerland, the F.S.B. cooperates with the Basel Committee on Banking Supervision to establish global rules governing finance. The F.S.B. chairman is Mario Draghi, governor of the Bank of Italy and a member of the European Central Bank’s Governing Council.
G-20 finance ministers and central bank governors endorsed the F.S.B.’s findings last week when they met in South Korea, the panel said.

The F.S.B. said that regulators and central bankers had contributed to the system’s dependence on credit ratings by “hard-wiring” their verdicts into laws and regulations. Central banks should, for example, avoid using credit ratings as the sole criterion for determining what kind of debt they accept from banks as collateral for loans, the F.S.B. said

The F.S.B. acknowledged that smaller banks might not have the resources to assess every investment. But if that is the case, then they should disclose how much they have depended on ratings agencies, the F.S.B. said. Regulators should consider setting limits on the percentage of assets that banks or institutional investors could hold for which they had not assessed the quality themselves, the panel said.

In addition, debt issuers should release more information so that investors were in a better position to make their own judgements. “In some cases, investors have weaker access to issuer information than C.R.A.s,” the F.S.B. said, referring to credit ratings agencies, “thus adding to their reliance on C.R.A. ratings.”