Credit Rating Agencies: No Easy Regulatory Solutions
Editor's Note: This is the eighth in a series of policy briefs on the crisis—assessing the policy responses, shedding light on financial reforms currently under debate, and providing insights for emerging-market policy makers.
About the authors: Jonathan Katz is a consultant and former secretary of the U.S. Securities and Exchange Commission. Emanuel Salinas is a senior investment officer at the Multilateral Investment Guarantee Agency (MIGA) of the World Bank Group. Constantinos Stephanou is a senior financial economist in the Financial and Private Sector Development Vice Presidency of the World Bank Group.
In the United States and Europe faulty credit ratings and flawed rating processes are widely perceived as being among the key contributors to the global financial crisis. That has brought them under intense scrutiny and led to proposals for radical reforms. The ongoing debate, while centered in major developed markets, will also influence policy choices in emerging economies: whether to focus on strengthening the reliability of ratings or on creating alternative mechanisms and institutions that can perform more effectively the role that in developed markets has traditionally been conferred on credit rating agencies.
Click here to view the policy brief in its entirety.
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Yes clearly the mistakes by the credit rating agencies, which had to happen, sooner or later, acted as the detonators of the current crisis. That said it would be wrong to focus too much on the credit rating agencies, instead of on the wrong use regulators are giving to the ratings.
Let me summarize in a couple of paragraphs what I have tried to argue over the years… with little luck until now.
When banks lend to an AAA rated corporation they are required to hold 1.6 percent capital while if they lend to an unrated entrepreneur they need 8 percent. The difference of 6.4 percent and if the cost of capital for banks is 15 percent it adds up to about one percent year. This one percent represents a regulatory tax on perceived risk, and which has to be added on to what the market already charges in premiums for perceived risks.
Knowing as we do that there is no other way to create real jobs than allowing risk-takers to take risk, or that risk-taking is the oxygen of any development, is this then a tax we can afford?
Absolutely not! And besides capital requirements based on perceptions of risk totally confuse the market.
Again, I dare the World Bank to become the champion of prudent risk-taking instead of staying in the ranks of those like the Basel Committee and the IMF who have been pushing for what I consider is an absolutely imprudent and extremely risky risk-aversion.
http://financefordevelopment.blogspot.com/
Posted by: Per Kurowski | Oct 7, 2009 4:36:00 PM