The Systemic Regulation of Credit Rating Agencies and Rated Markets

Credit ratings have contributed to the current financial crisis. Proposals to regulate credit rating agencies focus on micro-prudential issues and aim at reducing conflicts of interest and increasing transparency and competition. In contrast, this paper argues that macro-prudential regulation is necessary to address the systemic risk inherent to ratings. The paper illustrates how financial markets have increasingly relied on ratings. It shows how downgrades have led to systemic market losses and increased illiquidity. The paper suggests the use of ‘ratings maps’ and stress-tests to assess the systemic risk of ratings, and increased capital or liquidity buffers to manage such risk.

Are Debt Crises Adequately Defined?

Crises on external sovereign debt are typically defined as defaults. Such a definition adequately captures debt-servicing difficulties in the 1980s, a period of numerous defaults on bank loans. However, defining defaults as debt crises is problematic for the 1990s, when sovereign bond markets emerged. Not only were there very few defaults in the 1990s, but liquidity indicators do not play any role in explaining defaults in this period. In order to overcome the resulting dearth of data on defaults and capture the evolution of debt markets in the 1990s, we define debt crises as events occurring when either a country defaults or its bond spreads are above a critical threshold. We find that, when information from bond markets is included, standard indicators—solvency and liquidity measures, as well as macroeconomic control variables—are significant. IMF Staff Papers (2007) 54, 306–337. doi:10.1057/palgrave.imfsp.9450010