The Collapse Of An Empire? Rating Agency Reform In The Wake Of The 2007 Financial Crisis

In 1996, Thomas Friedman’s remarks echoed the sentiments of many. The rating agency business was booming, and it seemed like the agencies themselves could do no wrong

The new Basel accord and developing countries: problems and alternatives

The new Basel Accord framework relies on markets and supervisors to discipline banks. Yet both markets and supervisors fail, and more so in developing countries than in high-income countries. Therefore, the new Accord is not, as its designers claim, suitable for wide application. Nevertheless, developing country policymakers have little choice but to implement it in part or in whole. Hence there are problems of governance in international regulation. I offer seven general principles for the design of a prudential regime more robust to government and market failure. Four alternative capital regimes are evaluated in the light of these principles. Simpler and harsher regimes are likely to achieve greater safety with a given level of resources

When AAA Means B: The State of Credit Rating in India

As in many other countries, India five year old credit rating industry has grown rapidly amidst persistent doubts about the quality of the rating service. This paper evaluates the ratings given by India leading credit rating agency, CRISIL. We find that CRISIL ratings are not only too liberal by international standards but also internally inconsistent. We argue that to improve the quality of credit rating in India, there must be more competition; credit rating must be opened up to the private sector; and raters must provide unsolicited ratings.

The Determinants of Credit Ratings in the United Kingdom Insurance Industry

Executive Summary The Determinants of Credit Ratings in the United Kingdom Insurance Industry Academic researchers have devoted a considerable amount of attention to the activities of credit rating agencies over the past 20 years, focusing in particular on the agencies’ potential role in overseeing corporate financial strength and promoting the efficient operation of financial markets. Examinations of credit rating practices has recently extended to the insurance industry, where the complex technical nature of market transactions leads to policyholders, investors and others facing particularly acute information asymmetries at the point-of-sale. Published credit ratings are therefore seen as helping to alleviate imperfections in insurance markets by providing a third party opinion on the adequacy of an insurer’s financial health and the likelihood of it meeting obligations to policyholders and others in the future. Although the United Kingdom (UK) insurance market is now one of the five largest in the world, relatively little is known about the practices of the major firms and policy-makers which influence its operations. In particular, whilst the determinants of rating agencies’ assessments of United States (US) insurers is well documented, published studies have yet to provide comprehensive evidence about insurance company ratings in the UK. This study attempts to fill this gap by examining the ratings awarded by two of the world’s leading agencies – A.M. Best and Standard and Poor (S&P) – and establishing the extent to which organizational variables can help predict: (i) insurance firms’ decision to be rated; and (ii) the assigned ratings themselves. Our sample of UK data comprises ratings made by A.M. Best and S&P over the period 1993-1997 for both life and property-liability insurers. The panel data we use is ordinal in nature and is therefore analysed using an ordered probit model. However, because neither A.M. Best or S&P rate the full population of UK insurance firms our data set is potentially subject to selfselection bias and we therefore extend the model to correct for such problems. In particular, the paper examines the effect of eight firm-specific variables (namely, capital adequacy, profitability, liquidity, growth, size, mutual/stockowner status, reinsurance level, and short/long-term nature of business) on the ratings awarded by the two agencies, as well as on insurance firms’ decisions to volunteer for the ratings in the first place. In general terms, our evidence concurs with earlier US findings, and suggests that although the decision to be rated by either of the agencies is largely influenced by a common set of factors, the determinants of the ratings themselves appear to differ. Specifically, our first main finding is that insurers’ decisions to be rated by either A.M. Best or S&P is positively related to surplus growth, profitability and leverage. Second, while we find that A.M. Best’s ratings are positively linked to profitability and liquidity, as well as being generally higher for mutual insurers, the findings for S&P differ substantially. Although liquidity again exerted a positive influence on assigned ratings, the only other statistically significant variable was financial leverage, which had a negative sign. We believe that the results of our research are of potential importance for companies operating in insurance markets as well as for policy-makers, brokers and others. For example, the evidence that mutual insurers are generally assigned higher ratings than stock insurers suggests that certain publicly-traded insurers, in particular new entrants, might not possess sound financial strength and may require closer regulatory scrutiny than other, more established, insurance firms. In addition, the finding that liquidity has a significantly positive effect on ratings assigned by two of the world’s leading credit agencies should provide a measure of confidence about the robustness of the ratings to industry regulators, policyholders and investors in the UK. This could imply that external ratings might eventually play a role in substituting for costly industry regulation. The study concludes that although the factors influencing the decision to be rated by A.M. Best or S&P are broadly the same, a degree of variability exists in the variables which influence the actual ratings themselves. Insurance company managers should be aware of this when contemplating whether to seek an independent rating and which agency to choose for the assessment. We therefore believe that this study fills an important gap in the literature about key players in the important UK insurance market and provides a basis for the conduct of future research

CREDIT RATING AGENCIES AND THEIR POTENTIAL IMPACT ON DEVELOPING COUNTRIES

Credit rating agencies (CRAs) play a key role in financial markets by helping to reduce the informative asymmetry between lenders and investors, on one side, and issuers on the other side, about the creditworthiness of companies or countries. CRAs´ role has expanded with financial globalization and has received an additional boost from Basel II which incorporates the ratings of CRAs into the rules for setting weights for credit risk. Ratings tend to be sticky, lagging markets, and overreact when they do change. This overreaction may have aggravated financial crises in the recent past, contributing to financial instability and cross-country contagion. The recent bankruptcies of Enron, WorldCom, and Parmalat have prompted legislative scrutiny of the agencies. Criticism has been especially directed towards the high degree of concentration of the industry. Promotion of competition may require policy action at national and international level to encourage the establishment of new agencies and to channel business generated by new regulatory requirements in their direction.

The Optimal Regulation of Credit Rating Agencies

Credit rating agencies (CRAs) very often have been criticized for announcing inaccurate credit ratings and are suspected of being exposed to conflicts of interest. Despite these objections CRAs remained largely unregulated. Based on Pagano & Immordino (2007), we study the optimal regulation of CRAs in a model where rating quality is unobservable and enforcing regulation is costly. The model shows that minimum rating standards increase the social value of credit ratings. The model also analyzes implications for regulation in the presence of conflicts of interest between the CRA and the rated clients by direct bribes and by the joint provision of rating and consulting services

A Century of Bond Ratings as a Business

Historical accounting datasets about a leader of the bond rating industry have been gathered in order to provide an unprecedented long term view on this business. To better judge of the dynamics at play, similar data for representatives of older and broader business fields is also introduced. Overall, this empirical discussion plays down the importance of regulatory « licenses » given to bond rating firms and puts forward the coming of a « modern » business model where issuers pay for ratings.Industry study, bond ratings, financial regulation

Modelling the role of credit rating agencies : Do they spark off a virtuous circle?

In this paper, we propose a model of credit rating agencies using the global games framework to incorporate information and coordination problems. We introduce a refined utility function of a credit rating agency that, additional to reputation maximization, also embeds aspects of competition and feedback effects of the rating on the rated firms. Apart from hinting at explanations for several hypotheses with regard to agencies' optimal rating assessments, our model suggests that the existence of rating agencies may decrease the incidence of multiple equilibria. If investors have discretionary power over the precision of their private information, we can prove that public rating announcements and private information collection are complements rather than substitutes in order to secure uniqueness of equilibrium. In this respect, rating agencies may spark off a virtuous circle that increases the efficiency of the market outcome

Avoiding the rating bounce : why rating agencies are slow to react to new information

Rating agencies state that they take a rating action only when it is unlikely to be reversed shortly afterwards. Based on a formal representation of the rating process, I show that such a policy provides a good explanation for the empirical evidence: Rating changes occur relatively seldom, exhibit serial dependence, and lag changes in the issuers’ default risk. In terms of informational losses, avoiding rating reversals can be more harmful than monitoring credit quality only twice per year

Financial sector pro-cyclicality: lessons from the crisis

We analyze the main forces affecting financial system pro-cyclicality (the fact that developments in the financial sector can amplify business cycle fluctuations). We first review some major structural developments in financial markets that may influence pro-cyclicality and that have been overlooked in earlier analyses. We then examine three issues that are center stage in the current debate: capital regulation, accounting standards and managers’ incentives. After reviewing the institutional set-up and the key mechanisms at work, we critically examine a series of proposals designed to mitigate pro-cyclicality.pro-cyclicality, financial accelerator, capital requirements, leverage, accounting standards, incentives